Characteristics of Firms Responding to Underwater Employee Stock Options

Download or read book Characteristics of Firms Responding to Underwater Employee Stock Options written by Valentina L. Zamora and published by . This book was released on 2008 with total page pages. Available in PDF, EPUB and Kindle. Book excerpt: I examine the characteristics of firms choosing to respond to underwater employee stock options using one of three stock option-based responses. A traditional repricing offers a new and lower exercise price to restore the incentive alignment and retention power lost in underwater options but is subject to potential expense recognition. A 6amp;1 exchange likewise restores what was lost in underwater options but avoids potential expense recognition by delaying the issuance of replacement options until six months and one day later. A makeup grant potentially increases the total option value lost and avoids potential expense recognition, but is more dilutive since old underwater options are not cancelled. Results indicate that makeup grant firms have relatively deeper underwater options with shorter expected remaining lives. Makeup grant firms also issue these options to more non-executives compared to traditional repricing firms. I also find that while both makeup grant and 6amp;1 exchange firms have less insider ownership and historically report positive income than traditional repricings, 6amp;1 exchange firms have greater overhang than makeup grant firms. Taken together, a possible explanation for these results is that firms that have more incentive alignment and/or retention power lost in underwater options prefer makeup grants that potentially increase total option value for its non-executive optionholders. However, when dilution from options is also a concern, it appears these firms may opt for a 6amp;1 exchange. In addition, it is possible that the choice of response is associated more with the desire to avoid recognizing option expense, rather than with potential rent extraction opportunities, as critics claim.