How do Broad-Based Stock Option Grants Affect Firms' Overall Future Productivity

We investigate the impact of broad-based stock option grants on future firm productivity using a sample of U.S. firms from 1990-2006. We focus on stock option grants predominantly to rank-and-file employees (broad-based stock options) because significant amount of stock options are granted to rank-and-file employees other than the top five named executives. This study documents that the extent of broad-based stock option grants are negatively associated with future firm productivity. Further tests show this negative relation is attenuated by a firm’s financial constraints and stock price informativeness but is exacerbated in new economy industry firms. We interpret these results as evidence that the expected incentive effect of broad-based stock options fails to compensate for the additional direct and indirect costs associated with such compensation programs. In cases when it is necessitated by a firm’s financial condition or when stock price informativeness closely link its value with firm performance, the broad-based stock option less likely leads to diminished productivity. However, it more likely does so in firms where resources for R&D and capital investment are crucial for growth. Robustness tests show endogeneity issues do not drive our results. Other than making significant contribution to the academic literature, this study also has important practical implications in designing efficient compensation packages.