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Entrenched CEOs tend to reprice their stock options -- unless, that is, they own a lot of company stock

December 1, 2002

For more information, contact: Benjamin Haimowitz,

With stock prices continuing to lag, controversy continues to swirl about the practice of repricing executive stock options -- lowering the exercise price of options issued during the bull market. Opponents of repricing argue that it rewards failure, while proponents contend that companies benefit through renewal of top managers' incentive to succeed.

What determines whether a company reprices executive stock options? A study in the Dec. 2002/Jan. 2003 issue of the Academy of Management Journal analyzes the corporate politics that decides the issue, and the results can only serve to cast new doubt on the practice.

A major finding of the research, which was first presented at an annual meeting of the Academy of Management: the more power and job security a CEO has, the more likely that executive stock options will be repriced; but the bigger the CEO's ownership stake, the less likely they will be repriced.

In other words, as the study's authors put it, "Direct CEO ownership, even though it increases CEO power, also limits self-serving behavior."

Timothy G. Pollock, of the University of Maryland and Harald M. Fischer and James B. Wade of the University of Wisconsin uncovered this apparent corporate hypocrisy by studying the computer-software industry in the last six months of 1998, when the stock market as a whole suffered a significant downturn and then recovered. Exploiting what they call a "natural experimental setting," Pollock, Fischer, and Wade investigated 136 firms, gathering monthly data on option repricings, size of executives' options packages, stock prices, company finances, and stock ownership by institutional investors and CEOs.

In the 17 companies that repriced CEO options, the average decline in share price between June 1 and the month before repricing was 46.7%,which was more than matched by an average 50% reduction in exercise prices. Unsurprisingly, the size of negative spread -- that is, the difference between exercise price and current share price -- emerged as the primary determinant of repricing.

But corporate politics significantly increased or reduced its likelihood. Thus, if the CEO were chairman of the board, a sign of entrenched executive power, it substantially increased the odds for repricing. With a negative spread of $5 between stock price and exercise price, CEO board chairmanship increased the likelihood of repricing by 70%.

In contrast, big blocs of stock ownership substantially reduced the odds of repricing, whether in the hands of institutional investors or the CEO. With a negative spread of $5, CEO ownership of 20% of a company's shares reduced the likelihood of repricing to about half what it was for CEOs owning 2%.

A company's visibility -- as measured by sales and the CEO's cash compensation -- also was a factor: the bigger and more visible the company, the smaller the likelihood of repricing.

These results, the authors conclude, suggest "that stock options are ineffective in aligning management and shareholder interests." But "it is possible," they add, "that alignment can be achieved with relatively small-percentage ownership stakes, as long as the holdings represent a significant portion of the CEO's total wealth…Restricted stock awards, which increase direct CEO ownership but prevent the CEO from selling the stock for a period of time, rather than stock options, may be a superior tool in achieving incentive alignment."

The Academy of Management Journal, a peer-reviewed publication now in its 45th year, is published every other month by the academy, an organization with more than 12,000 members in 60 countries that seeks to foster the advancement of research, education, and practice in the management field.

Media Coverage:
The New York Times. Disspelling the myth that options help shareholders. (Sunday, July 29, 2001).

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