How Do Broad-Based Stock Option Grants Affect Firms’ Overall Future Productivity?

• In Event: Firm Performance
  In Paper Session: Managerial Accounting

Abstract

We investigate the impact of broad-based stock option grants on future firm productivity. The number of U.S. employees holding employee stock options as well as the grant date value of those stock options substantially increased over recent decades (Revsine et al., 2012; Murphy 2012b). At the same time, firms generally reduce R&D and capital expenditures subsequent to option grants merely to minimize the dilutive effect of stock options on EPS (Bens et al., 2002; Bhargava, 2013). While firms expect that stock option grants will lead to increased alignment of shareholders’ and employees’ interests, questions often arise as to whether the incentive effect outweighs the cost. We focus on option grants to lower level employees because 1) rank-and-file employees lack the influence to affect overall firm performance and 2) a significant part of stock options are granted to employees other than the top five named executives. We posit that stock option grants to a large number of rank-and-file employees have negative effect on future performance owing to limited incentive effect but the increased associated cost. Using 9,501 firm-year observations for 1,832 U.S. companies, we document that higher broad-based stock option awards are negatively associated with future productivity. In further tests, we also examine the extent to which the relationship between broad-based stock options and productivity is influenced by financial condition of the firm or industry practice. We show that the negative relationship between broad-based stock options and productivity is exacerbated in “new economy” industry firms, where broad-based stock option grants are prevalent. However, the negative relationship is attenuated when option grants are necessitated by cash constraints. We interpret our results as evidence that supplements prior research which suggests that stock options are associated stock repurchases and subsequent reduction in R&D and capital expenditures.

Authors

• Menghistu (Stu) M Sallehu, Eastern Illinois University

• Wenjing Ouyang, University of the Pacific