Repricing of employee stock options

Various circumstances and developments in the start-up environment can cause fluctuations in company value and thus the need to reprice. On the one hand, it can happen that when a start-up goes public, there is a real hype that causes the share price to skyrocket at the beginning. Only after a certain period the share price stabilises and thus provide a more realistic picture of the company's value. On the other hand, the share prices of start-ups can be significantly more volatile than the share prices of companies that are already established in the market and high price fluctuations are common. If share prices do fall in the long run, it may be necessary to adjust the exercise price of the employee options downwards in order to ensure that the option stays attractive. 

The following section describes the accounting treatment and the effect of repricing on the income statement in accordance with IFRS 2, which is the accounting standard that deals with the accounting treatment of all share-based payments and how to account for them. A distinction must first be made between two types of employee share options, the equity-settled share-based payments and the cash-settled share-based payments. IFRS 2 does not contain any specific requirements for changes to cash-settled options, as they are measured at every balance sheet date. The treatment of equity-settled options is therefore described below (IFRS 2.26 et seq.).

In accordance with IFRS 2.27, the benefits received by the employees from the share-based payment agreement must be recognised at least at the fair value of the equity instruments determined on the grant date. Furthermore, a company must recognise the effects of changes and modifications that increase the total fair value of the share-based payment agreement, if they are beneficial to the employees.

For the correct accounting, the fair value must therefore be determined twice in the course of a change in the exercise price, once at the original grant date and then at the modification date.

Hence, the original commitment to the employees continues to be recognised as it has been before. The modified commitment, which is determined using the modified period and conditions, is then added to the original commitment (IFRS 2.B43(a)).

When accounting for the above, the following two scenarios need to be considered when recognising expenses on an accrual basis in accordance with IFRS 2:

The following overview provides an overview of the accounting treatment of modifications to share-based payments:

Repricing and the associated recognition of expenses, IFRS 2.47 requires the share-based payments to be amended in the reporting period with an explanation of the reason for the amendment, the additional fair value and information on how the additional fair value granted was determined.

In year 1, company X grants 50 share options to 10 employees each. The prerequisite for exercising the options is that the employees remain with the company for at least 3 years after grant (vesting period = 3 years). The company determines an initial exercise price of EUR 18 per share option. Respectively the grant-date fair value of an option is determined to be EUR 15. At the end of the first year, the company's share price falls below the exercise price, meaning that exercising the options would no longer be attractive for the employees. Accordingly, the company carries out a repricing in which the end date of the vesting period remains unchanged. The modified exercise price is set at EUR 5 per share and the incremental fair value is EUR 3 per option. No employees participating in the share option programme will leave the company during the vesting period and all employees have accepted the offer. No new employees will be accepted to the share option programme. 

In accordance with IFRS 2, the company must recognise the following expense:

Year 1: Expense EUR 2,500 to equity EUR 2,500 

Year 2: Expense EUR 3,250 to equity EUR 3,250

Year 3: Expense EUR 3,250 to equity EUR 3,250

The inherent volatile market environment of start-ups and the associated price fluctuations make a possible repricing of the share options granted to employees relevant and the corresponding accounting treatment must be considered. According to IFRS 2, the benefits received from a share option programme must be recognised at least at the fair value calculated at the time of granting. A subsequent reduction in the exercise price increases the fair value of the share options in total compared to the fair value prior to the change. The difference must be recognised as an expense accordingly. If a company does not reprice, there would no longer be any incentive for employees to remain with the company any longer or not to exercise the option at all. Therefore, the option programme would not fulfil its purpose and not reflect the real expense to the company.