Cheap Stock Options: Antecedents and Outcomes
52 Pages Posted: 20 Apr 2022 Last revised: 21 May 2024
Date Written: May 16, 2024
Abstract
We examine the prevalence, determinants, and consequences of cheap stock. Practitioners have adopted the label “cheap stock” to refer to equity-based compensation granted before a firm’s IPO that uses a share price below the IPO price. Cheap stock grants have drawn regulators’ attention, with the SEC frequently commenting on issues related to cheap stock when reviewing firms’ IPO registration statements. We find that the average firm’s IPO price is more than five times the exercise price of options issued in the fiscal year before the IPO. This divergence between the IPO price and the exercise price of recently granted options is greater for firms that grant more options, have larger public offerings, and have venture capital backing. Finally, cheap stock options are associated with greater IPO underpricing, lower post-IPO investment, and higher CEO compensation. Collectively, our results illustrate the extent of cheap stock option grants and how these grants influence firms’ post-IPO behavior.
Keywords: Initial public offering, IPO, cheap stock, stock options, earnings management, executive compensation, financial reporting quality
JEL Classification: G14, G24, M12, M13, M40, M41
Suggested Citation: Suggested Citation