Selection Benefits of Stock-Based Compensation for the Rank-and-File

Abstract

We investigate a potential selection benefit of stock-based compensation for rank-and-file employees, whose pay under this compensation form is insensitive to their individual efforts. Using a laboratory experiment, where we control for both the timing and expected magnitude of compensation, we demonstrate that individuals with higher levels of dispositional optimism are more likely to choose compensation contingent on a company’s future stock price over a fixed salary, even after controlling for the individual’s risk tolerance. Furthermore, individuals who select stock-based compensation also perform better when confronted with a challenging problem-solving task, as compared to those selecting a fixed salary. As expected, dispositional optimism mediates this performance effect, consistent with theory suggesting that optimists believe more strongly that their efforts will generate high productivity motivating them to work harder on a task. In addition to contributing to a better understanding of the puzzling prevalence of stock-based compensation plans at the rank-and-file level, our results also offer testable empirical implications.

Keywords: stock-based compensation, contract self-selection, employee optimism