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Journal of Accounting and Economics 50 (2010) 7492

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Journal of Accounting and Economics


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Employee stock options and future rm performance: Evidence from


option repricings$
David Aboody a,1, Nicole Bastian Johnson b,2, Ron Kasznik c,
a
Anderson Graduate School of Management, University of California at Los Angeles, Los Angeles, CA 90095, USA
b
Haas School of Business, University of California at Berkeley, Berkeley, CA 94720, USA
c
Graduate School of Business, Stanford University, Stanford, CA 94305, USA

a r t i c l e i n f o abstract

Article history: We investigate rms operating performance subsequent to the repricing of executive
Received 27 April 2007 and non-executive employee stock options. We nd that, relative to non-repricers,
Received in revised form repricing rms have a larger increase in operating income and cash ows in subsequent
14 September 2009
periods. This performance improvement is attributable to the underlying economic
Accepted 16 December 2009
Available online 4 January 2010
determinants of the decision to restore the options incentive properties. However, only
repricings of executive stock options are associated with improvement in performance;
JEL classication: we nd no such evidence for non-executive employees. Our ndings suggest employee
G30 stock options provide sufciently large incentive effects to favorably affect rms
J33
performance, but primarily so at the executive level.
& 2009 Elsevier B.V. All rights reserved.
Keywords:
Employee stock options
Firm performance
Option repricing

1. Introduction

The objective of this study is to investigate rms operating performance subsequent to the repricing of employee stock
options. The large increase in the use of stock options in employee compensation during the past two decades has
intensied the debate on the effectiveness of stock options in enhancing rm protability and shareholder value.3
Proponents of stock option compensation argue that options help improve rm performance by attracting and retaining
key employees, and by aligning employee and shareholder incentives. Moreover, those who support broad-based option

$
We greatly appreciate the helpful comments and suggestions from S.P. Kothari (the Editor), an anonymous referee, and workshop participants at
Massachusetts Institute of Technology, University of British Columbia, and University of California, Los Angeles. We acknowledge the nancial support of
the Anderson Graduate School of Management at UCLA, the Haas School of Business at UC Berkeley, and the Graduate School of Business at Stanford
University.
 Corresponding author. Tel.: + 1 650 725 9740.
E-mail addresses: david.aboody@anderson.ucla.edu (D. Aboody), njohnson@haas.berkeley.edu (N.B. Johnson), kasznik_ron@gsb.stanford.edu
(R. Kasznik).
1
Tel.: +1 310 825 3393.
2
Tel.: +1 510 642 6590.
3
Survey evidence indicates most US public companies have a stock option plan, with many of them allowing participation by non-executive
employees. For example, a 2002 survey by the National Center for Employee Ownership estimates that over 25% of all US public companies provide
options to most or all of their full-time employees. Hall and Murphy (2002) document a ten fold increase between 1992 and 2002 in the value of option
grants made by S&P 500 rms, mostly due to grants to employees below the top-ve executive level.

0165-4101/$ - see front matter & 2009 Elsevier B.V. All rights reserved.
doi:10.1016/j.jacceco.2009.12.003
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D. Aboody et al. / Journal of Accounting and Economics 50 (2010) 7492 75

plans, which allow participation by rank-and-le employees, argue that such plans can motivate employees to work harder
and can reduce costly employee turnover. Critics of stock option compensation counter, however, that options can be used
opportunistically by executives to extract excessive rents from their companies, and that the effect of lower-level
employees actions on overall rm protability is insufcient for options to provide meaningful performance incentives.
Our study contributes to the discussion on the effectiveness of broad-based stock option plans by investigating the
association between executive and non-executive employee stock options and subsequent operating performance using a
sample of rms that have repriced their out-of-the-money stock options.
When a rms stock price falls signicantly below the exercise price of its outstanding stock options, such options can
lose much of their incentive effects. Thus, when a rm with out-of-the-money options chooses to reprice its stock options
to the current stock price, performance incentives should be restored. To the extent that stock options provide performance
incentives, the restoration of incentives associated with an option repricing event is similar to the creation of performance
incentives when a new stock option plan is initiated. This characteristic of option repricings makes such events a
potentially more powerful setting to investigate the incentive effects of stock option compensation than the study of
regular annual option grants. Additionally, some repricing rms only allow certain employee ranks to participate in the
repricing. This cross-sectional variation allows us to separately investigate the potential incentive effects associated with
option repricings for executive- and non-executive employees.4
Our sample consists of 1364 rms with employee stock option plans that experienced an annual stock price decline of
at least 30% in any of the years between 1990 and 1996. For each of these observations, we examine the notes to the
nancial statements for both the year of the price decline and the subsequent year to determine whether the rm repriced
any of its stock options. Of the 1364 rm-year observations, we identify 300 repricing rms. We hand-collect all of the
stock option footnote disclosure for the 300 repricing rms and for the 1064 non-repricing rms.
Our rst set of tests investigates whether option repricing is associated with changes in future operating performance.
We nd that repricing rms signicantly outperform the control group of non-repricing rms in terms of changes in
operating income (operating cash ows) over the three- and ve- (one-, three-, and ve-) year period following the event
year. This nding is consistent with the repricing of out-of-the-money options leading to changes in employee incentives
that are sufciently large to increase future rm performance.
Our second set of tests extends the analysis by investigating whether the performance increase identied for repricing
rms is attributable to the incentive alignment effect of the repriced options. We conduct this analysis by estimating a
two-stage model, following the approach used by Hanlon et al. (2003) and Ittner et al. (2003). In the rst stage, we regress
the repricing decision on a large set of variables that the prior literature suggests are associated with the use of employee
stock options for incentive purposes (see, e.g., Carter and Lynch, 2001; Core and Guay, 2001; Ittner et al., 2003). We
document that the repricing decision is associated with many of these economic determinants in a manner consistent with
incentive alignment. In the second stage, we use the coefcient estimates from the repricing model to parse out the
likelihood of repricing into its predicted and residual components, and investigate the relation between these two
components and subsequent changes in rms performance. We nd that the component predicted by the underlying
economic determinants of the repricing is signicantly positively associated with future operating performance. This
suggests that rms with stronger motivation to restore the incentive properties of their employee stock options are more
likely to reprice their options, and that such rms exhibit a more pronounced increase in subsequent rm performance. We
also nd no association between the residual component of the repricing and subsequent performance, suggesting option
repricing in and of itself does not necessarily lead to improved rm performance.
Our third set of tests examines whether option repricing has different incentive effects for different ranks of employees.
Specically, we investigate the relation between repricings and subsequent rm performance separately for rms with
executive-only repricings, rms with non-executive-only repricings, and rms with all-employee repricings. We nd that
the improved performance following the repricing is attributable to the repricing of executive stock options. In particular,
we nd that rms with executive-only repricings signicantly outperform the control group of non-repricing rms, and
that the positive relation between the repricing of executive stock options and subsequent performance is driven by the
underlying economic determinants of the decision to restore the incentive properties of these options. These ndings
suggest that executive-level options provide incentive effects that are sufciently large to be reected in subsequent rm
performance. In contrast, rms with non-executive-only repricings exhibit no improvement in performance relative to the
control group, which suggests that the repricing of options held by non-executive employees may not induce employee
actions that lead to improved operating performance. To the extent our inferences from the repricing setting can be
extended to stock option compensation in general, our study lends credence to concerns that the incentive effects of option
grants to rank-and-le employees are too negligible to have a meaningful effect on overall rm protability.
Our research design and empirical ndings extend the literature on the incentive effects of employee stock options
along a number of dimensions. First, we contribute to the relatively sparse empirical literature that assesses whether stock
option compensation to non-executive employees can induce behavior that leads to improved rm performance. Our
hand-collected sample of repricing rms includes rms that repriced only the stock options of their top executives as well

4
Throughout the paper we distinguish between executive and non-executive employees. When we use the term employees, we refer to all
employees (i.e., both executives and non-executives).
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as rms that repriced only the options of their non-executive employees. These subsamples allow us to compare the
incentive effects of options granted to different employee ranks.5 If stock option compensation reduces costly employee
turnover and provides incentives for employees to work harder and make better decisions, one would expect to see
improved operating performance subsequent to the repricing of out-of-the-money options. Thus, our study provides new
evidence on the effectiveness of using stock options as a form of compensation for non-executive employees.
Second, we extend the growing literature on repricings. This literature has focused largely on the determinants of the
repricing decision (see, e.g., Carter and Lynch, 2001) and the effects of repricings on shareholder wealth and employee
retention (see, e.g., Callaghan et al., 2003; Carter and Lynch, 2004). We contribute to this literature by examining whether
repricings provide incentive effects large enough to favorably affect future rm performance.6
Finally, we contribute to the literature on executive stock option compensation. Prior studies examine the relation
between annual grants of options to the rms top executives and the future operating performance of the rm.7 However,
because most rms grant options to their executives on a regular basis, it is difcult to infer a causal relation between
grants in a particular period and performance in subsequent periods (Larcker, 2003). Our option repricing setting allows us
to study the association between option grants and future rm performance in a different and potentially more powerful
setting. Rather than measuring how abnormal stock option grants or option grant levels over time affect rm operating
performance, the repricing setting mimics the initiation of a new stock option plan. This allows us to more directly
measure the performance effects of stock option grants by comparing the ex-post performance of repricing rms to a
control group of non-repricing rms with out-of-the-money options.
The paper proceeds as follows. Section 2 provides institutional details related to option repricing, and Section 3
describes the sample. Section 4 outlines the research design and presents our primary ndings. Section 5 details additional
analyses. Section 6 concludes.

