Give Everyone a Prize? Employee Stock Options in Private Venture-backed Firms

Abstract

This study investigates the impacts on the equity values of private venture-backed firms of the organizational depth to which they grant employee stock options. I develop two hypotheses. First, applying the reasoning of Demsetz and Lehn (1985), I propose that firms' equity values will be unrelated to the optimal component of stock option grant depths. Second, I hypothesize that firms' equity values will be more negatively related to the suboptimal component of stock option grant depths when options are not granted deeply enough than when they are granted too deeply. The latter asymmetry stems from the differential contribution of senior versus junior employees to equity value. Using the fitted and residual values from a model of stock option grant depths in private venture-backed firms as proxies for the optimal and suboptimal stock option grant depth components, I find evidence consistent with these hypotheses.