A Comparison of Options, Restricted Stock, and Cash for Employee Compensation
A Comparison of Options, Restricted Stock, and Cash for Employee Compensation
Paul Oyer and Scott Schaefer
September 4, 2003
Abstract
Using a detailed data set of employee stock option grants, we compare observed stock-optionbased pay plans to hypothetical cash-only or restricted-stock-based plans. We make a variety of assumptions regarding the possible bene ts of options relative to cash or stock, and then use observed option grants to make inferences regarding rms ' decisions to issue options to lower-level employees. If the favorable accounting treatment is the sole reason underlying rms ' choices of options over cash-only compensation, then we estimate that the median rm in our data set incurs $0.64 in real costs in order to increase reported pre-tax income by $1. This gure is several times larger than the willingness-to-pay for earnings reported by Erickson, Hanlon and
Maydew (2002), who study rms that (allegedly) commit fraud in order to boost earnings. If, on the other hand, rms ' option-granting decisions are driven by economic-pro t maximization, then observed stock option grants are most consistent with explanations involving attraction and retention of employees.
Oyer: Graduate School of Business, Stanford University, pauloyer@stanford.edu. Schaefer: Kellogg School of
Management, Northwestern University, s-schaefer@northwestern.edu. We thank Corey Rosen and Ryan Weeden for providing the NCEO data. We thank Rachel Hayes, Kevin J. Murphy, Madhav Rajan, Stefan Reichelstein and Je
Zwiebel for valuable discussions.
1 Introduction
Employee stock options have generated substantial media and political attention recently, thanks largely to the ongoing policy debate about accounting methods for option grants. Though options were once rarely granted below top executive levels, broad-based option plans have become more common in recent years.1 In some sectors of the U.S. economy, stock options appear to be the default method by
Paul Oyer and Scott Schaefer
September 4, 2003
Abstract
Using a detailed data set of employee stock option grants, we compare observed stock-optionbased pay plans to hypothetical cash-only or restricted-stock-based plans. We make a variety of assumptions regarding the possible bene ts of options relative to cash or stock, and then use observed option grants to make inferences regarding rms ' decisions to issue options to lower-level employees. If the favorable accounting treatment is the sole reason underlying rms ' choices of options over cash-only compensation, then we estimate that the median rm in our data set incurs $0.64 in real costs in order to increase reported pre-tax income by $1. This gure is several times larger than the willingness-to-pay for earnings reported by Erickson, Hanlon and
Maydew (2002), who study rms that (allegedly) commit fraud in order to boost earnings. If, on the other hand, rms ' option-granting decisions are driven by economic-pro t maximization, then observed stock option grants are most consistent with explanations involving attraction and retention of employees.
Oyer: Graduate School of Business, Stanford University, pauloyer@stanford.edu. Schaefer: Kellogg School of
Management, Northwestern University, s-schaefer@northwestern.edu. We thank Corey Rosen and Ryan Weeden for providing the NCEO data. We thank Rachel Hayes, Kevin J. Murphy, Madhav Rajan, Stefan Reichelstein and Je
Zwiebel for valuable discussions.
1 Introduction
Employee stock options have generated substantial media and political attention recently, thanks largely to the ongoing policy debate about accounting methods for option grants. Though options were once rarely granted below top executive levels, broad-based option plans have become more common in recent years.1 In some sectors of the U.S. economy, stock options appear to be the default method by
References: Benartzi, S.: 2001, Excessive extrapolation and the allocation of 401(k) accounts to company stock, Journal of Finance 56, 1747{1764. Madrian, B. C. and Shea, D. F.: 2001, The power of suggestion: Inertia in 401(k) participation and savings behavior, Quarterly Journal of Economics 116, 1149{1187.