2. Background on the repricing of employee stock options

The authority to approve and set the terms of stock option repricings generally lies with the board of directors, and the
repricing decision is disclosed in notes to the nancial statements. In announcing option repricings, rms often argue that
repricing is an important tool that restores lost incentives and promotes employee retention. For example, Ferri (2004)
nds that 79% of the disclosures related to option repricings indicate that the decision to reprice was directly related to
concerns about re-incentivization, retention, or both.8 Critics disagree, however, and argue that opportunistic
executives can inuence boards of directors to reprice options before run-ups in stock price and that repricing rewards
poor performance.
To implement the repricing, rms can either reduce the exercise price of existing options or give option holders the
opportunity to surrender the existing options for new options with a lower exercise price. In our sample, most repricings
are accomplished through an exchange program in which new options are exchanged for old ones at a one-to-one
exchange rate. The two types of repricings are economically equivalent; vesting provisions can be reset in either case.
As further described below, our sample is drawn from the 1990 to 1996 period. We focus on this period due to the 1998
change in the accounting treatment of repricings, as specied in FASB Interpretation 44 (Financial Accounting Standards
Board, 2000).9 FIN 44 mandates that rms that reprice employee stock options recognize a compensation expense in each
future year that its stock price increases and the repriced options remain unexercised (see Carter and Lynch, 2003 for
further discussion).10 In contrast, during our sample period, consistent with the treatment of option grants, repricings did

5
Prior literature on non-executive employee stock options has focused on understanding why rms grant options to such employees. Core and Guay
(2001) nd that rms use more non-executive options when they are larger, when they have higher growth opportunities, and when human capital is an
important production factor. They conclude that these results are consistent with rms granting options to provide incentives. Oyer (2004) and Oyer and
Schaefer (2005) argue that rms grant options with multi-year vesting provisions to reduce costly employee turnover. Consistent with this argument,
Carter and Lynch (2004) and Ferri (2004) nd evidence that employee turnover falls after stock options are repriced. However, prior literature does not
examine whether, and to what extent, reduced employee turnover translates into improved rm performance.
6
Our focus on the relation between repricings and future rm performance also extends prior research that examines the association between stock
option compensation and stock price performance (see, e.g., Core et al., 1999; Ittner et al., 2003; Aboody et al., 2004). Our tests do not rely on stock price-
based performance measures because they impose additional assumptions with respect to the efciency with which option incentive effects are
incorporated into investor expectations.
7
Hanlon et al. (2003) nd that future earnings are positively associated with the Black-Scholes (1973) value of option awards to the rms top ve
executives, consistent with executive stock options providing an incentive effect. Using a sample of new economy rms, Ittner et al. (2003) nd that
lower-than-expected new option grants and option holdings by the CEO are correlated with lower future return-on-assets, but do not nd that higher-
than-expected grants or holdings are associated with higher return-on-assets. In contrast, Hillegeist and Penalva (2004) nd that unexpectedly high
option grants are associated with higher future earnings, but nd no effect for unexpectedly low option grants.
8
The following is an example of a repricing disclosure from Readicares 1995 10-K: (The) Stock Option Committeeynoted that a number of key
employees of the Company held options having exercise prices substantially in excess of the market price of the Companys stock. The Committee
believed that one purpose of the stock option plan, to provide equity incentives, would not be achieved for employees holding such options exercisable
above the market price.
9
FIN 44 was made effective on July 1, 2000 for all repricing events occurring after December 15, 1998.
10
Firms can avoid the compensation charge resulting from FIN 44 if they cancel the options and wait for at least six months and one day before
reissuing new ones. Descriptive statistics from periods subsequent to FIN 44 reveal a signicant shift from traditional repricings to these new 6-and-1
repricings (see, e.g., Coles et al., 2006).
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D. Aboody et al. / Journal of Accounting and Economics 50 (2010) 7492 77

not result in a charge to net income as long as the repriced options were not granted in-the-money.11 In our sample, the
new exercise price equals the market price of the underlying stock at or near the time of the repricing in over 90% of the
repricings and no rm reported a new exercise price set below the market price at the time of repricing. Hence, none of our
sample rms recognized a compensation expense in connection with the repricing of their employee stock options.
Thus, to the extent that the nancial reporting costs associated with rms decision to reprice their employee stock
options have increased subsequent to the 1998 accounting change, our ndings on the association between repricings and
future rm performance might not generalize to more recent years. Nonetheless, to the extent that our inferences from the
repricing setting can be extended to stock option compensation in general, our inferences regarding the incentive effects of
broad-based option plans should continue to hold in the post-1998 period.

3. Sample selection

Our sample is drawn from the C/R/S/P database and consists of all rm-years between 1990 and 1996 that satisfy the
following three criteria: (i) the rm experienced a stock price decline of at least 30% during the scal year, (ii) the market value
of equity is greater than $10 million, and (iii) the ratio of common shares reserved for stock option conversion to common
shares outstanding is greater than 10%. We identify 1773 rm-years that meet these sample criteria. For each of these rm-
year observations, we retrieved and read the stock option footnote disclosure included in the 10-K lings for both the year of
the stock price decline and the subsequent year to determine if the rm had repriced any of its employee stock options.
We classify observations as repricing events if 10-K disclosures indicate the exercise price on options currently held by
employees had been reduced or if option holders had been given the opportunity to surrender their options for new options
with a lower exercise price. Of the 1773 observations that meet our selection criteria, we identify 396 that initiated a full or
partial option repricing. Of these 396 repricings, we omit 28 that appear to be duplicates and 68 with missing data, and thus
our nal repricing sample comprises 300 observations. We classify all remaining 1377 observations as non-repricing events.
After excluding 313 observations due to missing data, our control group of non-repricers comprises 1064 observations.
Table 1 presents industry classications for the repricing and non-repricing rms. The table reveals that repricing rms
are concentrated in a few industries, with nearly 60% of repricing events carried out by rms in the following ve
industries: Chemicals, Machinery, Electrical Equipment, Instruments, and Business Services. The control group of non-
repricing rms exhibits similar industry clustering, indicating that rms in these industries are more likely to experience a
large drop in stock price during our sample period.
For each repricing rm, we collect detailed data about the repricing event from the 10-K ling, including information
about the repricing date, option holders that were allowed to participate in the repricing, the new and original exercise
prices of the repriced options, the repricing exchange ratio, the number of new options granted, and the number of old
options surrendered. For both the repricing and non-repricing rms we also collect from the 10-K all publicly disclosed
stock option data. Other nancial statement data are from Compustat.
Table 2 reports descriptive statistics for the 300 repricings in our sample. As noted in Panel A, in 185 repricing events the
repricing was offered to all option holders. In 38 repricings, only non-executive employees participated in the repricing, whereas
45 repricings were limited to executives and top management. Participation in the repricing was not specied in 32 cases.
Panel B reports descriptive statistics pertaining to details of the repricing event.12 The mean and median ratio of new
exercise price to old exercise price is close to 50% across all repricing categories, indicating that repricings confer a
substantial benet to the holders of the repriced options. In many cases, the repricing was accomplished by canceling old
options and reissuing new ones with a lower exercise price, rather than changing the exercise price of existing options. The
median exchange ratio of new options granted to old options surrendered is one-to-one (100%) across all of our repricing
categories; no rm reported an exchange ratio greater than 100%. The statistics in Panel B also indicate that the mean
(median) number of repriced options as a percentage of shares outstanding in executive-only repricings is 4.62% (3.46%),
whereas the mean (median) proportion for non-executive-employee repricings is 3.20% (2.66%). Moreover, our descriptive
statistics indicate that the repricing of employee stock options carries a non-trivial cost. In particular, across our sample of
repricing rms, the mean (median) value of the options granted in the repricing is 4.67% (2.97%) of lagged market value of
equity.13 As expected, the cost of repricing is particularly high when all employees are included in the repricing; the mean
(median) option value is 5.24% (3.28%) of the rms market value of equity.

11
Until recently, accounting for stock-based compensation was specied in APB No. 25 (1973) and SFAS No. 123 (1995). Under APB 25, stock-based
compensation expense is recognized over the vesting period based on the option intrinsic value on grant date. Because most companies grant options at-
the-money, the expense under APB 25 typically equals zero. Under SFAS 123, stock-based compensation expense is based on grant-date fair values.
However, SFAS 123 permitted rms to not recognize the expense in determining net income, and instead disclose it in notes to the nancial statements.
Following the issuance of SFAS 123-R (FASB, 2004), all companies are now required to expense the fair value of their stock options.
12
These data are available for only 189 of the repricings included in our sample.
13
We compute option values using the Black-Scholes (1973) option pricing formula based on the following inputs: the new exercise price of the
repriced option, the rms stock price on repricing date, option life (typically ten years), historical stock price volatility and dividend yield (based on data
available for the past ten years), and risk-free interest rate with term to maturity similar to the option life. We then multiply the option value by the
number of options repriced, and deate this product by the market value of equity at the beginning of the period.
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78 D. Aboody et al. / Journal of Accounting and Economics 50 (2010) 7492

Table 1
Industry classication for 300 repricing rms and 1064 non-repricing rms.

Industry Repricing rms Non-repricing rms

N % N %

Agriculture, mining 6 2.0 33 3.1


Construction 2 0.7 20 1.9
Food, tobacco 1 0.3 19 1.8
Textile, apparel 4 1.3 19 1.8
Lumber, furniture 1 0.3 11 1.0
Paper 2 0.7 3 0.3
Printing 1 0.3 18 1.7
Chemicals 45 15.0 113 10.6
Rubber, plastics 5 1.7 15 1.4
Leather, glass 2 0.7 10 0.9
Machinery 33 11.0 82 7.7
Electrical equipment 28 9.3 101 9.5
Instruments 21 7.0 115 10.8
Misc. manufacturing 3 1.0 14 1.3
Transportation services 4 1.3 15 1.4
Communications 6 2.0 24 2.3
Utilities 7 2.3 25 2.4
Durableswholesale 10 3.3 32 3.0
Nondurableswholesale 1 0.3 11 1.0
Retail 2 0.7 21 2.0
Apparel stores 9 3.0 31 2.9
Eating and drinking 5 1.7 36 3.4
Misc. retail 9 3.0 33 3.1
Banks 2 0.7 18 1.7
Insurance services 2 0.7 20 1.9
Business services 51 17.0 108 10.2
Entertainment 8 2.7 17 1.6
Health services 12 4.0 26 2.4
Other services 7 2.3 28 2.6
Other 11 3.7 46 4.3

Total 300 100.0 1064 100.0

4. Research design and ndings

In this section we describe our primary empirical tests and ndings. We begin by investigating whether the repricing of
employee stock options is associated with subsequent changes in rm operating performance (Section 4.1). We then
extend this baseline model by examining the underlying economic determinants of rms decision to reprice their stock
options (Section 4.2). Based on coefcient estimates from the repricing choice model, we compute the component of option
repricing attributable to underlying economic determinants, and investigate whether this predicted component is
positively associated with subsequent changes in operating performance (Section 4.3). Finally, we examine the relation
between repricings and subsequent operating performance separately for executive and non-executive employees (Section
4.4).

