Abstracted from: Broad-Based Employee Stock Options Grants And IPO Firms
Authors: Roosenboom, Peter; van der Groot, Tjalling
Source: Bowne, Routledge, Applied Economics - Vol. 38, No. 12, Pgs. 1343-1351
Sweetening the pot. CFOs may wonder about the best ways to keep stock-owning employees committed to the company after an IPO. Research by corporate finance professors Peter Roosenboom and Tjalling van der Groot shows a decrease in insiders' stock ownership from 52.1% before the IPO to 34% afterward, an indication of the powerful financial lure a post-IPO stock sale presents. As their ownership interests decrease, employees may become less concerned about the company's and their own performance. Granting broad-based stock options is one way to help employees continue to think like shareholders and act in the best interests of the company. The authors studied IPOs occurring between 1985 and 2000, attempting to determine the characteristics of companies most likely to grant stock options to both upper-level and lower-level employees.
When grants are common. Previous research analyzing stock option grants to employees indicates they are most prevalent after stock price increases and less acceptable to employees when stock performance has suffered. Other studies indicate that companies whose managers own a lot of corporate stock do not use option grants as frequently as those where employee ownership is minimal. This finding suggests, the authors point out, that executives who already own company stock are not as willing to accept another form of equity-based compensation. Another researcher found that companies with a larger number of independent board members use grants less frequently than those with fewer independent members and concluded that board monitoring takes the place of option grants.
Small companies use options more. The authors' research shows that stock option grants are most common among firms with higher stock price performance, substantial growth opportunities, and higher market-to-book ratios. Grants are less common among companies with high retained ownership, those with venture capital monitoring or independent boards, and those with a high level of takeover defenses in place. Companies may view high levels of retained ownership and the watchful eyes of venture capitalists to be worthy substitutes for the incentive power of options; companies with robust takeover defenses may be more concerned with managerial entrenchment than with increasing firm value. The issue of retention is particularly important in smaller companies, where a relatively large proportion of the individual employees are key to corporate success. This may partially explain why the use of options is greater at small firms than large ones.