The Structure and Performance Consequences of Equity Grants to Employees of New Economy Firms

Abstract

The paper examines the determinants and performance consequences of equity grants to senior-level executives, lower-level managers, and non-exempt employees of "new economy" firms. We find that the determinants of equity grants are significantly different in new versus old economy firms. We also find that employee retention objectives, which new economy firms rank as the most important goal of their equity grant programs, have a significant impact on new hire grants, but not subsequent grants. Our exploratory performance tests indicate that lower than expected grants and/or existing holdings of options are associated with poorer performance in subsequent years. The Structure and Performance Consequences of Equity Grants To Employees of New Economy Firms AbstractThe paper examines the determinants and performance consequences of equity grants to seniorlev el executives, lower-level managers, and non-exempt employees of"new economy" firms . We find that many of the equity grant determinants and their relative importance vary significantly between new and old economy firms. In addition, we find that employee retention objectiv es, which new economy firms rank as the most important goal of their equity grant programs, have a significant impact on new hire grants, but not on annual, ongoing grants. Our exploratory performance tests indicate that lower than expected option grants and/or ex isting option holdings are associated with lower accounting and stock price performance in subsequent years. However, we find that greater than expected option and equity grants and holdings have little consistent association with future performance.

Do executive stock option grants have value implications for firm performance?

“…This is especially so if the firm's risk is high because diversification is costly. Lewellen, Loderer and Rosenfeld (1985) and 1 While Ittner, Lambert and Larcker (2003) use firm size as one of the determinants of equity grant intensity, they argue that the predicted relation between equity grants and firm size is unclear due to two opposing effects. One, it is difficult to monitor managers in large firms and two, it is more difficult for individual employees to affect firm value in a large firm.…”

“…One, it is difficult to monitor managers in large firms and two, it is more difficult for individual employees to affect firm value in a large firm. Unlike Ittner, Lambert and Larcker (2003) who examine a wider spectrum of employees in firms, we do not face the same problem as our study focuses on the top five executives in firms. 2 Prior studies such as Morck, Shleifer and Vishny (1988) and McConnell and Servaes (1990) use R&D and advertising expenses as proxies for future growth opportunities.…”

“…2 Prior studies such as Morck, Shleifer and Vishny (1988) and McConnell and Servaes (1990) use R&D and advertising expenses as proxies for future growth opportunities. On the other hand, Ittner, Lambert and Larcker (2003) treat them as part of the firm's investment opportunity set. Lewellen, Loderer and Martin (1987) support this argument when they find that executives with equity grants in firms have higher exposure to undiversifiable firm risk.…”

Are Stock Options Grants to CEOs of Stagnant Firms Fair and Justified?

“…Consistent with Ittner et al (2003), Klassen and Mawani (2000), and Yermack (1995) we define the proportion of stock options compensation for each firm-year as follows:…”

“…HITAX and LOTAX are indicator variables to capture the effects of high and low marginal tax rates. We expect equity grants to be negatively associated with HITAX and positively associated with LOTAX (Ittner et al, 2003).…”