4.1. Option repricing and subsequent rm performance

4.1.1. Research design


We assess whether the repricing of out-of-the-money employee stock options is positively associated with subsequent
changes in rm performance, as measured by operating income and cash ows. Our baseline empirical model is as follows:
X
96 X
30
DOPINCt t;i a0Y YRYti a0N INDNti a1 REPRICEti a2 DOPINCti a3 MBti a4 ASSETSti e1ati 1a
Y 90 N1

X
96 X
30
DCFOt t;i a0Y YRYti a0N INDNti a1 REPRICEti a2 DCFOti a3 MBti a4 ASSETSti e1bti 1b
Y 90 N1

We estimate Eqs. (1a) and (1b) separately for each of three horizons, from year t to year t+ t, where t = 1, 3, or 5. The
dependent variable in (1a), DOPINCt + t, is operating income in year t+ t minus operating income in year t, deated by
beginning-of-year t market value of equity. Operating income is dened as income before extraordinary items,
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D. Aboody et al. / Journal of Accounting and Economics 50 (2010) 7492 79

Table 2
Descriptive statistics for 300 repricing events.

Panel A: Ranks of employees participating in the repricing


Employee rank N %

All option holders 185 61.7


Executives and other management only 45 15.0
Non-executive employees only 38 12.7
Not specied 32 10.6

Total 300 100.0

Panel B: Repricing details (for 189 repricings with available data)


Mean Median Std. Dev.

All repricings with available data (n= 189)


No. of options cancelled (as % of shares outstanding) 6.03 4.94 5.20
No. of options granted (as % of shares outstanding) 5.80 4.68 5.17
Exchange ratio (in %) 92.40 100.00 15.60
Ratio of new exercise price to old exercise price (in %) 51.40 52.60 20.00
Black-Scholes value of repricing (as % of equity market value) 4.67 2.97 5.60

Repricings to all option holders (n= 113)


No. of options cancelled (as % of shares outstanding) 7.51 6.08 5.34
No. of options granted (as % of shares outstanding) 7.19 5.92 5.32
Exchange ratio (in %) 93.80 100.00 13.90
Ratio of new exercise price to old exercise price (in %) 52.40 52.70 19.00
Black-Scholes value of repricing (as % of equity market value) 5.24 3.28 5.93

Repricings to non-executive employees only (n= 38)


No. of options cancelled (as % of shares outstanding) 3.20 2.66 2.80
No. of options granted (as % of shares outstanding) 2.53 2.58 2.40
Exchange ratio (in %) 89.60 100.00 21.80
Ratio of new exercise price to old exercise price (in %) 52.30 52.60 24.90
Black-Scholes value of repricing (as % of equity market value) 3.53 1.72 4.63

Repricings to executives and management only (n= 38)


No. of options cancelled (as % of shares outstanding) 4.62 3.46 5.75
No. of options granted (as % of shares outstanding) 4.01 3.22 5.33
Exchange ratio (in %) 93.60 100.00 9.50
Ratio of new exercise price to old exercise price (in %) 49.60 53.80 22.70
Black-Scholes value of repricing (as % of equity market value) 3.08 1.50 4.30

discontinued operations, and accounting changes. Similarly, the dependent variable in (1b), DCFOt + t, is operating cash
ows in year t+ t minus operating cash ows in year t, deated by beginning-of-year t market value of equity.14 We focus
on performance over several years subsequent to the repricing and non-repricing event years because stock options
generally vest over several years and any change in incentive effects due to the repricing decision could manifest over
several periods. We present ndings for each horizon, even though they are not independent, because we have no
prediction for the length of horizon over which such incentive effects, if any, manifest.15
The focus of our test is on the coefcient estimate on REPRICE, an indicator variable that equals one (zero) for the rms
that repriced (did not reprice) their stock options in response to the stock price decline. If option repricing helps align
employees interests with those of shareholders, and if these changes in employee incentives are sufciently large to
increase subsequent operating income and cash ows, a1 in Eqs. (1a) and (1b) will be positive.
The change in operating income (operating cash ows) from year t  1 to year t, DOPINCt (DCFOt), controls for the time-
series properties of earnings (cash ows). We deate the DOPINC and DCFO variables (both the dependent and independent
variables) by beginning-of-year t market value of equity. The market-to-book ratio, MB, controls for the potential effects of
rm risk and growth opportunities, and the logarithm of total assets, ASSETS, controls for rm size effects. To control for
omitted time- and industry-specic effects, we permit the regression intercept to vary across years and industries.
Specically, YRY equals one if the observation is from year Y, and zero otherwise, and INDN equals one if the rm is in
industry N (based on the classication in Table 1), and zero otherwise.

14
The specication of these models follows prior research that investigates the association between rms nancial reporting decisions and
subsequent operating performance (see, e.g., Aboody et al., 1999).
15
Changes in future operating performance over the three horizons are not perfectly correlated. The untabulated Pearson correlations between one-
year-ahead and three- and ve-year-ahead changes in operating income (cash from operations) are 0.54 and 0.18 (0.58 and 0.36), respectively. Spearman
correlations are similar in magnitude.
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Table 3
Descriptive statistics for 300 repricing rms and 1,064 non-repricing rms.

Repricings rms (n= 300) Non-repricings rms (n =1064) p-Value

Mean Median Std. Dev. Mean Median Std. Dev. t-Test Wilcoxon

Dependent variables
DOPINCt + 1 0.017 0.022 0.523 0.003 0.001 0.352 0.582 0.004
DOPINCt + 3 0.072 0.041 0.508 0.033 0.017 0.399 0.202 0.146
DOPINCt + 5 0.109 0.057 0.671 0.022 0.031 1.041 0.161 0.114
DCFOt + 1  0.017 0.011 0.456 0.012 0.008 0.490 0.334 0.423
DCFOt + 3 0.049 0.016 0.443 0.033 0.018 0.420 0.614 0.895
DCFOt + 5 0.087 0.021 0.592 0.048 0.037 0.718 0.445 0.510

Independent variables
DOPINCt  0.019  0.036 0.780  0.051  0.024 0.337 0.490 0.191
DCFOt  0.004  10.003 0.310 0.006  0.004 0.536 0.232 0.742
MB 2.097 1.547 7.023 2.608 1.547 8.147 0.324 0.959
ASSETS 11.217 1.016 82.463 8.722 0.964 71.994 0.608 0.116

DOPINCt is operating income (income before extraordinary items, discontinued operations, and accounting changes) in year t minus operating income in
year t  1, deated by market value of equity at the beginning of year t. DOPINCt + t is operating income in year t + t (t = 1, 3, and 5) minus operating income
in year t, deated by market value of equity at the beginning of year t.
DCFOt is cash from operations in year t minus cash from operations in year t  1, deated by market value of equity at the beginning of year t. DCFOt + t is
cash from operations in year t+ t (t = 1, 3, and 5) minus cash from operations in year t, deated by market value of equity at the beginning of year t.
MB is the ratio of market value of equity to book value of equity at the end of year t. ASSETS is the natural logarithm of the book value of total assets at the
end of year t.
p-values for differences in means and medians between repricing and non-repricing rms are based on two-tailed tests.

4.1.2. Findings
Table 3 provides univariate descriptive statistics for the variables included in Eqs. (1a) and (1b). These statistics indicate
that, in the repricing year, sample rms experienced negative changes in operating income and cash ows. This nding is
not surprising as our sample selection criteria identify rms that experienced a stock price decline of at least 30% in the
year of, or the year prior to, the repricing year. Similarly, as expected from the selection criteria, rms in the control group
experienced comparable declines in both operating performance measures.
More interestingly, the mean and median changes in operating income and cash ows in subsequent periods are
generally positive for both repricing and non-repricing rms, indicating the average rm had an improvement in operating
performance over the period t + 1 to t+ 5. While the increase in subsequent performance is larger for the repricing rms,
most univariate differences are not statistically signicant. The median repricing rm is slightly larger than the median
non-repricing rm, and median market-to-book ratios are nearly identical across the two groups, although the larger mean
for non-repricers suggests a more skewed distribution.
Table 4 presents regression summary statistics from (1a) and (1b), which relate the option repricing event in year t to
subsequent changes in the rms operating performance.16 Panel A indicates that repricings are positively associated with
subsequent changes in operating income. Across all three time horizons, the coefcient on the repricing indicator variable,
REPRICE, is positive as predicted, and signicantly so in the three- and ve-year-ahead horizons; it is marginally signicant
in the one-year-ahead test (t-statistics= 1.63, 2.77, and 2.56 for the one-, three-, and ve-year-ahead horizons).17 These
ndings suggest that repricings are associated with changes in employee actions that translate into improved operating
income in subsequent periods. If future operating performance is sustained, the coefcient estimates on REPRICE should
increase with horizon length because year t is the base year for calculating changes in performance for all three horizons.
Indeed, with regard to changes in operating income we observe a steady increase in performance over time, with 0.1%
improvement after one year, 2.6% improvement after three years, and 3.5% improvement after ve years; these
improvements are measured as a percentage of equity market value at the beginning of year t.
Table 4, Panel B indicates that option repricings are positively associated with subsequent changes in operating cash
ows. Across all three time horizons, the coefcient estimate on REPRICE is signicantly positive, as predicted
(t-statistics=1.80, 1.82, and 2.15, respectively). Moreover, there is a steady increase in the coefcient estimates on REPRICE
over time, suggesting a steady improvement in operating cash ows over the periods subsequent to the repricing (0.8%
improvement after one year, 1.4% after three years, and 2.3% after ve years). These ndings are consistent with the

16
We estimate all equations using a robust regression technique, pooling data across years. The procedure begins by calculating Cooks D statistic
and excluding observations with D 41. Then, the regression is re-estimated, weights for each observation are calculated based on absolute residuals
Huber weights and biweights and the estimation is repeated iteratively using the weighted observations until convergence in the maximum change in
weights is achieved (see Berk, 1990). Our signicance tests are based on standard errors calculated using the pseudo values approach described in Street
et al. (1988), after adjusting them to be heteroskedasticity-consistent (White, 1980).
17
We use the term signicant to denote statistical signicance at less than the 10% level (two-tailed).
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D. Aboody et al. / Journal of Accounting and Economics 50 (2010) 7492 81

Table 4
Summary statistics from robust regressions. Sample of 300 repricing rms and 1064 non-repricing rms.

