Stock Price Reactions to the Repricing of Employee Stock Options

We study whether the repricing of employee stock options is in the best interests of common shareholders by examining the excess stock returns associated with timely, noncontamin†ated repricing announcements made by Canadian firms. On the basis of three theories of why firms reprice, we develop competing predictions about the mean announcement†date excess stock return and the cross†sectional relations among excess stock returns, the estimated probability of repricing, and proxies for predictions from each theory. For a sample of 72 noncontaminated repricing announcements made by Canadian firms between November 1994 and July 2001, we find a reliably positive three†day announcement†date mean excess return of 4.9 percent. The results of our cross†sectional analyses suggest that the market responds favorably to repricings because they assist in retaining key employees even though, at the margin, they enable managers to extract rents from shareholders. We do not find sufficient statistically significant evidence to reliably conclude that repricings are done to realign employee incentives.