Broadly Granted Stock Options Improve Corporate Performance
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Email this pageThe first assessment of the impact of broad-based stock option plans on corporate performance shows that they appear to increase productivity and return on assets. This improved performance offsets the dilution the issuance of options creates, so that the plans appear to have a neutral impact on total shareholder return. These are the principal findings of a new study by Douglas Kruse, Joseph Blasi, Jim Sesil, and Maya Krumova of Rutgers University, using data provided by the NCEO. Kruse and Blasi are considered to be the preeminent academic analysts of employee ownership.The study was based on data from the 1998 version of the NCEO's study Current Practices in Stock Option Plan Design. That study sent surveys to 1,360 companies that were identified as possibly having broad-based option plans, which we defined as plans in which more than 50% of full-time employees would actually receive options. We received 141 responses, of which 96 both met our criteria and provided usable data. For the Rutgers study's purposes, however, 105 companies provided usable data. In any study sampling bias can be an issue, but we do not believe it has a significant impact here. First, we believe our sample is reasonably representative of the universe of publicly traded stock option companies. Second, most of the Rutgers study used a methodology that reduces or eliminates sampling bias.
Background and Methodology
This is the first study to evaluate whether broad-based stock options have any impact on corporate performance. As a relatively recent phenomenon, it is only now beginning to be possible to make this assessment. The issue is one of increasing importance as these plans have grown to cover an estimated seven to ten million people and are expanding quickly. The plans are also distributing a lot of equity, with overhang rates (the dilution that would be caused if all unexercised options were exercised) running at between 5% and 20% in most companies offering broad options. Typically, just under half this dilution comes from options issued to non-management employees. A growing number of shareholder groups have questioned whether this dilution is excessive, but a tight labor market and an increasing emphasis on employee involvement in companies has made sharing ownership with employees either highly desirable or imperative at many companies.One of the typical assumptions behind a broad-based plan is that as owners employees will be more productive and that this productivity will justify the dilution the plans create. It is important to note, however, that even if this were not true companies might still offer options if they were the only way to attract and retain people. Options can also be justified as a compensation strategy that conserves cash and shares risk between employees and shareholders.
Ninety-one percent of the sample companies were publicly traded (and many of the results apply only to them); 28% were manufacturers of electronic and measurement equipment, 23% were from other manufacturing sectors, 22.5% provided business services, and the rest belonged to other sectors. Data were gathered on productivity, return on assets, Tobins Q (a complex financial measure of return on assets that produced similar results to the return on assets measure and is not reported here), and total shareholder return. These were then compared to all companies in their industries of similar size (the full sample group) and to paired comparisons of matched companies (the paired sample).
The detailed econometrics of the study are beyond this brief report. To oversimplify, however, productivity was measured as a ratio of sales per employee. Return on assets was the income-adjusted depreciation x 100 divided by capital plus current assets minus current liabilities. Total shareholder return was the increase in stock price and dividends adjusted for splits. These measures were statistically adjusted to provide more reliable results using standard econometric models.
The ideal study would look at companies before and after a broad-based plan was initiated, indexing out market effects. Unfortunately, we only had specific plan start dates that were early enough to do this for 16 companies. While the Rutgers study looked at this sub-sample, the results (which follow the general pattern of other results) are not very reliable. As a substitute, the study analyzed companies in the period 1985-87 and 1995-97, reasoning that few, if any, of the companies had option plans in the earlier period and most had them in the later period. Comparisons were made with non-stock option companies for the two periods and the difference subtracted. In effect, the earlier period results provide a baseline to measure the performance in the later period. If a stock option company had productivity 3% greater than its peers in the earlier period and 6% greater in the later period, than it could be argued that the plan improved relative performance on this measure by 3%. To analyze the data, a statistical technique known as regression was used. Essentially, this analyses the differences between two sets of samples (in this case the option and non-option companies) on a variable (productivity, for instance) holding other factors constant.
Results
The study found that productivity rates did improve with the institution of a plan. The difference between productivity scores for the overall sample from the pre-plan period (1985 to 1987) to the post-plan period (1995 to 1997) was 16% when the comparison group was all non-option companies and 19.4% when looking just at paired comparisons. Neither result is likely to have occurred at random.Return on assets showed a similar pattern. Here the stock option companies showed an improvement of 2.5% on ROA relative to the full sample in the post-plan period compared to the pre-plan period. When just paired comparisons are used, the improvement was 2.05%. Again, these results were very unlikely to have occurred randomly.
Total shareholder return, however, showed no statistically significant difference in the relative performance during the two periods (meaning the researchers cannot be sure that the results they found were not just random).
Looking simply at how the companies did in the period 1992 to 1997, without trying to adjust for market effects, a similar pattern emerges. Productivity growth is 1% per year greater and return on assets 5.8% greater, but shareholder return is not statistically distinguishable. The study also looked at companies that provide options to 50% of non-management employees (rather than 50% or more of all employees), but this did not significantly change the results.
These findings provide encouragement to those promoting broad-based plans, but the researchers caution that this is only a first look at limited data over a limited time. Further work will be needed to understand the issue more fully.
Full Text of Original Report
For academics and others, we also have the full text of the researchers' original report online, complete with tables:Document 1: Report (PDF format)
Document 2: Tables (PDF format)
