Do Broad-Based Option Compensation Plans Improve Future Firm Performance for Technology and Non-Technology Firms?

Abstract

We examine the relation between non-executive option compensation and future firm performance. As broad-based plans have become increasingly prevalent in the compensation landscape, our findings may help managers and shareholders evaluate the potential benefits of providing more inclusive option compensation plans. We also extend prior research linking executive option compensation to future firm performance by extending the definition of performance to include both earnings and cash flows. Our cash flow analyses provide support for other research linking option compensation to stock price and returns. Consistent with prior research, we find a positive payoff for executive options; one dollar of options granted to top executives leads to future operating income (cash flow) of $2.58 ($2.36). However, future operating income (cash flow) is only $0.40 ($1.15) for one dollar option value granted to non-executive employees suggesting that broad-based option compensation plans result in a negative or no payoff to shareholders, on average. We also provide evidence of that the payoff to option compensation differs in technology versus non-technology firms.