Panel A: Dependent variableFuture changes in operating income


DOPINCt + 1 DOPINCt + 3 DOPINCt + 5

Independent variable Pred Coeff t-Stat Coeff t-Stat Coeff t-Stat

REPRICE + 0.001 1.63 0.026 2.77 0.035 2.56


DOPINCt ?  0.488  57.24  0.591  24.68  0.672  16.97
MB ? 0.001 13.21  0.001  0.47  0.001  1.49
ASSETS ?  0.001  1.55  0.002  1.07 0.001 0.35

N 1364 1208 988


Adj R2 0.78 0.58 0.40

Panel B: Dependent variableFuture changes in cash from operations


DCFOt + 1 DCFOt + 3 DCFOt + 5

Independent variable Pred Coeff t-Stat Coeff t-Stat Coeff t-Stat

REPRICE + 0.008 1.80 0.014 1.82 0.023 2.15


DCFOt ?  0.273  14.74  0.474  102.56  0.443  82.05
MB ?  0.001  4.48 0.001 0.71  0.001  0.10
ASSETS ?  0.001  1.76  0.001  1.43 0.001 0.22

N 1364 1208 988


Adj R2 0.74 0.87 0.81

REPRICE is an indicator variable that equals one (zero) for repricing (non-repricing) rms.
DOPINCt is operating income (income before extraordinary items, discontinued operations, and accounting changes) in year t minus operating income in
year t  1, deated by market value of equity at the beginning of year t. DOPINCt + t is operating income in year t + t (t = 1, 3, and 5) minus operating income
in year t, deated by market value of equity at the beginning of year t.
DCFOt is cash from operations in year t minus cash from operations in year t  1, deated by market value of equity at the beginning of year t. DCFOt + t is
cash from operations in year t + t (t =1, 3, and 5) minus cash from operations in year t, deated by market value of equity at the beginning of year t.
MB is the ratio of market value of equity to book value of equity at the end of year t. ASSETS is the natural logarithm of the book value of total assets at the
end of year t.
The regression equations include untabulated year- and industry-specic intercepts.

evidence in Panel A, indicating a positive relation between repricings and subsequent rm performance. With respect to
the control variables, Panel B reveals a fairly similar pattern to Panel A.
We interpret the positive coefcient estimate on REPRICE as evidence that repricings create changes in employee
incentives that are large enough to increase subsequent rm performance. However, because we do not control for the
explicit and implicit costs associated with repricing, and to the extent these costs vary cross-sectionally, our methodology
is not designed to assess the net wealth effects of the repricing decision. Instead, our objective is to assess whether the
repricing of out-of-the-money employee stock options is associated with incentive effects that are large enough to have a
detectable effect on future rm performance. Moreover, the baseline model, Eqs. (1a) and (1b), does not control for
the underlying economic determinants of the decision to reprice the options. Therefore, it does not directly test whether
the positive coefcient estimate on the repricing variable is attributable to the incentive alignment effect. We extend the
analysis and conduct such tests in the following sections.

4.2. Economic determinants of option repricing

4.2.1. Research design


In this section we model the underlying economic determinants of rms decision to reprice their employee stock
options. To do so, we incorporate variables that the prior literature suggests are associated with the use of employee stock
options in general, and option repricing in particular, for incentive alignment, attraction and retention, and cash ow
considerations. Specically, we estimate the following logit model:
X
96 X
30
REPRICEti d0Y YRYti d0N INDNti d1 OOMti d2 IND_RETti d3 FIRM_RETti d4 HITECHti d5 R&Dti
Y 90 N1

d6 HIST_VOLti d7 IMPL_VOLti d8 FIRMAGEti d9 ASSETSti

d10 NUM_EMPLOYEESti d11 CF_SHORTFALLti d12 INT_BURDENti d13 LTDti d14 TAXti e2ti 2

OOM is the difference between the weighted average exercise price and the end-of-year stock price,
deated by the weighted average exercise price. The further stock options are out-of-the-money, the lower their
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82 D. Aboody et al. / Journal of Accounting and Economics 50 (2010) 7492

pay-to-performance sensitivity. Thus, OOM captures the economic motivation of rms to restore the incentive properties
of employee stock options (Carter and Lynch, 2001). Prior research also suggests repricing is related to declining rm
and industry performance (Carter and Lynch, 2001; Ittner et al., 2003). Our model therefore includes industry
performance, IND_RET, measured as the median cumulative annual stock return for the event year for all rms in the same
two-digit SIC code, and rm performance, FIRM_RET, measured as the rms cumulative annual stock return in excess
of IND_RET.
Consistent with the prior literature, we predict a higher likelihood of repricing for high technology rms because rms
in these sectors operate in a more competitive labor market and therefore can experience greater difculty in employee
attraction and retention (Carter and Lynch, 2004). Moreover, Ittner et al. (2003) nd that the use of stock option
compensation is related to the level of innovation (measured by R&D spending and number of patents), which is greater for
high technology rms. Hence, we include HITECH, an indicator that equals one for rms in the high technology sector,
based on the Fama and French (1997) industry classication, and zero otherwise, and R&D, the three-year average of
research and development expenses, deated by total assets.18
Ittner et al. (2003) argue that higher volatility makes stock price a noisier indicator of employee performance, therefore
imposing greater risk on employees. This view suggests lower use of stock option compensation in higher variance rms.
However, a countervailing effect relates to the convex shape of stock option payouts, making them more valuable to
employees when volatility is high. The latter view suggests that stock return volatility and the use of options for
compensation should be positively related. Hence, we include in our model HIST_VOL, the rms historical stock return
volatility, and IMPL_VOL, the implied stock return volatility based on publicly traded options.19
Prior research also suggests it is more difcult to monitor employees in larger rms, strengthening the role of stock
options as an incentive device (see, e.g., Ittner et al., 2003). A countervailing argument, however, is that options may
provide a more effective incentive device in smaller rms, where it may be easier for employees to have a meaningful
effect on overall rm value. Hence, we include in our model FIRMAGE, the number of years the rm is public, ASSETS, the
natural logarithm of total assets, and NUM_EMPLOYEES, number of employees.
The nal group of economic determinants comprises proxies for cash constraints. Prior research suggests
rms with more cash constraints are more likely to substitute equity for cash compensation (Core and Guay, 2001).
Thus, we include CF_SHORTFALL, the three-year average cash from investing activities plus dividends less cash from
operations, deated by total assets. We also include INT_BURDEN, the three-year average interest expense deated by
operating income before depreciation, LTD, long-term debt deated by total assets, and TAX, an indicator variable equal to
one for rms with negative taxable income and with net operating loss carryforward in each of the prior three years, and
zero otherwise,. Finally, we also include YRY and INDN to control for potentially omitted time- and industry-specic
effects.20

4.2.2. Findings
Table 5, Panel A provides univariate descriptive statistics for the variables included in the repricing decision model,
Eq. (2). The panel indicates that repricing is more likely when stock options are further out-of-the-money, for rms in the
high technology sector, for younger rms, and for rms with greater cash ow constraints, larger investments in research
and development, and higher historical and implied stock return volatility.
Table 5, Panel B presents regression summary statistics from the estimation of Eq. (2). These estimation results are
generally consistent with the univariate statistics and with the ndings in the extant literature on stock option
compensation in general, and option repricing in particular. For example, we nd that the likelihood of repricing is higher
for rms whose options are more out-of-the-money, for smaller rms, for rms with larger investments in research and
development, for rms with higher historical stock return volatility, and for more mature rms. Not surprisingly given that
our control group of non-repricing rms comprises rms with a large decline in stock price, the coefcient estimate on
rm-specic return is not statistically signicant.21 The Pseudo R2 of the logit regression is 22%. Overall, these ndings
indicate that rms repricing decision is related to many of the hypothesized economic determinants in a manner
consistent with the incentive alignment hypothesis.

4.3. Economic determinants of repricing and subsequent rm performance

4.3.1. Research design


We next parse out the likelihood of repricing for each sample and control rm into its predicted and unexpected
components, and investigate the relation between such components and rms subsequent performance. This approach is
similar to that employed by Hanlon et al. (2003) and Ittner et al. (2003) to investigate the economic consequences of equity
and stock option grants. Our objective is to assess whether the positive association identied in the baseline model

18
If Compustat reports a missing value for the rms research and development expense, we set this value to zero.
19
If the rm had no publicly traded stock options, we measure IMPL_VOL as the ex-post annual stock return volatility in the subsequent year.
20
All the explanatory variables included in Eq. (2) are measured as of the event year.
21
In Carter and Lynch (2001), the control group of non-repricers comprises a more random set of rms. Thus, it is not surprising that in their analysis,
the stock return variable is signicantly associated with the repricing decision.
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D. Aboody et al. / Journal of Accounting and Economics 50 (2010) 7492 83

Table 5
Repricing decision model. Sample of 300 repricing rms and 1064 non-repricing rms.

