Title: Employee Stock Options and Future Firm Performance: Evidence from Option Repricings
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Authors: David Aboody (University of California at Los Angeles), Nicole Bastian Johnson (University of California at Berkeley), and Ron Kasznik (Stanford University)
Publisher: Journal of Accounting and Economics, vol. 50, no. 1
Date Published: May 2010
The past two decades have seen a large increase in the use of stock options in employee compensation, especially in the technology industry. Supporters argue that options aid in the retention of key employees and spur them to work harder and more efficiently, and that aligning staff and shareholder incentives will lead to better firm performance. Critics have complained that widespread stock options have almost no value because they let executives collect bonuses out of proportion with their workload, and lower-level employees don’t have enough impact on a company’s bottom line for incentives to make a difference. Many studies have examined the impact of option compensation at the executive level, but this paper also explores the effect of incentives on non-executive employees. The researchers found that although stock options provided to executives did indeed boost firm performance, such incentives did little to improve a company’s operations when they were offered to rank-and-file employees. They concluded that granting options to a large range of employees may not be as effective as is widely believed.
The authors examined SEC filings between 1990 and 1996 for companies whose stock price fell below the options exercise price for many employees. The researchers wanted to find companies that repriced their options for top-level employees and/or rank-and-file workers, which is essentially the same as starting a new options program, to see the impact of options on employee incentive as manifested by company cash flow and operating income. Because only 300 of the 1,364 companies that met the criteria for this study repriced their options, the authors were also able to compare the effect of two different compensation strategies on corporate performance. The study revealed that companies that repriced options significantly outperformed those that didn’t — and the performance gap grew steadily over five years.
The key finding, however, concerned the difference between executives and rank-and-file employees. Companies that repriced options only for upper management did much better than companies that chose not to reprice at all — but companies that repriced options only for lower-level workers did not outperform the companies that retained their original option price.
This paper confirms that stock options provide incentives for executives that are reflected in a company’s overall performance. But the researchers find no evidence that a similar effect exists among lower-level employees.