Repricing stock options accounting

When the stock price of Brocade Communications Systems, a fast-growing publicly held computer networking equipment maker based in San Jose, Calif. But it did not fall equally on all investors. Like a significant number of other companies in similar situations, Brocade protected one class of investors — employees with stock options whose strike, or exercise price, had fallen below the market value — by simply issuing new stock options at the market price, effectively restoring their value.

The company said that by doing so, it could retain talented employees who might otherwise jump ship. A paper written by Wharton accounting professor Mary Ellen Carter and Luann J. Lynch, a professor at the Darden Graduate School of Business, examines the relationship between repricing underwater stock options and retaining employees.

The results indicate that although repricing underwater stock options does not appear to affect executive turnover, evidence shows that overall employee turnover decreases significantly in repricing firms. Interestingly enough, the relationship of repricing to retention appears to hold up across industries. The results are valid for both large and small firms, she added in a recent telephone interview.

While reviewing her study, one question naturally comes to mind: Are her results still relevant? After all, in through the economy was still expanding and companies were worried about finding workers, not shedding them. First, it may be even more important to retain good employees when the economy is bad since they are the ones that will help the firm get through it.

Second, even in , firms continue to reprice stock options, and the stated reason is still because of retention. Potential Windfall, or Worthless Piece of Paper?

Stock options are basically a promise made by a company to offer a number of its shares at a set price, for a set period of time. However, the effectiveness of options for retention can decrease substantially if the option sinks underwater.

The cause-and-effect relationship appears to be fairly straightforward. But in fact, the strategy of repricing underwater options has along with the larger issue of stock option-based compensation generated significant controversy.

Companies, however, characterize such action as an investment in the long-term health of the enterprise, saying repricing is necessary to retain talented employees during lean times.

According to recent surveys, turnover is expensive for firms, says Carter. So despite the controversy, repricing underwater options may in fact conserve funds by giving employees a stake in their current company. A Controversial Strategy Gains Momentum Either way, the practice appears to be gaining ground.

According to the Investor Responsibility Research Center, a Washington, D. By the end of February , 26 companies had already announced employee-option-repricing plans; and up to companies are expected to announce such plans this year, according to a Center spokesman.

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Meanwhile, if new rules proposed by the New York Stock Exchange NYSE and under consideration by the Securities and Exchange Commission SEC are adopted, those companies might have to do a bit more explaining to their shareholders.

According to the commentary that accompanies the proposed rule, a provision that prohibits repricing of options — or any revision that deletes or limits the scope of such a provision — would generally require a shareholder vote. Further, if a plan does not contain a provision that specifically permits repricing of options, the plan will be considered for this purpose to prohibit repricing, and any actual repricing of options will also generally trigger a shareholder vote with some exceptions.

So far, management has usually been able to initiate option repricing without shareholder approval. No one can predict, with certainty, what will happen to repricing if a shareholder vote is required.

But investor sentiment, which is traced by the Investor Responsibility Research Center, may provide a clue.

Does Repricing Stock Options Work?

Mark Neagle, a partner at the national office of PricewaterhouseCoopers in Florham Park, N. In any case, he adds, the overall issue of stock options could shift if the Financial Accounting Standards Board FASB adopts a rule currently under consideration that would require companies to recognize the value of compensation-based stock options as an expense on the income statement. Currently, businesses can limit the reporting of these charges to footnote disclosure.

Returning to the overall issue of repricing underwater options, Carter says that, regardless of its merits, the strategy may generate its own conflicts. If they are, then the benefit of repricing to retain employees may exceed the cost of the negative publicity.

Perhaps the controversy over repricing stock options was to be expected in the wake of Enron and other debacles, at a time when the stock market seems mired in a slow-performance phase, and as investors, regulators and the general public call for greater transparency in corporate transactions.

Stock Option Repricing: Employees Benefit But What about Investors? - Knowledge@Wharton

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Repricing “Underwater” Stock Options

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