Panel A: Descriptive statistics for variables included in the repricing decision model
Repricing rms (n =300) Non-repricing rms (n =1064) p-Value

Mean Median Std. Dev. Mean Median Std. Dev. t-Test Wilcoxon

OOM 0.425 0.402 0.544 0.313 0.382 0.377 0.001 0.001


IND_RET 0.105 0.108 0.089 0.109 0.108 0.091 0.471 0.387
FIRM_RET  0.101  0.089 0.879  0.093  0.095 0.585 0.843 0.192
HITECH 0.352 0.000 0.479 0.292 0.000 0.455 0.089 0.089
R&D 0.129 0.051 0.197 0.076 0.007 0.137 0.001 0.001
HIST_VOL 0.937 0.639 1.920 0.654 0.513 0.589 0.001 0.001
IMPL_VOL 1.024 0.652 1.204 0.882 0.550 1.297 0.081 0.001
FIRMAGE 6.712 7.549 5.465 7.895 7.649 6.402 0.001 0.006
ASSETS 4.018 3.989 1.158 3.976 3.985 1.120 0.541 0.645
NUM_EMPLOYEES 1.772 0.331 4.757 2.390 0.467 101.260 0.295 0.155
CF_SHORTFALL 0.178  0.002 0.553 0.092  0.051 0.513 0.010 0.002
INT_BURDEN 0.202 0.013 1.261 0.150 0.056 1.450 0.566 0.013
LTD 7.605 0.581 21.136 8.277 0.992 33.222 0.732 0.590
TAX 0.211 0.000 0.965 0.144 0.000 0.129 0.375 0.118

Panel B: Summary statistics from Logit regression


Independent variable Coefcient z-Statistic

OOM 0.655 2.88


IND_RET  4.795  0.98
FIRM_RET 0.840 1.56
HITECH 0.487 1.08
R&D 0.303 3.55
HIST_VOL 0.356 1.78
IMPL_VOL  1.022  0.27
FIRMAGE 0.986 2.68
ASSETS  1.390  2.85
NUM_EMPLOYEES 0.969 0.91
CF_SHORTFALL 0.662 1.21
INT_BURDEN  1.016  0.18
LTD 0.998 0.36
TAX 0.010 0.81

N 1,364
Pseudo R2 0.22

The dependent variable, REPRICE, is an indicator variable that equals one (zero) for repricing (non-repricing) rms.
OOM is the extent to which options are out-of-the-money, measured as the difference between the weighted average exercise price and the end-of-year
stock price, deated by the weighted average exercise price. IND_RET is the median cumulative annual stock return for the event year for all rms in the
same two-digit SIC code. FIRM_RET is the rms cumulative annual stock return in excess of IND_RET. HITECH is an indicator that equals one for rms in
the high technology sector, based on the Fama and French (1997) industry classication, and zero otherwise. R&D is the three-year average of research
and development expenses, deated by total assets. If Compustat reports a missing value for the rms research and development expenses, this value is
set to zero. HIST_VOL is stock return volatility. IMPL_VOL is the implied stock return volatility based on publicly traded options. If the rm has no publicly
traded options, IMPL_VOL is measured based on ex-post annual stock return volatility in the subsequent period. FIRMAGE is the number of years the rm
has been reported on CRSP. ASSETS is the natural logarithm of the total assets at the end of the event year. NUM_EMPLOYEES is the rms number of
employees (in thousands). CF_SHORTFALL is the three-year average cash ow from investing activities plus dividends less cash ow from operations,
deated by total assets. INT_BURDEN is the three-year average interest expense deated by operating income before depreciation. LTD is long-term debt
deated by total assets. TAX is an indicator variable equal to one for rms with a negative taxable income and net operating loss carryforward in each of
the prior three years, and zero otherwise.
The regression equations include untabulated year- and industry-specic intercepts.
p-Values for differences in means and medians between repricing and non-repricing rms are based on two-tailed tests.

between option repricing and subsequent performance is attributable to the underlying economic determinants of the
repricing or to some other effects such as rent extraction. Such tests would enable us to draw stronger inferences about the
effectiveness of repricing in restoring the incentive properties of employee stock options.
Specically, we compute REPRICE_PRED, the predicted value of the repricing choice based on the coefcient estimates
obtained from Eq. (2). We also compute the regression residual, REPRICE_RESID, which we refer to as the unexpected
component of the repricing.22 We then re-examine the association between repricing and subsequent rm performance by

22
Hanlon et al. (2003) also examine the incremental effect of corporate governance quality, based on proxies extracted from Execucomp. They nd
that the economic signicance of stock option compensation predicted by governance quality is relatively small. Because our sample comprises many
rms that are not in Execucomp, we did not incorporate similar governance proxies. We presume these effects are reected in REPRICE_RESID.
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84 D. Aboody et al. / Journal of Accounting and Economics 50 (2010) 7492

substituting REPRICE_PRED and REPRICE_RESID for REPRICE in the baseline model:


X
96 X
30
DOPINCt t;i a0Y YRYti a0N INDNti a1 REPRICE_PREDti a2 REPRICE_RESIDti a3 DOPINCti a4 MBti
Y 90 N1
a5 ASSETSti e3ati 3a
X
96 X
30
DCFOt t;i a0Y YRYti a0N INDNti a1 REPRICE_PREDti
Y 90 N1

a2 REPRICE_RESIDti a3 DCFOti a4 MBti a5 ASSETSti e3bti 3b

We interpret a positive coefcient estimate on REPRICE_PRED as evidence consistent with the joint hypothesis that rms
make repricing decisions that are motivated by the economic determinants included in the rst-stage model (e.g., restore the
option incentive properties) and that these incentive effects are sufciently large to be reected in subsequent rm performance.
We include REPRICE_RESID in the model as a specication check. If one takes an extreme optimization perspective
that all rms are optimizing with respect to their repricing decisions, there should be no reason to expect performance
differences between repricing and non-repricing rms after controlling for REPRICE_PRED (Demsetz and Lehn,
1985; Ittner and Larcker, 2001). In such a case, a signicant coefcient on REPRICE_RESID can only be attributable to
measurement error or misspecication of the repricing choice model. However, as noted by Hanlon et al. (2003),
Ittner et al. (2003), and Larcker (2003), an extreme optimization perspective that fails to acknowledge the possibility of any
off-equilibrium behavior is somewhat unrealistic. These studies argue that a more realistic perspective is that rms are
dynamically learning and moving towards the optimal level of compensation (or repricing, in our setting), and, thus, a
cross-sectional sample should consist of rms that are distributed around, but not necessarily at, the optimal level. The
inclusion of REPRICE_RESID therefore allows us to reect the notion that some repricings may not be optimal.23

4.3.2. Findings
Table 6 presents regression summary statistics from the estimation of (3a) and (3b). We nd that the repricing
component attributable to underlying economic determinants is positively associated with subsequent changes in
operating income and cash ows. Specically, in the operating income specication, the coefcient estimate on
REPRICE_PRED is positive, as predicted, and signicantly so in the one- and three-year-ahead horizons (t-statistics= 2.45,
1.97 and 1.19 for the one-, three-, and ve-year-ahead horizons). In the operating cash ow specication, the coefcient
estimate on REPRICE_PRED is signicantly positive in all three horizons (t-statistics=2.49, 2.69, and 2.41). In contrast, the
residual component, REPRICE_RESID, is insignicant in all models (t-statistics=1.27, 0.07, and 0.26 in the operating income
specication, and  0.60,  0.67, and 0.28 in the operating cash ow specication).
Taken together, these ndings suggest the positive association documented in the baseline model between repricing
and future rm performance is attributable to the underlying economic determinants of the repricing decision rather than
to other factors such as rent extraction. Specically, rms with stronger motivation to restore the incentive properties of
employee stock options (e.g., rms with more growth opportunities) are more likely to reprice their options, and such
rms also exhibit a more pronounced increase in future performance. Furthermore, the lack of signicance on the residual
component indicates that when the repricing decision is unrelated to the underlying economic determinants specied in
our repricing model, there is no evidence for subsequent improvement in performance. This nding suggests that option
repricing in and of itself does not necessarily lead to increased rm performance.

4.4. Repricing of executive and non-executive employee stock options

4.4.1. Research design


Our next set of tests investigates whether repricing has different incentive effects for different ranks of employees. To
do so, we investigate whether subsequent changes in operating income and cash ows vary across rms based on which
employee ranks are permitted to participate in the repricing. As before, we rst estimate a baseline model:
X
96 X
30
DOPINCt t;i b0Y YRYti b0N INDYNi b1 REPRICE_EXECti
Y 90 N1
b2 REPRICE_NONEXECti b3 REPRICE_ALLti b4 DOPINCti b5 MBti b6 ASSETSti e4ati 4a

X
96 X
30
DCFOt t;i b0Y YRYti b0N INDYNi b1 REPRICE_EXECti b2 REPRICE_NONEXECti b3 REPRICE_ALLti
Y 90 N1
b4 DCFOti b5 MBti b6 ASSETSti e4bti 4b

23
Replacing REPRICE with the tted value from the repricing model, REPRICE_PRED, also mitigates concerns about potential endogeneity between the
repricing decision and the magnitude of the change in subsequent performance. However, as noted by Larcker (2003), some of the explanatory variables
in the rst-stage model may be endogenous themselves, and, consequently, any attempt to mitigate the endogeneity bias using a two-stage approach
may simply be pushing the endogeneity back one level.
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D. Aboody et al. / Journal of Accounting and Economics 50 (2010) 7492 85

Table 6
Summary statistics from robust regressions. Sample of 300 repricing rms and 1064 non-repricing rms.

