Articles

Repricing Stock Options Should Not Be Tolerated

Monday, September 3, 2001
by Marc J. Lane

Reprint permission from the September 3, 2001 issue of Crain's Chicago Business.

When it looked like the Nasdaq would never give ground, new economy companies aggressively relied on stock options to lure their top managers away from traditional firms. And since tech stocks started their free-fall, too many optionnaires have been rewarded for bad performance by boards that "reprice" their options.

Doing what it takes to recruit and retain talented managers is good business. But when stock values tank, boards sometimes run scared. They fear that key managers will bolt and their companies will lock into an irreversible death spiral.

When a stock's price falls below an option's exercise price, a board may see no way out but to lower the exercise price and keep management happy, motivated and employed at the firm.

And the board will defend repricing on the grounds that the costs hurt shareholder value less
than the departure of top managers would, especially if leadership is critical to a successful
turnaround.

The plain fact is that repricing options sends an unmistakable signal that a company is in
trouble. Empirical evidence shows that its stock price is likely to continue to suffer and its
executives are more likely than ever to bail out.

Institutional and other outside shareholders are up in arms over options repricing. They take
the brunt of falling stock prices, while management's stake in the company remains protected
— and profitable — in good times and bad.

Repricing is controversial for other reasons, too. It tends to occur most in companies that
perform the worst in their peer group. And it tends to be approved most by boards dominated
by execs who happen to own the very options being repriced.

As the interests of execs and shareholders diverge, options repricing is drawing increasing
attention from regulators.

Last year, the Financial Accounting Standards Board ruled that companies that reprice their
options must take a charge to earnings, as the value of the underlying stock fluctuates each year
— but only if lower-priced options are issued within six months after the options they replace
are canceled. And companies are already wise to the strategy of building in a time lag to avoid
the imposition of the penalty.

There's also a growing movement, led by former Securities and Exchange Commission (SEC)
Chairman Arthur Levitt, to require that shareholders approve employee stock option plans.
Mr. Levitt knows that options are often priced well below a share's market value and, when
they're exercised, market value will probably drop.

For its part, the SEC has for years forced companies that reprice options to make painfully
detailed proxy disclosures. And now, the agency is subjecting public companies that exchange
new options for worthless ones to the scrutiny of a tender offer.

The SEC's initiative should be applauded and its efforts redoubled.

Stock option repricing is a totally unwarranted transfer of wealth from shareholders to
managers. It rewards failure and punishes both outside shareholders and the venture they've
capitalized.

Marc J. Lane is a Chicago lawyer and financial planner and an adjunct professor of law at Northwestern University School of Law. He can be reached at [email protected].

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Marc J. Lane ([email protected]) is a Chicago lawyer and financial planner and an adjunct professor of law at Northwestern University School of Law. His recently published book is Advising Entrepreneurs: Dynamic Strategies for Financial Growth (John Wiley & Sons, Inc.).

 

Copyright © 2001 by Crain Communications Inc. 


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