What Is a Reprice?
A reprice is a situation involving the exchange of worthless employee stock options for new options that do have intrinsic value. This is a common practice for companies to keep or incentivize executives and other highly valued employees when the value of the company's shares falls below the exercise price, or break-even point for the options issued in the original incentive program.
- Repricing occurs when a company retires employee stock options that have become quite out-of-the-money with new options that have a lower strike price.
- This is done when a company's share price falls well below the exercise price of the original employee stock options issue.
- By repricing, the company effectively replaces now-worthless options with those that have value in order to keep top managers or key employees.
- Repricing may have tax implications for both the issuing firm and recipients.
Understanding a Reprice
While repricing is not new, it became a common event after the Internet bubble burst in 2000 and again following the financial crisis of 2008-09 as many stock prices experienced a deep bear market. As company share prices dropped sharply, employee stock options found themselves underwater, meaning that their strike prices rose above current market prices. For instance, a company may have issued employee stock options that could be exercised at $30 after a vesting period, when the shares were trading at $35. This option effectively granted holders the right to buy shares at $30 regardless of the market price in the future. However, nobody will agree to buy the stock at $30 if it falls to $25 a share in the open market.
This, in effect, is equivalent to a standard option being out-of-the-money (OTM). Therefore, to retain and incentivize executives and highly valued employees, companies essentially took back the worthless stock options and issued new options. The newer options would likely be struck near or just below the current price of the share price.
This is an important issue as many valued employees agreed to substantial pay cuts from previous jobs when joining new companies. This is true, especially for start-ups. The hope is that the employee will make up the difference many times over as the company's stock price increases.
Tax and Reporting Issues
Some companies changed their incentive programs to grant restricted stock instead of stock options. Others, issued options that converted immediately into shares to eliminate uncertainty in the future. Which route the company takes depends on the tax and reporting issues unique to it. Repricing will increase the option expenses a firm must deduct from net income.
Also, the new stock options granted must use the current fair market value of the underlying stock as their "strike." For privately held companies, the board of directors must determine a new value on the common stock of the company and that directly impacts all existing shareholders.
Under the Financial Accounting Standards Board (FASB) rules, when the company cancels an existing stock option and grants a new option "six months and a day" later it is technically not a reprice. Therefore, it avoids variable accounting treatment. For that period of time between cancellation and new granting, the employee only has a promise that they will get the new options.
Another approach, called a “restricted stock swap,” the company cancels the underwater (worthless) stock options and replaces them with actual restricted stock.
Finally, the company may issue additional stock options, leaving the original options in place. This is called a “make-up grant.” This does put existing shareholders at the risk of additional dilution should the stock price surge, putting the original underwater options back in the money.