The main conclusions on executive stock options come from two large studies (Jensen and Murphy, 1990; Hall and Liebman, 1998). Briefly, the results show that the sensitivity of firm performance to CEO stock options has dramatically increased in the last decade. They conclude that the dramatic rise in CEO compensation has been driven by increases in annual stock option grants which have produced a large buildup in total CEO holdings of stock options. The authors of these studies conclude that no matter which measure is used, there has been a dramatic increase in responsiveness of CEO pay to firm performance during last 15 years, largely as a result of stock options.
Executive stock option studies have also reached a number of secondary conclusions that may be relevant to our study. Miller and Scholes (1981) have reported that stock option plans may be an attractive part of compensation package because of tax benefits. Because of the very favorable accounting treatment of stock option plans, this suggests that the role these incentives play merit closer security.
• Prior studies review
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Agency theory predicts that incentive conflicts arise because the interests of managers are not aligned with the interests of shareholders. In order to bring the interests of two parties into closer alignment owners incur cost in the form of incentive contracts (Jensen and Meckling). The notion that stock options might increase firm performance is based on extending the rationale of incentive contact theory to employee beyond the executive suite.
Other theoretical considerations include the lowering of information costs because managers’ and employees’ are more closely aligned. This recognizes that employee have access to information that may be valuable to management. The presence of a group incentive scheme may result in employees having the necessary incentive to communicate, or act on their superior information. The majority of the research associated with information sharing has been evaluating top-down information sharing (Kleiner and Bouillon, 1988; Morishima, 1988). While Kleiner and Bouillon did not find a positive effect of information sharing on performance measures, Morishima found that there was s positive association with information sharing and profitability and productivity.
Profit sharing theory suggests a more positive prediction. Several studies have found that profit-sharing companies are more productive than firms without sharing although researchers have noted that it is hard to distinguish the effects of profit sharing from those of other human resource practices (Weitzman and Kruse 1990; Kruse 1993).
2.2 Hypothesizes statement
Hereafter, we review related researches and develop expected relations between the issuance of ESOs and firm’s financial indicators such as ROA, FCF, growth opportunity /Tobin’s Q/, Sales per employee and ownership structures.
2.2.1 Firm efficiency- the Return on assets
We referred the important measures of the firm’s profitability are return on asset (ROA).
ROA measures how effectively the firm’s assets are used to generate profits net of expense.
Core Holthausen and Larcker (1999) find for 205 US firms during 1982-1984 that the
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average ROA negatively related to the “predicted excess compensation”, which are controlled by stock ownership and board of directors’ variables. Ke,Petroni and Safieddine (1999) find that ROA and level of compensation is positively related only for the publicly-held insurance companies.
H1: The ROA has positive relationship with possibility of decision to make issue ESOs.
2.2.2 The Free cash flow
Prior studies suggest that cash-strapped firms tend to use equity grants in place of cash compensation (Yermark 1995). In addition, firms may grant stock options in place of cash pay to reduce the impact of compensation on earnings when profitability is lower. This is because cash compensation appears on the financial statement as an expense whereas the value of stock option grants appears only in its footnotes (Core & Guay, 2001). We follow previous studies by taking the free cash flow (FCF) as a possible factor for making a decision to issue ESOs. Thereby developed the first hypothesis:
H2: The free cash flow has the negative relationship with possibility of decision to issue ESOs.
2.2.3 The firm’s growth opportunity – Tobin’s Q ratio
The investors’ chance to make investments in perceived profitable projects are generally called growth opportunity. Firms with abundant investment opportunities pay higher level of total compensation for their executives, long term incentive contracts motivating managers to take action to seek out and exploit new investment opportunities (Gaver, J.J and K.M. Gaver 1995). When managers have special information or specific knowledge about investment options, it would be efficient to let them choose which options are pursue (Jensen and Meckling 1995). Employee participation mostly effect on organizational outcomes.
