Broad-based employee stock options grants and IPO firms

Abstract

This paper examines the broad-based grant of employee stock options (ESOs) in the period following the Initial Public Offering (IPO). Stock option grants are used to reduce the negative effects of conflicts of interests associated with a firm's going public. The study documents that option grants can be seen as corporate governance instruments for a number of model specifications. Also, it is found that there is a robust relation between option grants and market and accounting returns, respectively. To the best of the authors' knowledge, no previous study has investigated the determinants of the grants of employee stock options in the post-IPO period to both upper-level and lower-level executives during a period of sixteen years. Because the cross-sectional data of this study amply encompasses more than a business cycle it is possible to examine the grants of ESOs across tight and soft labour markets. During the former type of labour market it appears that more options are granted. Also, the empirical results provide evidence that option grants are an increasing function of the employees’ benefits for the firm. Finally, the findings show that cash constrained firms appear to use employee stock option grants in place of cash compensation.

Acknowledgements

We gratefully acknowledge the helpful comments of Lieke Adema, Piet Duffhues, Noud van Giersbergen, Martin Hoogendoorn, Hans Meijer, Hans van Ophem, and participants of the Financial Accounting Research Seminar of the Amsterdam Graduate Business School, and the 2003 Southern Finance Conference at Charleston, and, in particular, Bill Rees on an earlier draft of this paper. We are much indebted to Pieter Knauff and Fabian Valkenburg for research assistance. All remaining errors are the responsibility of the authors.

Notes

¹ Dutch companies have a two-tier board structure. The management board consists of executive directors and is entrusted with the day-to-day management of the company. A Dutch company's supervisory board consists of non-executive directors and is responsible for supervising the executive directors.