What Is a Reprice?
A reprice is a situation involving the exchange of worthless employee stock options for new options that 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 break-even point for the original incentive program.
Understanding a Reprice
While repricing is not new, it became a common event after the Internet bubble burst in 2000 and again after the financial crisis in 2008 as the stocks suffered a bear market. As company stock prices dropped sharply, employee stock options became underwater, meaning their strike prices were above current share prices. This is similar to a standard option being out-of-the money (OTM). Therefore, to keep 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 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 he or she 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.