Discussion of Real Investment Implications of Employee Stock Option Exercises

Abstract

Bens, Nagar, and Wong [BNW, 2001] investigate how employee stock option plans influence corporate payout policy and investing decisions. BNW hypothesize that firms divert cash from profitable investment expenditures to fund share repurchases in an attempt to mitigate earnings-pershare (EPS) dilution from stock option exercises. The relation between corporate finance, managerial incentives and investing decisions is a rich and important area of academic research. In recent years, the widespread growth in employee stock option plans has spurred increased interest on the part of shareholders, regulators and academics as to the effects of these plans on financing activities, incentives and equity valuation. Further, there is growing evidence that managers are concerned with the financial accounting implications of stock options plans (e.g., Carter and Lynch [2001]1). BNW motivate their study with four assumptions about managerial behavior. The first assumption is that managers believe employee stock option exercises dilute EPS. Second, BNW assert that managers believe share repurchases mechanically increase EPS. Third, BNW assume that managers and/or investors myopically focus on short-term EPS. The fourth critical assertion is that BNW's sample of S&P 500 firms have severe cash constraints and high financing costs (e.g., low free cash flow, small reserves of liquid assets, and no source of inexpensive short-term debt financing) that force