Stock Options & Firm Performance
Theory and empirical evidence both suggest that stock options as part of an employment package can contribute to firm performance because they align the incentives of the employee who receives the options with the interests of the stockholders as a whole. Yet there is disagreement over whether it matters who exactly receives the incentive.
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Stock options
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A stock option is a contractual right to buy or sell a stock at a specified price, on a specified date. An option to sell is a "put," while an option to buy is a "call." The sort of option that the issuer of the underlying stock provides as a compensation package is a call.
The specified price (the "strike price") is critical to the value of the option. If you have the right to buy a stock for $20, and that stock is selling on the market for $20 or less anyway, then the contract is of no value to you. If you have the right to buy it for $20, and its market value is $30, then that right is worth $10.
Repricing
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Companies that use stock options regularly as a form of compensation also regularly reprice those options. In other words, they redefine the strike price. Especially in cases where the market price has fallen below the old strike price, the options may be expected to lose their effect as incentives unless an appropriate new strike price is adopted.
A study on the incentive effects of stock options published in the "Journal of Accounting and Economics" in 2010 used such repricings as a way to select pertinent data.
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Study
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Ron Kasznik, a Professor at Stanford Business School, Nicole Bastian Johnson of the Haas School of Business, University of California at Berkeley, and David Aboody of Anderson School of Management, UCLA, looked at 1,364 companies with employee stock options who saw their stock price fall by 30 percent or more in any one year between 1990 and 1996. Of those companies, 1,064 did not reprice (effectively letting the stock option expire as a significant form of compensation), the other 300 did reprice. The scholars hypothesized that if stock options do drive performance, the repricing companies should have done better after the re-pricing than the control-group companies.
Results
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Kasznik and his colleagues found that the repricing group did outperform the control group, and that the gap in performance increased over time. They also found, though, that the effect depends upon which employees receive the options. Options appropriately repriced improve performance if awarded to executives, but not if awarded to non-executive employees.
Contradiction
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This result contradicts some earlier research. A 2004 study from the University of Navarra, in Spain, found an incentive result that holds "regardless of whether the amount of unexpected option incentives is based on option incentives held by executives or employees." No doubt studies and controversy will continue.
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