Panel A: Dependent variableFuture changes in operating income


DOPINCt + 1 DOPINCt + 3 DOPINCt + 5

Independent variable Pred Coeff t-Stat Coeff t-Stat Coeff t-Stat

REPRICE_PRED + 0.034 2.45 0.071 1.97 0.021 1.19


REPRICE_RESID ? 0.003 1.27 0.001 0.07 0.001 0.26
DOPINCt ?  0.488  54.01  0.843  20.03  0.757  15.18
MB ? 0.001 7.70  0.001  1.28  0.001  0.67
ASSETS ?  0.001  1.93  0.002  1.60  0.001  0.07

N 1364 1208 988


Adj R2 0.80 0.56 0.47

Panel B: Dependent variableFuture changes in cash from operations


DCFOt + 1 DCFOt + 3 DCFOt + 5

Independent variable Pred Coeff t-Stat Coeff t-Stat Coeff t-Stat

REPRICE_PRED + 0.051 2.49 0.077 2.69 0.131 2.41


REPRICE_RESID ?  0.001  0.60  0.001  0.67 0.001 0.28
DCFOt ?  0.126  7.43  0.279  9.78  0.380  9.08
MB ?  0.001  7.30 0.001 1.84  0.001  0.31
ASSETS ?  0.001  2.79  0.001  2.00  0.001  0.47

N 1364 1208 988


Adj R2 0.25 0.23 0.33

REPRICE_PRED and REPRICE_RESID are the predicted and residual components, respectively, from the estimation of the Logit model in Table 5, Panel B.
DOPINCt is operating income (income before extraordinary items, discontinued operations, and accounting changes) in year t minus operating income in
year t  1, deated by market value of equity at the beginning of year t. DOPINCt + t is operating income in year t+ t (t = 1, 3, and 5) minus operating income
in year t, deated by market value of equity at the beginning of year t.
DCFOt is cash from operations in year t minus cash from operations in year t  1, deated by market value of equity at the beginning of year t. DCFOt + t is
cash from operations in year t + t (t =1, 3, and 5) minus cash from operations in year t, deated by market value of equity at the beginning of year t.
MB is the ratio of market value of equity to book value of equity at the end of year t. ASSETS is the natural logarithm of the book value of total assets at the
end of year t.
The regression equations include untabulated year- and industry-specic intercepts.

Eqs. (4a) and (4b) are similar to (1a) and (1b), with the exception that we now allow the coefcient estimate on the
repricing variable to vary for rms with executive-only repricings, non-executive-only repricings, and all-employee repricings.
Specically, REPRICE_EXEC, REPRICE_NONEXEC, and REPRICE_ALL are indicator variables that equal one if the repricing applies
to executives/top management only, non-executive employees only, or all employee holders of stock options, respectively.24 If
repricings help restore the incentive properties of stock options across all employee ranks sufciently to be reected in
subsequent rm performance, the coefcient estimates on the repricing indicator variables should all be positive.
Next, for each rm we parse out the likelihood of repricing into its predicted and residual components, and investigate
their association with subsequent rm performance. We conduct the analysis separately for executive-only repricings,
non-executive-only repricings, and all-employee repricings. Specically, we estimate the repricing model, Eq. (2),
separately for each group of repricing rms and the control group of non-repricing rms.25 We use the coefcient
estimates to compute REPRICE_PRED and REPRICE_RESID and estimate Eqs. (3a) and (3b).

4.4.2. Findings
Table 7 presents regression summary statistics for the baseline model, Eqs. (4a) and (4b). Consistent with options
having different incentive effects for different ranks of employees, Panel A indicates that the coefcient estimate on
REPRICE_EXEC is signicantly positive in the three- and ve-year-ahead specications (t-statistics=0.16, 1.97, and 2.38 for
the one-, three-, and ve-year-ahead tests), whereas that on REPRICE_NONEXEC is insignicant across all three horizons
(t-statistics =0.96, 0.59, and 0.56). The coefcient estimate on REPRICE_ALL is signicantly positive in all three horizons
(t-statistics =3.18, 2.12, and 2.06). Similarly, Panel B indicates the relation between executive-only repricings and
subsequent changes in operating cash ows is signicantly positive across all specications (t-statistics for REPRICE_EXEC

24
We perform this classication using the information disclosed in notes to the nancial statements. As noted above, we are able to classify 268 of
the 300 repricing rms into one of the three categories. The remaining 32 unclassied repricings are excluded from these tests.
25
This approach assumes that the repricing decision model is descriptive for each of the three groups, sufciently enough to distinguish that group
from the control group of non-repricing rms. Untabulated results indicate that the explanatory power of the model is fairly similar across the three
groups; the Pseudo R2 of the logit regression is 18%, 24%, and 22% for executive-only repricings, non-executive-only repricings, and all-employee
repricings, respectively. Moreover, inferences from the model are similar across the three specications.
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Table 7
Summary statistics from robust regressions. Sample of 45 executive-only repricings, 38 non-executive-only repricings, 185 all-employee repricings, and
1064 non-repricing rms.

Panel A: Dependent variableFuture changes in operating income


DOPINCt + 1 DOPINCt + 3 DOPINCt + 5

Independent variable Pred Coeff t-Stat Coeff t-Stat Coeff t-Stat

REPRICE_EXEC + 0.003 0.16 0.048 1.97 0.073 2.38


REPRICE_NONEXEC + 0.011 0.96 0.012 0.59 0.017 0.56
REPRICE_ALL + 0.022 3.18 0.024 2.12 0.034 2.06

DOPINCt ?  0.488  55.87  0.589  24.58  0.677  17.33


MB ? 0.001 11.75  0.001  0.43  0.001  1.45
ASSETS ?  0.001  1.32  0.001  0.92 0.001 0.27

N 1329 1173 953


Adj R2 0.74 0.49 0.48

Panel B: Dependent variableFuture changes in cash from operations


DCFOt + 1 DCFOt + 3 DCFOt + 5

Independent variable Pred Coeff t-Stat Coeff t-Stat Coeff t-Stat

REPRICE_EXEC + 0.042 3.41 0.076 2.95 0.045 1.71


REPRICE_NONEXEC +  0.005  0.50 0.002 0.13 0.010 0.41
REPRICE_ALL + 0.010 1.66 0.001 0.05 0.028 1.91

DCFOt ?  0.276  15.03  0.474  99.90  0.443  80.86


MB ?  0.001  4.57 0.001 0.79  0.001  0.22
ASSETS ?  0.001  1.45  0.001  1.64 0.001 0.01

N 1329 1173 953


Adj R2 0.25 0.87 0.81

REPRICE_EXEC is an indicator variable that equals one for rms that repriced executive stock options only, and zero otherwise. REPRICE_NONEXEC is an
indicator variable that equals one for rms that repriced non-executive employee options only, and zero otherwise. REPRICE_ALL is an indicator variable
that equals one for rms that repriced all stock options, and zero otherwise.
DOPINCt is operating income (income before extraordinary items, discontinued operations, and accounting changes) in year t minus operating income in
year t  1, deated by market value of equity at the beginning of year t. DOPINCt + t is operating income in year t + t (t = 1, 3, and 5) minus operating income
in year t, deated by market value of equity at the beginning of year t.
DCFOt is cash from operations in year t minus cash from operations in year t  1, deated by market value of equity at the beginning of year t. DCFOt + t is
cash from operations in year t+ t (t = 1, 3, and 5) minus cash from operations in year t, deated by market value of equity at the beginning of year t.
MB is the ratio of market value of equity to book value of equity at the end of year t. ASSETS is the natural logarithm of the book value of total assets at the
end of year t.
The regression equations include untabulated year- and industry-specic intercepts.

are 3.41, 2.95, and 1.71 for the one-, three-, and ve-year-ahead tests). In contrast, repricings that exclude executives
exhibit no association with changes in operating cash ows (t-statistics for REPRICE_NONEXEC are  0.50, 0.13, and 0.41).
The coefcient estimate on REPRICE_EXEC is greater than that on REPRICE_NONEXEC across all three horizons, and
signicantly so in the one- and three-year-ahead specications (p-value of an F-test= 0.01, 0.02, 0.31 for the one-, three-,
and ve-year-ahead tests). The coefcient estimate on REPRICE_ALL is positive in all three horizons (t-statistics= 1.66, 0.05,
and 1.91). Taken together, these ndings suggest the increased operating income and cash ows in periods subsequent to
the repricing are attributable to repricings that include top executives; when top executives are excluded from the
repricing, we nd no evidence that repricing rms outperform non-repricing rms in subsequent periods.
Table 8 presents regression summary statistics from Eqs. (3a) and (3b), estimated separately for rms with executive-
only repricings, non-executive-only repricings, and all-employee repricings. Panel A presents the estimation results for the
subsample of executive-only repricings. We nd that the repricing component that is attributable to underlying economic
determinants is positively associated with subsequent changes in operating income and cash ows. Specically, in both the
operating income and cash ow specications, REPRICE_PRED is positive, as predicted, and signicantly so in the three- and
ve-year-ahead tests (t-statistics= 0.07, 3.12, and 2.58 for the operating income specication, and 1.31, 2.76, and 1.86 for
the cash ow specication). In contrast, the residual repricing component, REPRICE_RESID, is insignicant in all but one of
the six specications (t-statistics= 0.19,  0.65, and  1.93 in the operating income specication, and 0.73, 1.53, and 0.86 in
the cash ow specication). These ndings suggest the positive association documented in the baseline model between the
repricing of executive stock options and subsequent rm performance is attributable to the underlying economic
determinants of the repricing. Specically, the increase in future operating performance is more pronounced for rms with
stronger motivation to restore the incentive properties of their executive stock options.
Panel B presents the estimation results for the subsample of non-executive-only repricings. In contrast to the ndings for
executive-only repricings, we nd little evidence that the underlying economic determinants of the repricing are associated
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Table 8
Summary statistics from robust regressions. Sample of 45 executive-only repricings (panel A), 38 non-executive-only repricings (panel B), and 185 all-
employee repricings (panel C). In each panel, the estimation also includes the control group of 1064 non-repricing rms.

