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The effect of employee stock options on bank investment choice, borrowing, and capital

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Author Info
Hamid Mehran
Joshua Rosenberg

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Abstract

In this paper, we test the hypothesis that granting employee stock options motivates CEOs of banking firms to undertake riskier projects. We also investigate whether granting employee stock options reduces the bank's incentive to borrow while inducing a buildup of regulatory capital. Using a sample of 549 bank-years for publicly traded banks from 1992 to 2002, we find some evidence that the bank's equity volatility (total as well as residual) and asset volatility increase as CEO stock option holdings increase. In addition, it appears that granting employee stock options motivates banks to reduce their borrowing, as evidenced by lower levels of interest expense and federal funds borrowing. Furthermore, we show that banking firms that grant more options to their employees build up more capital in future years.

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Paper provided by Federal Reserve Bank of New York in its series Staff Reports with number 305.

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Date of creation: 2007
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Handle: RePEc:fip:fednsr:305

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Keywords: Stock options Bank stocks Bank directors Bank employees Employee fringe benefits Bank capital

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