Stock Option Repricing in the Context of Executive Compensation

Abstract

Firms that reprice executive stock options typically defend this practice as a policy that is needed to restore managerial incentives. Shareholder protection groups, however, argue that this policy unfairly rewards managers for poor performance while shareholders do not participate in similar practices. Repricing is seen as extracting rents from shareholders. I argue that this criticism is flawed because it abstracts from the cost of pay increases to managers not holding repriced options who are instead of repricing underwater options compensated by increases in other pay components. Since options have become an important part of executive compensation managerial pay is more sensitive towards the performance of the underlying stock. When stock prices decline the value of equity based pay in the compensation package erodes. Companies are then in need to reprice options or increase other components to compensate for the loss. Then the cost of repricing should be compared to the cost of otherwise adjusting the pay package. In the analyses here I find that repricing is no more expensive to shareholders than otherwise adjusting compensation components.