Panel A: Executive-only repricings


Dependent variableFuture changes in operating income
DOPINCt + 1 DOPINCt + 3 DOPINCt + 5

Independent variable Pred Coeff t-Stat Coeff t-Stat Coeff t-Stat

REPRICE_PRED + 0.005 0.07 0.076 3.12 0.177 2.58


REPRICE_RESID ? 0.003 0.19  0.019  0.65  0.014  1.93
DOPINCt ?  0.479  115.34  0.786  15.49  0.708  11.57
MB ? 0.001 0.56  0.001  1.65  0.001  1.93
ASSETS ?  0.001  2.86  0.001  1.65  0.001  0.91

N 1109 979 813


Adj R2 0.87 0.50 0.42

Dependent variableFuture changes in cash from operations


DCFOt + 1 DCFOt + 3 DCFOt + 5

Independent variable Pred Coeff t-Stat Coeff t-Stat Coeff t-Stat

REPRICE_PRED + 0.038 1.31 0.098 2.76 0.138 1.86


REPRICE_RESID ? 0.004 0.73 0.004 1.53 0.007 0.86
DCFOt ?  0.268  9.26  0.289  5.96  0.451  6.75
MB ?  0.001  2.79  0.001  0.60  0.001  1.36
ASSETS ?  0.001  2.40  0.001  1.60  0.001  0.91

N 1109 979 813


Adj R2 0.29 0.22 0.21

Panel B: Non-executive-only repricings


Dependent variableFuture changes in operating income
DOPINCt + 1 DOPINCt + 3 DOPINCt + 5

Independent variable Pred Coeff t-Stat Coeff t-Stat Coeff t-Stat

REPRICE_PRED + 0.023 0.59 0.043 0.93 0.028 0.22


REPRICE_RESID ? 0.001 0.30 0.002 1.45 0.002 1.78
DOPINCt ?  0.690  21.38  0.773  16.05  0.774  9.06
MB ? 0.001 0.37 0.001 1.40  0.001  2.11
ASSETS ?  0.001  2.71  0.001  2.08  0.001  0.74

N 1102 973 805


Adj R2 0.68 0.53 0.37

Dependent variableFuture changes in cash from operations


DCFOt + 1 DCFOt + 3 DCFOt + 5

Independent variable Pred Coeff t-Stat Coeff t-Stat Coeff t-Stat

REPRICE_PRED + 0.007 0.23 0.100 2.13 0.159 1.55


REPRICE_RESID ? 0.003 0.25 0.001 0.38 0.002 1.47
DCFOt ?  0.281  8.65  0.413  6.23  0.303  4.25
MB ?  0.001  2.37  0.001  1.55  0.001  2.33
ASSETS ?  0.001  0.77  0.001  2.49  0.001  0.95

N 1102 973 805


Adj R2 0.21 0.24 0.15

Panel C: All-employee repricings


Dependent variableFuture changes in operating income
DOPINCt + 1 DOPINCt + 3 DOPINCt + 5

Independent variable Pred Coeff t-Stat Coeff t-Stat Coeff t-Stat

REPRICE_PRED + 0.031 2.26 0.087 2.01 0.044 0.63


REPRICE_RESID ? 0.006 1.40  0.011  2.29  0.004  0.60
DOPINCt ?  0.485  76.76  0.861  19.59  0.803  16.52
MB ? 0.001 6.81  0.001  1.58  0.001  1.35
ASSETS ?  0.001  1.44  0.001  1.07 0.001 0.79
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Table 8 (continued )

Panel C: All-employee repricings


Dependent variableFuture changes in operating income
DOPINCt + 1 DOPINCt + 3 DOPINCt + 5

Independent variable Pred Coeff t-Stat Coeff t-Stat Coeff t-Stat

N 1259 1110 896


Adj R2 0.83 0.59 0.52

Dependent variableFuture changes in cash from operations


DCFOt + 1 DCFOt + 3 DCFOt + 5

Independent variable Pred Coeff t-Stat Coeff t-Stat Coeff t-Stat

REPRICE_PRED + 0.068 3.04 0.102 2.96 0.181 3.88


REPRICE_RESID ?  0.002  0.58  0.009  2.49  0.001  0.03
DCFOt ?  0.128  7.12  0.267  9.77  0.487  9.27
MB ?  0.001  7.26 0.001 1.80  0.001  0.08
ASSETS ?  0.001  2.57  0.001  1.48 0.001 0.96

N 1259 1110 896


Adj R2 0.25 0.24 0.30

REPRICE_PRED and REPRICE_RESID are the predicted and residual components, respectively, from the estimation of the Logit model in Table 5, Panel B.
DOPINCt is operating income (income before extraordinary items, discontinued operations, and accounting changes) in year t minus operating income in
year t  1, deated by market value of equity at the beginning of year t. DOPINCt + t is operating income in year t + t (t = 1, 3, and 5) minus operating income
in year t, deated by market value of equity at the beginning of year t.
DCFOt is cash from operations in year t minus cash from operations in year t  1, deated by market value of equity at the beginning of year t. DCFOt + t is
cash from operations in year t+ t (t = 1, 3, and 5) minus cash from operations in year t, deated by market value of equity at the beginning of year t.
MB is the ratio of market value of equity to book value of equity at the end of year t. ASSETS is the natural logarithm of the book value of total assets at the
end of year t.
The regression equations include untabulated year- and industry-specic intercepts.

with subsequent changes in operating income and cash ows. Specically, in both the operating income and cash ow
specications, most coefcient estimates on REPRICE_PRED are insignicant; the only exception is the three-year-ahead cash
ow test (t-statistics=0.59, 0.93, and 0.22 for the operating income specication, and 0.23, 2.13, and 1.55 for the cash ow
specication). The coefcient estimates on REPRICE_RESID are insignicant in all specications, with the exception of the ve-
year-ahead operating income test (t-statistics=0.30, 1.45, and 1.78 in the operating income specication, and 0.25, 0.38, and
1.47 in the cash ow specication). These results suggest the repricing of non-executive-employee options to restore their
incentive properties does not seem to improve rms operating performance in subsequent periods.
Finally, Panel C presents the estimation results for the subsample of rms that repriced the options of all employees.
This panel reveals that REPRICE_PRED is signicantly positive in most specications (t-statistics= 2.26, 2.01, and 0.63 in the
operating income specication, and 3.04, 2.96, and 3.88 in the cash ow specication), whereas REPRICE_RESID is
signicant only in the three-year-ahead horizon (t-statistics= 1.40,  2.29, and 0.60 in the operating income specication,
and 0.58,  2.49, and 0.03 in the cash ow specication).
Taken together, our ndings suggest the improved operating performance in periods subsequent to the repricing is
attributable to the repricing of executive stock options. This is consistent with options providing incentive effects at the
executive level that are large enough to be reected in future rm performance.26 In contrast, we nd no evidence that
repricing rms outperform non-repricing rms when executives are excluded from the repricing. Thus, there is little
evidence that repricing of non-executive employee options induces employee actions that lead to improved rm
performance. To the extent our inferences from the repricing setting can be extended to stock option compensation in
general, our study lends credence to concerns raised by critics of broad-based stock option plans that the incentive effects
of option grants to rank-and-le employees are too small to have a meaningful effect on overall rm protability.

5. Additional analyses

We employ several additional approaches to investigate the relation between the repricing of executive and non-
executive employee stock options and subsequent performance.

26
Because executives can inuence their rms repricing decision, the performance improvement immediately after the repricing of executive stock options
could also be consistent with opportunistic timing (see, e.g., Callaghan et al., 2004). However, it is less likely that ndings from the longer-horizon tests (e.g., three
and ve years after the repricing) are attributable to opportunistic timing of the repricing. Moreover, our nding that the positive relation between repricing and
subsequent operating performance is attributable to the economic determinants of the repricing makes this alternative interpretation less plausible.
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D. Aboody et al. / Journal of Accounting and Economics 50 (2010) 7492 89

5.1. Excluding non-repricing rms

We conduct a within-repricing-rms analysis using the following model:


DOPINCt t;i b1 REPRICE_EXEC_ONLYti b2 REPRICE_NONEXEC_ONLYti b3 DOPINCti b4 MBti b5 ASSETSti e5ati 5a

DCFOt t;i b1 REPRICE_EXEC_ONLYti b2 REPRICE_NONEXEC_ONLYti b3 DCFOti b4 MBti b5 ASSETSti e5bti 5b


REPRICE_EXEC_ONLY is an indicator that equals one for executive-only repricings, and zero otherwise. REPRICE_NONEX-
EC_ONLY is an indicator that equals one for non-executive-only repricings, and zero otherwise. We estimate this model
using the 45 executive-only repricings and the 38 non-executive-only repricings. Comparison between these two groups
helps mitigate concerns about whether the control group of non-repricing rms provides an appropriate benchmark.
However, the small sample size reduces the power of the statistical tests.27
Table 9 presents regression summary statistics from Eqs. (5a) and (5b). We nd that rms with executive-only
repricings exhibit a signicant increase in operating income and cash ows in all six specications. In contrast, rms with
non-executive-only repricings do not exhibit a consistent increase in future performance; the coefcient estimate on
REPRICE_NONEXEC_ONLY is signicantly positive only in the three-year-ahead horizons. Moreover, the coefcient estimate
on REPRICE_EXEC_ONLY is greater than that on REPRICE_NONEXEC_ONLY across all specications, and signicantly so in the
one-year ahead operating income specication (p-value of F-test= 0.01) and the one- and ve-year-ahead cash ow
specication (p-value of F-test=0.04 and 0.08, respectively). Taken together, these ndings support our inferences from the
primary tests that the increased operating income and cash ows in periods subsequent to the repricing is mostly limited
to rms that repriced the options of their top executives; when executives are excluded from the repricing, there is limited
evidence of improvement in rm performance.

