ESO Repricing

ESOs are almost always "at the money" when they are issued, meaning that the stock price is equal to the strike price. Notice that, in this case, the intrinsic value is zero, so there is no value from immediate exercise. Of course, even though the intrinsic value is zero, an ESO is still quite valuable because of, among other things, its very long life.

If the stock falls significantly after an ESO is granted, then the option is said to be "underwater." On occasion, a company will decide to lower the strike price on underwater options. Such options are said to be "restruck" or "repriced."

The practice of repricing ESOs is very controversial. Companies that do it argue that once an ESO becomes deeply out of the money, it loses its incentive value because employees recognize there is only a small chance that the option will finish in the money. In fact, employees may leave and join other companies where they receive a fresh options grant.

Critics of repricing point out that a lowered strike price is, in essence, a reward for failing. They also point out that if employees know that options will be repriced, then much of the incentive effect is lost. Today, many companies award options on a regular basis, perhaps annually or even quarterly. That way, an employee will always have at least some options that are near the money even if others are underwater. Also, regular grants ensure that employees always have unvested options, which gives them an added incentive to stay with their current employer rather than forfeit the potentially valuable options.

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