Why Do Some Firms Give Stock Options to All Employees?: An Empirical Examination of Alternative Theories

Abstract

Many firms issue stock options to all employees. We consider three potential economic justifications for this practice: providing incentives to employees, inducing employees to sort, and helping firms retain employees. We gather data on firms' stock option grants to middle managers from three distinct sources, and use two methods to assess which theories appear to explain observed granting behavior. First, we directly calibrate models of incentives, sorting and retention, and ask whether observed magnitudes of option grants are consistent with each potential explanation. Second, we conduct a cross-sectional regression analysis of firms' option-granting choices. We reject an incentives-based explanation for broad-based stock option plans, and conclude that sorting and retention explanations appear consistent with the data.

Lower Salaries and No Options? On the Optimal Structure of Executive Pay

“…A number of further explanations for the use of stock options have been put forward in the literature and might turn out to be successful in aligning theory and compensation practice. Oyer and Schaefer (2005) suggest that CEOs may be overconfident or overly optimistic about the future development of the stock of their companies. We replicate their results and find qualitatively very similar conclusions, namely, only very moderate increases in option holdings.…”

“…The literature on the structure of executive compensation contracts offers two complementary perspectives on executive stock options 1 . One perspective highlights the fact that stock options are “expensive” because they are risky (e.g., Oyer and Schaefer (2005)). For instance, for typical parameter values, an option that is worth $100 to diversified investors may be worth only $20 to $40 to an undiversified, risk‐averse CEO.…”

Broad‐Based Employee Stock Ownership: Motives and Outcomes

“…However, Ittner, Lambert, and Larcker () find the opposite; using a different sample, they find that more cash‐constrained firms are less likely to adopt BBSO plans. Oyer and Schaefer () examine this issue based on cash flows and investment outlays and find mixed evidence.…”

“…Core and Guay () argue that they do, whereas Ittner, Lambert, and Larcker () argue that they do not. Oyer and Schaefer () find mixed evidence. ESOPs are similar to BBSO plans in that they both grant equity stakes to employees on a broad base.…”

Worker overconfidence: Field evidence and implications for employee turnover and firm profits

“…In a different application for workers, Spinnewijn () analyzed the impact of overconfidence about job‐finding on optimal unemployment insurance. For work on overoptimism and stock options for nonexecutive workers see, for example, Oyer and Schaefer ().…”