ON RESCISSIONS IN EXECUTIVE STOCK OPTIONS

Abstract

We study executive stock options that permit the option holder to rescind an exercise decision, returning the shares acquired to the company and obtaining a refund of the exercise price. Rescissions occurred at a number of U.S. companies in 2000 after the large decline in internet stocks, and have been widely condemned as a weakening of incentives. To the contrary, we find that in many situations rescindable options dominate ordinary options by delivering greater value and stronger incentives to the employee at a lower cost to the firm. The attractiveness of rescindable options arises as a consequence of the income tax treatment of most executive stock options in the U.S.