Article in Press

ARTICLE IN PRESS

Journal of Financial Economics 76 (2005) 99–133 www.elsevier.com/locate/econbase

Why do some firms give stock options to all employees?: An empirical examination of alternative theories$

Paul Oyera, Scott Schaeferb,Ã

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Stanford Graduate School of Business, Stanford University, Stanford, CA 94305, USA Department of Management and Strategy, Kellogg School of Management, Northwestern University, Leverone Hall, 2001 Sheridan Road, Evanston, IL 60208-2013, USA Received 24 July 2003; accepted 24 March 2004 Available online 25 August 2004

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Abstract 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 employee retention. We gather data from three sources on firms’ stock option grants to middle managers. First, we directly calibrate models of incentives, sorting and retention, and ask whether observed magnitudes of option grants are consistent with each potential explanation. We also 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. r 2004 Elsevier B.V. All rights reserved.

JEL classification: G30; J33; J41 Keywords: Employee compensation; Stock options; Incentives; Sorting; Retention

$ We thank Corey Rosen and Ryan Weeden for providing the NCEO data, John Bishow, Anthony Barkume, and John Ruser for their assistance with the BLS data, Paul Pfleiderer and Robert McDonald for their assistance with option valuation, and Anthony Barkume, Brian Hall, Edward Lazear, Jonathan Levin, Kevin J. Murphy, Jan Zabojnik, Jeffrey Zwiebel, an anonymous referee, and participants in numerous seminars for comments. ÃCorresponding author. Tel.: +1-847-467-6598. E-mail address: s-schaefer@kellogg.northwestern.edu (S. Schaefer)....