On rescissions in executive stock options

In recents years, some executives have been permitted by firms to rescind stock option exercise decisions by returning the stock to the company for a refund of the exercise price. Such rescissions have been widely condemned as weakening incentives. We find that rescissions often deliver the same incentive payoffs as a standard option but at a lower cost. The cost savings arise as a consequence of the tax treatment of the exercise/rescission decisions under U.S. tax law. The savings are associated positively with stock volatility and the personal/corporate tax rate spread and negatively with interest rates.