Stock Option Incentives and Firm Performance

This paper analyzes the performance consequences of employee stock options for a broad sample of firms during the period 1996-1999. Our tests are performed separately for the top-5 executives and all other employees. We estimate the expected level of option incentives based on each firm's economic characteristics. We examine the association between the unexpected level of option incentives and firm performance as measured by future abnormal returns, future return on assets, and current and future firm value (Tobin's Q). We find consistent evidence that firms with unexpectedly high levels of option incentives exhibit significantly higher levels of firm performance. The results hold for both Executives and Employees and are consistent across each of our three measures of firm performance