Incentives, Targeting and Firm Performance: An Analysis of Non-Executive Stock Options

We examine whether options granted to rank and file employees affect the performance of the firm by exploring the link between option portfolio implied incentives and firm operating performance. We employ an instrumental variables approach that combines information about the labor market characteristics in which firms compete with information on firm option programs from the IRRC to identify causal effects. Firms whose non-executive employee option portfolios have higher implied incentives exhibit higher subsequent operating performance. Consistent with economic theories, the incentive-performance effect is larger in smaller firms and in firms with higher growth opportunities. Additionally, the incentive-performance effect is concentrated solely in firms that grant options broadly to non-executive employees, consistent with non-executive options inducing mutual monitoring among co-workers.