Management for the masses: Stock options as compensation

Indiana University Kelley School of Business  8.31.10While it is true that different people are motivated by different things, when it comes to employees one thing is universal. Money motivates behavior. The age old question, though, is how best to pay people to get the level and type of performance that you want.

One form of compensation gaining popularity is stock options. The stock option given to specified employees of the company gives them the right, but not the obligation, to buy a certain amount of shares of the company at a predetermined price. The idea behind stock options is to align employees’ perspectives with those of shareholders. In theory, when employees have compensation tied to your company’s performance, they think about the big picture and work to ensure that their behaviors are in the best interest of the organization. Unfortunately, very little research has examined employees’ perceptions of and satisfaction with this type of compensation.

Researchers set out to examine this question. Generally, they found that companies offering stock options significantly outperformed their peers that didn’t. Even when companies limited stock option plans to just the executive level, they saw significant productivity gains. However, they did find a difference in the way that employees viewed this compensation.

Executives who received stock options tended to see them as something that helped their productivity, enhanced their willingness to stay with the firm, and strengthened their commitment to the long-term success of the organization. These executives tended to retain their stock in the organization for a longer period of time. On the other hand, nonmanagerial employees tended to view stock options merely as a short-term bonus. Unlike executives, they tended to exercise stock options – meaning sell their stock – quickly. Consequently, any productivity gains seen before the stock was granted did not last.

From this research, it appears that firms would be best advised to limit stock-option compensation to those at the highest levels of the organization. Cash bonuses, or other incentives intended for short term productivity improvements, are better suited for rank and file workers.

Reference: Sesil, J. C., & Lin, Y. P. (2011).The impact of employee stock option adoption and incidence on productivity: Evidence from U.S. panel data.  Industrial Relations, 50(3), 514-534.Academy of Management Journal, 56, 1274-1294.