Abstract
Using simulated returns series and empirically observed stock returns, we show that broad-based option grants can generally lead to direct financial benefits for the company. Cash resources can be preserved internally by substituting options for a portion of payment in cash. However, the substitution of options for $1000 cash pay will result in only $10-$30 dollars of savings to the firm. This raises the question of whether savings of this magnitude can be universally considered as economically significant. We find that the sorting mechanisms in option grants and the financial-constraints explanation cannot be easily separated and both hypotheses should be studied jointly. The financing-constraints explanation for option grants can simply be a positive supplement to the sorting processes in compensating structures used by the firms.
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