According to incentive contract theory, firms with high- growth opportunities and large research activities are more likely to grant employee stock options because stock-based
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measures provide a more accurate assessment of managerial effectiveness (Lambert &
Larcker, 1987).
H3: The Tobin’s Q has positive relationship with possibility of decision to make issue ESOs.
2.2.4 Firm productivity - Sales per employee
This ratio does give investors some sense of a firm’s productivity and financial health and it gets a reliable idea of performance during over several years. In prior studies, Black and Lynch (2000) show that stock options are associated with increased productivity by using a unique nationality representative sample of U.S. establishments surveyved in 1993 and 1996. However, they do not indicate which explanation justifies the positive correlation. Sesil et.al (2002) documents that the issuance of stock options program results in higher levels of velue added per employee. Shu-Hui, Lin (2009) examined the difference between granted ESOs firms and didn’t grant firms, confirmed that had higher market-to-book ratio, R&D expenditures, volatility, employee growth, larger and profitability firms more likely to issue ESOs. Yu Peng Lin, James C.Sesil have examined that stock options program indeed improves firm productivity. They used the sales per employee ratio and suggested further work needed to clarify this issue. In other words, if stock options could motivate employees (Lazear, 2000) the productivity should be higher soon after such program being issued, thus we have stated next hypothesis:
H4: The ratio of sales per employee has positive relationship with possibility of decision to make issue ESOs.
2.2.5 Firm’s ownership structure
In a study of firm performance using 1979-1980 compensation data for 153 randomly selected manufacturing firms, Mehran (1995) finds that firm performance, measured by Tobin’s Q and ROA, is positively related to the proportion of equity-based compensation, management ownership of stock and options, and research and development expense over
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sales. This study confirms that, if when ratio of managers shares in total shares high, the firm’s value would increase while if when ratio of director board’s share high, the percent of equity based compensation in total compensation would increase. Also, the firm with directors and outside big shareholders’ ownership high, they would reduce the equity based compensation. Following prior studies, we use the ownership structure’s measures, such as managers’ shares, board of directors’ share and outside big shareholders shares, stated the next hypothesis.
H5-1: The percent of board of directors’ shares negative influence to make a decision to issue ESOs.
H5-2: The percent of managers’ shares positive influence to make a decision to issue ESOs.
H5-3: The percent of outside big shareholders’ shares negative influence to make a decision to issue ESOs.
Table 2- 1: List of previous studies that have explored association between ESOs and different explanatory variables
Res ea rchers Arti cl e Countr
y 1 Da vi d Yerma ck, 1995 Do corpora ti ons a wa rd CEO s tock
opti ons effecti vel y? USA 792 1984‐1991 Fi rm
2 連偵均 Zhen Jun, Li a n 2008
員工認股權 , 公司治理特性與盈餘管理
關聯性之研究
TW 671 2002‐2007 Fi rm
3 Jens en & Murphy, 1990 Ma na gers
4 Rya n H.E. & Wi ggi ns R.A. 20
The i nfl uence of fi rm‐ a nd ma na ger‐
s peci fi c cha ra cteri s ti cs on the s tructure of executi ve compens a ti on
USA Both
5 Ma ts una ga , 1994 The effects of fi na nci a l reporti ng
cos ts on the us e of ESOs USA
6 Shu‐Hui , Li n 2009 Why fi rms a wa rds s tock opti ons ? TW 189 a l l 2001‐2003 Fi rm
7 Ga ver & Ga ver, 1993 321 1992
8 Smi th a nd Wa tts , 1992 a l l 1965‐1985
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10 巴安琪, 2011
The Infl uence of Fi rm‐Speci fi c Cha ra cteri s ti cs on the Is s ua nce of
Empl oye e Stock Opti ons
TW 1099 2001‐2009 fi rm
Source: by this study
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Table 2- 2: Examined firm characteristics in prior studies listed above
Different explanatory variables 1 2 3 4 5 6 7 8 9 10
1 growth opportunity 1 1
1-positive 0-negative /Source: by the study/
CHAPTER 3: RESEARCH DESIGN AND METHODOLOGY