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Broadly Granted Stock Options Improve Corporate Performance

There have been a number of studies on this topic, more of which are summarized in the overall review of employee ownership and corporate performance on this site, but there are two very large studies that provide the most comprehensive analyses of these issues.

The Kruse, Blasi, Sesil, and Krumova Study

The 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. The study was performed 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 data results are in submission for publication as of this writing.

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.


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)

The Hochberg-Lindsey Study

In one of the most comprehensive and convincing studies to date on the effect of broad-based option plans on company performance, Yael V. Hochberg of the Kellogg School of Management at Northwestern University and Laura Lindsey at the W. P. Carey School of Business at Arizona State University found that companies that grant options broadly to their employees show a significant improvement in industry-adjusted return on assets (ROA) while companies that grant options more narrowly show a decline in performance. The study, "Incentives, Targeting and Firm Performance: An Analysis of Non-Executive Stock Options," appeared in the November 2010 (Vol. 23, No. 11) issue of the Review of Financial Studies. It is particularly impressive in the scope of the data used and its ability to rule out alternative explanations.


The authors note that the traditional theory of most academic observers on the question of who should get options is that the awards should be concentrated among key decision makers and perhaps some other critical employees. These are the only people, the theory argues, who can directly affect results and, in any event, awards granted to more than a small number of people will result in the "free-rider" effect where employees receiving them have insufficient incentives to make any extra effort, or encourage others to do so, because their personal reward is so marginally dependent on what they do. Hochberg and Lindsey, however, point to growing evidence that people will monitor and punish non-cooperative behaviors far beyond any purely "rational" economic calculation. In that environment, distributing awards too narrowly misses an opportunity to more fully engage the workforce in collective effort.


The primary data source for the study was the Investors Responsibility Research Center (IRRC) Dilution Database. That contains company option plan information collected from public filings for firms in the S&P 500, S&P midcap 400, and the S&P small cap 600. The study period was from 1997 through 2004. The identification of companies with broad grants is inferential. Following prior researchers, they identify companies where the bottom 90% of the workforce gets half the option value, after making certain adjustments. This complex calculation cannot assure that the data set they are using is entirely composed of companies that actually grant options to more than half their work force (the definition of broad-based used by other studies on this topic). They identify 44% of the companies as having broad-based plans; survey data from that period suggest that about 20% of public companies were granting options to most employees. So about half the 44% probably had plans that went well beyond the executive level but not to most or all employees.

There seems no plausible explanation, however, for why this group of companies that gave employees to many, but not most, employees would have performed well enough so that it systematically outperformed both the companies that did have truly broad-based options and those that gave them primarily to executives, which would have to be the case for the ultimate results to be explained by this sub-group only.


Looking at non-executive options and the subsequent firm operating performance as measured by the firm's industry adjusted return on assets (ROA), the authors find that "both the existence of a broad based option plan and the implied incentives of an option plan exert a positive effect on firm performance... holding all other variables constant, a move from the 25th percentile of per-employee delta [that is, increased option grants per employee] to the 75th percentile of per employee delta implies an increase of 0.17% in ROA and a 0.15% increase in cost-adjusted ROA. The effect we estimate is approximately a 0.4 percentage point change in industry-adjusted ROA for every $1000 increase in per employee delta. Since the average per employee delta in our sample is about $760, a $1000 increase represents a little over a doubling of pay to performance sensitivity."

By contrast, companies with grants focused on executives do worse. As the authors put it, "for both performance measures, the coefficient on aggregate option incentives for firms with broad-based option plans is positive and statistically significant and the coefficient on incentives for firms without broad-based plans is negative."

Size does matter here, however. "When we segment the incentive measure by firms with fewer or greater numbers of workers," the authors write, "we find that the relation between incentives and performance is confined to smaller firms, consistent with the notion that free-riding may counteract the incentive effect in larger firms." The authors also segment the companies into those where an increase in the share price has a potential impact on option value above and below the median amount. Companies with this greater leverage opportunity do significantly better.

The authors examine a number of potential alternative explanations for the results, such as region, research intensity, and the ability of broad-based option companies to attract and retain better employees. They find no evidence for any of these factors, however, and hypothesize instead that it must be that employees are monitoring other employees' behavior more. Our own work suggests the explanation is more complex than peers putting pressure on each other, but rather that companies with these kinds of plans are more likely to have engaged employees with opportunities to share ideas and information—and a reason to do it.

Sources for Future Research

If you want to do further research in the area of employee ownership, the NCEO maintains a variety of useful data sources. For details, go to the article on the site NCEO Data Sources on Employee Ownership.

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