Reprice Options

Repricing options (also known as an 'option exchange' or 'option reset') is the corporate practice of lowering the strike price of previously granted stock options. This typically happens after a company's stock price has fallen significantly, rendering the original options worthless or “underwater.” The strike price is the pre-set price at which an employee can buy the company's stock. If the current market price is below the strike price, the options have no immediate value, and the employee can't profit from them. By lowering the strike price to a level at or near the current market price, a company’s Board of Directors attempts to restore the options’ value as a tool for executive compensation and employee retention. While it can be a way to keep key talent motivated, the practice is highly controversial among investors.

The primary argument for repricing options is talent retention. Stock options are a major component of compensation, especially in technology and growth-oriented industries. They are designed to align the interests of employees with those of shareholders—if the company does well and the stock price rises, everyone wins. However, when options become underwater options, they lose their power as an incentive. An option to buy a stock at €50 is useless if the stock is currently trading at €20. The company argues that without a “reset,” key employees might lose motivation or, worse, leave for a competitor where they can receive a fresh, more valuable compensation package. From the board's perspective, repricing existing options can seem more straightforward and less expensive than designing a whole new retention bonus plan from scratch.

For investors, especially those following a value investing philosophy, option repricing often looks like a “heads I win, tails we reset the game” scenario for management. It can be seen as a reward for failure, insulating executives from the very downside risk that ordinary shareholders must endure.

When a stock price plummets due to poor management decisions, a subsequent option repricing can feel like a slap in the face to shareholders. It effectively erases the financial consequences of poor performance for the management team, while shareholders are left holding the bag. This creates a moral hazard: if executives know their options will be repriced if the stock tanks, they may be encouraged to take excessive risks, knowing they are shielded from the personal financial fallout.

Resetting options at a lower strike price makes them more likely to be exercised in the future. When these options are exercised, the company issues new shares, which increases the total number of shares outstanding. This increase results in dilution, meaning each existing share now represents a smaller percentage of ownership in the company, potentially reducing shareholder value. Essentially, shareholders pay for this “do-over” through the dilution of their own stake.

Not all option repricing is created equal. While it should always be viewed with skepticism, there are situations where it might be less damaging. Before drawing a conclusion, an investor should investigate the details, which are typically found in a company's proxy statement. Here are a few questions to ask:

• What caused the stock to fall? Was it a broad market crash that dragged down all stocks, or was it due to specific company missteps? Repricing is more defensible in the former case.
• Who is benefitting? Is it a narrow repricing for a few top executives, or is it a broad-based program for a wide range of employees, including valuable engineers or scientists? The latter is often more palatable.
• Are there new strings attached? This is critical. A responsible board won't just hand out a lower strike price for free. They should demand concessions in return, such as:
  1. A longer vesting period, requiring the employee to stay with the company longer.
  2. The addition of performance hurdles that must be met before the options can be exercised.
  3. A “value-for-value” exchange, where employees must trade in a larger number of old options to receive a smaller number of new ones.
• Was there a shareholder vote? Companies that put the repricing plan to a shareholder vote are showing a commitment to transparency and good corporate governance. Companies that do it without shareholder approval should be viewed with extra suspicion.