Reprice (Stock Options) - Explained
What is Repricing Stock Options?
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Table of ContentsWhat does it mean to Reprice Stock Options?How Does Repricing Stock Options Work? Academic Research on Repricing Stock Options
What does it mean to Reprice Stock Options?
Repricing is a strategy of replacing the worthless stock options held by employees with new options. Companies use this strategy to deal with underwater stock options. Underwater stock options are those whose exercise price exceeds the fair market value of the underlying stock.
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How Does Repricing Stock Options Work?
Repricing became popular during the internet bubble burst in 2000 and then again during the economic crisis in 2008. Traditionally, many companies rely on stock options to attract, retain, and incentivize their valued employees.
Repricing allows the companies to retain those employees during the economic crisis by taking back the worthless stocks and issuing new ones having intrinsic value.
Repricing becomes necessary during the economic crisis as the price of the stocks experience a sharp decline and employee stock options become worthless. Otherwise, the employees may take up a new employment with another company. In such situations, the companies often tweak their incentive program and grant restricted stocks instead of stock options.
Others might issue stocks that can be converted into shares immediately avoiding any future risks. The board of directors of a company has the authority to make decisions regarding repricing stock options, as it is a matter of corporate governance. Repricing directly affects all the existing shareholders. Repricing increases the option expenses which must be deducted from net income.
The strike price of the newly issued stocks must be based on the current fair market value of the underlying stocks to avoid a tax consequence to the employee recipient. According to the rules of the Financial Accounting Standards Board (FASB), if the new stocks are issued more than six months after the cancelation of an existing stock, it is not a repricing.
Companies may avoid variable accounting treatment by following this. In such cases, the employees get assurance from the company that they will be granted new stocks after that period of time. The companies may also swap the worthless stocks of the employees with restricted stocks. Another approach of dealing with this issue is called a makeup grant. In this case, the company keeps the original options in place and issues additional stock options for the employees.
This tactic puts the existing shareholders at risk of additional dilution. If a future hike in stock price puts the original underwater stocks back in money, then that would lead to further dilution of existing shareholders. The management of a company needs to make the decision of opting for any of these approaches with utmost care and caution avoiding any further risk.
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