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Do Stock Options Improve Performance?
Prof. Nicole Johnson compares their effects on executives and rank-and-file workers
Stock options have rewarded many thousands of employees, particularly those working in the information technology industry, with income that far outstrips their normal salaries. It's become an article of faith in Silicon Valley that those rewards create incentives for employees to work harder and smarter, in turn rewarding the companies that lavish options on the workforce with better performance and greater shareholder value.
But does that assumption stand up to careful scrutiny? The answer: It depends on who is receiving the options, according to a new study co-authored by Assistant Accounting Professor Nicole Bastian Johnson.
provide evidence that options provide incentive effects
at the executive level that are sufficiently
large to be reflected in firm
performance, but no evidence for
similar incentive effects for non-executive
employees," wrote Johnson and
co-authors David Aboody of UCLA's
Anderson School of Management and
Ron Kasznik of Stanford's Graduate
School of Business.
Their paper, "Employee Stock
Options and Future Firm Performance:
Evidence from Option Repricings," will
be published in the Journal of Accounting
and Economics later this year. Learning
that granting options to a broad selection
of employees may not be an effective tool
is the paper's most important contribution
to the literature, Johnson says.
Options and their effect on corporate performance have been frequently studied. However, nearly all of the research has focused on options for executive-level employees. Few researchers have looked at companies that granted options to rank-and-file employees, largely because obtaining data is so difficult, says Johnson.
Public companies generally disclose option grants on regularly scheduled proxy statements, but usually for only top-level managers. Digging through hundreds of corporate filings with the Securities and Exchange Commission to find who else may have received options is extremely time-consuming. But that's exactly what Johnson and her colleagues did.
The researchers identified 1,364 companies
with employee stock options whose
stock price declined by 30 percent
or more annually in any of the years
between 1990 and 1996. Of those companies,
300 repriced and formed a basis
of comparison to a control group of the
1,064 that didn't.
The researchers theorized that when
a company's stock price falls below the
exercise price of an option, much of
any incentive effect the options may
have had disappears. Repricing those
options should restore those incentives,
the researchers assumed. A situation
in which options have been repriced
should be similar to that of a newly instituted
So the researchers first asked
whether companies that repriced outperformed
the companies that didn't,
as measured by cash flow and operating
income over one, three, and five years.
Companies that repriced options did
significantly outperform the control
group, and the performance gap grew
Johnson and her colleagues also
found that companies that had repriced
options for only executive-level
employees significantly outperformed
the companies that had not repriced at
all. But firms that repriced options for
only non-executive employees did not
outperform the control group.
While Johnson is confident that the
study's results are meaningful, there are,
she says, a number of caveats.
The researchers chose to study performance before significant accounting changes were made to the treatment of options, particularly the rule instituted in 2005 requiring companies to expense the cost of options. However, while that rule may have prompted some firms to cut back on granting stock options, the researchers do not have any reason to assume it would have changed the effect that option grants have on employee behavior—the focus of their study.
"Our findings provide evidence that
options provide incentive effects
at the executive level … but no
evidence for similar incentive effects
for non-executive employees."
- Prof. Nicole Johnson