5.2. Executive turnover

The improved rm performance subsequent to the repricing of executive stock options is consistent with an incentive
alignment effect. It is also consistent with options helping to reduce costly executive turnover. To examine more directly
the effect of repricing on executive turnover, for each repricing and non-repricing rm we calculate RETENTIONT, the
proportion of the top ve executives who are still in place T years (T= 1, y, 5) after the event year.28 For example, if all top
ve executives are still with the company one year after the event year, RETENTION1 = 1; if none of them is with the
company after ve years, RETENTION5 =0.29
Table 10 compares RETENTIONT for repricing and non-repricing rms. Consistent with Carter and Lynch (2004), we nd
no differences in executive retention rates between the two groups within the rst two years after the event year.
However, consistent with repricings having a positive effect on longer-term executive retention, we nd signicantly
higher retention rates for repricing rms in the third, fourth and fth years after the event year.30
To investigate whether differences in executive turnover explain performance differences between repricing and non-
repricing rms, we include RETENTIONT as an additional explanatory variable in (1a) and (1b). Untabulated results indicate
the coefcient estimate on REPRICE remains signicantly positive is all specications, indicating that inferences regarding
the relation between repricing and subsequent rm performance are robust to controlling for retention effects.31 We also
estimate (1a) and (1b) after including the interaction of RETENTIONT and REPRICE as an additional explanatory variable, in
addition to their main effects. Untabulated results indicate that the coefcient estimate on RETENTIONT *REPRICE is positive
in all specications, and signicantly so in the three- and ve-year-ahead horizons. This suggests the improvement in
operating performance subsequent to option repricing is more pronounced for rms with higher executive retention rates.

5.3. Other changes to executive compensation

Following Balachandran et al. (2004), we also examine whether repricing and non-repricing rms make changes to CEO
cash salary, cash bonuses, and stock option compensation during the event year.32 For each component, we compute the

27
Because the literature on stock option compensation largely focuses on top executives, we are limited in our ability to model rms decision with
respect to which employee ranks to include in the repricing. Thus, to the extent that the economic determinants of the repricing differ across employee
ranks, our inferences may be affected.
28
We do not examine retention rates for non-executive employees due to a lack of available data.
29
We rely on proxy statements to identify the top ve executives in each of the ve years subsequent to the event year. We assume that executives
that are no longer on the list of top ve executives are no longer with the company.
30
We also compare retention rates for rms with executive-only repricings and with non-executive-only repricings. Although retention rates are
higher for executive-only repricing rms, the differences are not statistically signicant.
31
The coefcient estimate on RETENTIONT is signicantly positive in all specications, consistent with lower executive turnover having a positive
effect on future rm performance. However, it is also consistent with the notion that executives are more likely to stay with their rm when performance
is more favorable.
32
We did not include changes in grants of restricted stock in our tests; only a small number of sample rms issued restricted stock during the event
year.
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Table 9
Summary statistics from robust regressions. Sample of 45 executive-only repricings and 38 non-executive-only repricings.

DOPINCt+1 DOPINCt+3 DOPINCt+5

Independent variable Coeff t-Stat Coeff t-Stat Coeff t-Stat

Panel A: Dependent variableFuture changes in operating income


REPRICE_EXEC_ONLY 0.060 2.26 0.061 2.32 0.082 2.71
REPRICE_NONEXEC_ONLY  0.015  0.77 0.041 1.75 0.041 1.56
DOPINCt  0.913  12.52  0.631  6.61  0.483  2.66
MB 0.001 0.41  0.012  2.53  0.016  2.69
ASSETS 0.001 1.66 0.001 0.39 0.001 2.92

N 83 75 69
Adj R2 0.81 0.48 0.40
p-Value of F-test 0.01 0.58 0.29

Panel B: Dependent variableFuture changes in cash from operations


REPRICE_EXEC_ONLY 0.036 2.22 0.066 2.24 0.059 2.60
REPRICE_NONEXEC_ONLY  0.001  0.10 0.049 1.95 0.007 0.35
DCFOt  0.559  5.52  0.501  3.18  0.269  2.02
MB  0.001  0.20  0.016  2.36  0.008  1.71
ASSETS 0.001 1.01 0.001 1.12 0.001 3.84

N 83 75 69
Adj R2 0.47 0.36 0.39
p-Value of F-test 0.04 0.60 0.08

REPRICE_EXEC_ONLY is an indicator that equals one for rms with executive-only repricings, and zero otherwise. REPRICE_NONEXEC_ONLY is an indicator
that equals one for rms with non-executive-only repricings, and zero otherwise.
DOPINCt is operating income (income before extraordinary items, discontinued operations, and accounting changes) in year t minus operating income in
year t  1, deated by equity market value at the beginning of year t. DOPINCt+t is operating income in year t+t (t=1, 3, and 5) minus operating income in
year t, deated by equity market value at the beginning of year t.
DCFOt is cash from operations in year t minus cash from operations in year t  1, deated by equity market value at the beginning of year t. DCFOt+t is cash
from operations in year t+t (t=1, 3, and 5) minus cash from operations in year t, deated by equity market value at the beginning of year t.
MB is the ratio of market value of equity to book value of equity at the end of year t. ASSETS is the natural logarithm of the book value of total assets at the
end of year t.
Table 10
Retention rates for the rms top ve executives (Chief Executive Ofcer, Chief Operating Ofcer, Chief Financial Ofcer, Chairman of the Board, and
President) over the ve years subsequent to the event year.

Repricing rms (n= 300) Non-repricing rms (n= 1064) p-Value

Mean Median Std. Dev. Mean Median Std. Dev. t-Test Wilcoxon

First year 0.795 1.000 0.329 0.764 1.000 0.347 0.182 0.213
Second year 0.588 0.667 0.394 0.562 0.667 0.398 0.352 0.354
Third year 0.439 0.500 0.388 0.371 0.333 0.389 0.013 0.026
Forth year 0.310 0.250 0.351 0.250 0.000 0.346 0.012 0.001
Fifth year 0.215 0.000 0.302 0.164 0.000 0.292 0.012 0.001

RETENTION is the proportion of the top ve executives that are still in place one to ve years after the event year. For example, if all top ve executives
remain with the company one year after the event year, (i.e., the repricing year for repricing rms and the year of stock price decline for non-repricing
rms), RETENTION for First year equals 1. If none of the top ve executives is with the company, RETENTION for First year equals 0. A higher value of
RETENTION indicates a lower turnover rate.
p-Values for differences in means and medians between repricing and non-repricing rms are based on two-tailed tests.

difference between compensation in the event year and the corresponding amount for the prior year, deated by lagged market
value of equity. Using hand-collected data from proxy statements, we are able to obtain complete CEO compensation data for
177 repricing rms. For the non-repricing group, we obtain from ExecuComp complete CEO compensation data for 115 rms.
Untabulated statistics indicate that mean and median changes in both salary and bonuses are not signicantly different
between repricing and non-repricing rms. Thus, there is no evidence that repricing and non-repricing rms differ with
respect to changes to CEO cash compensation in response to the stock price decline. In contrast, mean and median changes
in CEO stock option grants are signicantly higher for the repricing rms.33 This nding indicates that non-repricing rms
are not compensating their executives for the reduction in the value of their option holding with new stock option grants.

33
The untabulated mean (median) change in CEO cash salary is 0.002 (0.004) percent of market value of equity for the repricing rms and 0.009
(0.006) for the non-repricing rms. The mean (median) change in cash bonuses is 0.005 (0.000) for the repricing rms and  0.002 (0.000) for the non-
repricing rms. Finally, the mean (median) change in the Black-Scholes (1973) value of CEO option grants is 0.007 (0.001) percent of equity market value
for the repricing rms and  0.018 ( 0.008) for the non-repricing rms.
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6. Summary and conclusions

We investigate the relation between the repricing of executive and non-executive employee stock options
and subsequent rm performance. We nd that repricing rms exhibit a greater increase in operating income and
cash ows over the subsequent ve years than a control group of non-repricing rms with a similar decline in stock price.
We document that the positive relation between repricing and rms subsequent performance is attributable to the
underlying economic determinants of the decision to restore the incentive properties of the options. Moreover, we nd
that the increase in subsequent performance is attributable to rms that included their top executives in the repricing.
Taken together, our ndings provide evidence that options provide incentive effects at the executive level that are
sufciently large to be reected in rm performance, but no evidence for similar incentive effects for non-executive
employees.
We note that our inferences are subject to a number of caveats. First, inferences are subject to the ability of the repricing
choice model to reect the use of stock options for incentive alignment purposes. Second, our focus on future operating
performance does not control for potential costs associated with the repricing, and hence we cannot draw inferences about
the effect of repricings on shareholders wealth. Finally, although we assess the effects of executive turnover, we do not
compare the effectiveness of repricing to that of other incentive mechanisms rms might use to deal with a stock price
decline.
Notwithstanding the above limitations, our study makes a signicant contribution to the extant literature by
providing evidence on the incentive effects associated with employee stock options in the context of repricing. To the
extent that our inferences from the repricing setting can be extended to stock option compensation in general, we
contribute to the on-going debate on the incentive effects of broad-based employee stock option plans. The high
technology industry strongly resisted the FASBs decision to expense all employee stock options, arguing that stock options
are the engine that fuels rms performance. Our ndings for non-executive employees provide little support to such
claims and lend more credence to concerns raised by critics of stock option compensation that the incentive effects of
option grants to rank-and-le employees are insufcient to have a meaningful effect on overall rm protability. Our
ndings may therefore provide insight into discussions on the effectiveness of broad-based option plans as a form of
employee compensation.

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