Performance Impact of Employee Stock Options

Abstract

In a sample of 200 large Nasdaq firms we examine the determinants of stock option grants and study whether options are associated with superior firm performance. We find that firms grant options in the face of financial constraints, to give incentives to increase firm value, and to hire and retain employees. We further find that grant of options to retain key employees and to relax financial constraints increases firm value and results in positive abnormal returns. However, there is little evidence that option grants to align employee incentives in high growth firms results in superior performance. There also exists some evidence that difficulty in the estimation of the true cost of stock options results in over estimation of firm value and abnormal returns, though this effect is confined only to the case when Fama-French size and book-to-market portfolios are used as reference portfolios.

Keywords: stock options, firm performance, incentives

JEL Classification: J33, D23