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We investigate the impact of stock-based compensation on managerial ownership. We find that equity compensation succeeds in increasing incentives of lowerownership managers, but higher-ownership managers negate much of its impact by selling previously owned shares. When executives exercise options to acquire stock, nearly all of the shares are sold. Our results illuminate dynamic aspects of managerial ownership arising from divergent goals of boards of directors, who use equity compensation for incentives, and managers, who respond by selling shares for diversification. The findings cast doubt on the frequent and important theoretical assumption that managers cannot hedge the risks of these awards. WE INVESTIGATE THE IMPACT OF STOCK-BASED COMPENSATION, including options and restricted stock, on the ownership of U.S. executives. Equity-based pay spread at explosive rates in the United States during the 1990s. Morgenson ~1998! reports that in 1997, the 200 largest U.S. companies had reserved more than 13 percent of their common shares for compensation awards to managers, up

We investigate stock option exercise decisions by over 50,000 employees at seven corporations. Controlling for economic factors, psychological factors in�uence exercise. Consistent with psychological models of beliefs, employees exercise in response to stock price trends—exercise is positively related to stock returns during the preceding month and negatively related to returns over longer horizons. Consistent with psychological models of values that include reference points, employee exercise activity roughly doubles when the stock price exceeds the maximum price attained during the previous year. I.

Many firms issue stock options to all employees. We consider three potential economic justifications for this practice: providing incentives to employees, inducing employees to sort, and helping firms retain employees. We gather data on firms’ stock option grants to middle managers from three distinct sources, and use two methods to assess which theories appear to explain observed granting behavior. First, we directly calibrate models of incentives, sorting and retention, and ask whether observed magnitudes of option grants are consistent with each potential explanation. Second, we conduct a cross-sectional regression analysis of firms option-granting choices. We reject an incentives-based explanation for broad-based stock option plans, and conclude that sorting and retention explanations appear consistent with the data.

Incentive options are held by managers and employees who invariably hold undiversified portfolios with substantial amounts invested in their own company’s common stock. This lack of diversification makes the subjective value of incentive items such as options less than their market value. This paper derives a model for the marginal value of such options or other incentive items. As such, it can be used to evaluate heterogeneous options which mature on different dates. It can also be used each time a new option is granted. The identical model (with different parameters) can be used to determine three different values for each option, the market value, the subjective value and the objective values. The market value is the value the option would have if it were held by an unconstrained agent. The subjective value — the value of the holder — is less than the market value because the option is held in an undiversified portfolio and because it is exercised suboptimally from the market perspective. The objective value is the cost to the firm of issuing the option and lies between the market and subjective values. This value recognizes the suboptimal exercise but not the undiversified discount. The model is no more difficult to use than is the Black-Scholes model. In fact, under the same conditions, it is simply the Black-Scholes model with modified parameters. The model can also be easily extended to handle vesting, employment termination, indexing, repricing and any number of other features found in incentive options.

Preliminary and incomplete 3 The use of broad equity-based compensation for employees in the lower ranks of an organization is a puzzle for standard economic theory: any positive incentive effects should be diminished by free rider problems, and undiversified employees should discount company equity heavily. We point out that employees do not appear to value company stock as prescribed by extant theory. Employees frequently purchase company stock for their 401(k) plans at market prices, and especially so after company stock has performed well, implying that their private valuation must at least equal the market price. We begin by developing a model of optimal compensation policy for a firm faced with employees with positive sentiment. Our goal is to establish the conditions necessary for the firm to compensate its employees with options in equilibrium, while explicitly taking into account that current and potential employees are able to purchase equity in the firm through the stock market. We show that using option compensation under these circumstances is not a puzzle if employees prefer the (non-traded) options offered by the firm to the (traded) equity offered by the market, or if the (traded) equity is overvalued. We then provide empirical evidence confirming that firms use broad-based option compensation when boundedly rational employees

This paper examines whether insiders use private information to time the exercises of their executive stock options. Before May 1991, insiders had to hold the stock acquired through option exercise for six months. Exercises from that regime precede signi¯cantly positive abnormal stock performance, suggesting the use of inside information to time exercises. By contrast, we ¯nd little evidence of such timing since insiders have been able to sell acquired shares immediately. Now, such timing should show up as negative abnormal stock returns after option exercise. However, we ¯nd negative stock performance only after exercises by The debate about the value of executive stock options has focused on features of these options that make them worth less than ordinary options, such as their forfeitability and nontransferability. However, other aspects of these options might enhance their value to the executive.

We find that employee stock option deductions lead to large aggregate tax savings for Nasdaq 100 and S&P 100 firms and also affect corporate marginal tax rates. For Nasdaq firms, the median marginal tax rate is 31 percent when option deductions are ignored but falls to 5 percent when one accounts for the deductions. For S&P firms, however, option deductions do not affect marginal tax rates to a large degree. In the spirit of DeAngelo and Masulis (1980), option deductions are important nondebt tax shields that can affect corporate policies. We find evidence consistent with option deductions substituting for interest deductions in corporate capital structure decisions. This evidence may explain in part why some firms use so little debt.

that, in the early 1990s, firms issued more shares than they repurchased, but that net repurchases turned positive again beginning in 1994. Their study does not distinguish between issuance related to stock options, which involves a wealth transfer to employees, and other issuance which does not. We focus on employee stock option-related issuance (as opposed to other sources of issuance) both because of that wealth transfer, and because the recent pattern of option grants creates a predictable source of future issuance. In particular, given the amount of employee options outstanding, as well as the flow of new option grants, one can make projections of the pace of future issuance. 1 1. Introduction and Summary Share repurchases by S&P 500 companies have risen sharply in recent years; in 1997 and 1998 they actually exceeded dividend payments to common stockholders of large public corporations. In fact, as shown in figure 1, share repurchases by nonbank S&P 500 firms mo

Abstract We examine the stock option exercise decisions of over 50,000 employees at seven corporations to provide evidence on the distribution of price-relevant non-public information among employees. When option exercise (adjusted for other factors affecting exercise) is low, stock returns in the coming 6 months are 10% higher than when option exercise is high. The exercise decisions of relatively junior employees contain at least as much price-relevant information as the exercise decisions of more senior employees. r