The Influence of Stock Options on Engagement and Employee Performance

By Nick Conrad, Josh Elder, Tyler Ingram, Leon Iskhakbayev, and Keoni Terrana

Attempting to garner consistent, productive employee engagement is a challenge in every workplace. Without the proper engagement, any hope of smooth operations and excellence in the work that does get done is misplaced. As a group of finance majors, we decided to take a look at some of the actions that employers take to draw that engagement out of their subordinates, with a bend towards finance. Specifically, we settled on the practice of distributing stock options as a form of incentive that adds wealth for the recipient which ties them more closely to the company they work for, further reducing any agency problem that may occur. Does this method actually produce the theoretical effects that one might assume it would?

Are stock options the only answer?

          To begin with, many companies like to offer options to corporate financial incentives for their employees in order to cultivate a feeling of independence and goodwill. To help compare the different incentive structures we examined multiple alternatives to stock options that could be just as effective, such as merit pay, profit sharing, and gain sharing (Agrawal et al., 2002). The major differentiating factor for stock options on the employee’s side is that they can’t be exercised by the employee until a certain predetermined time. This makes this option less competitive compared to the other three forms of incentives. For the employer utilizing this practice, it is important to note that a dollar today is worth more than a dollar tomorrow. Therefore, finding the right balance between the types of incentive, amount, and date paid will make a difference in exactly how much the employee will increase their productive engagement.

Is the value gained by distributing your own wealth worth the cost?

It was also found that within a business, when an employee has a small portion of the company, they are overly confident about the future of the firm (Hallock and Olson 2006) and this directly correlates to an increase in employee engagement with their employer. As the company thrives, so do the shares of the company held by both employee and employer. This serves as a positive feedback loop which begets only stronger engagement and work ethic than previously seen. It has been demonstrated that other incentive structures, though they create similar motivations for the incentivized, they do not instill the same sense of loyalty/long term thinking as the former. However, this comes with a decision on the part of the employer. They must decide whether they would like to make that same commitment to their employees if they utilize this method.

Are employee stock options better for the long-term or short-term?

It is necessary, when looking at incentives, for a company to measure the cost of the incentive, for instance the price of a stock call option, and compare it to the actual increase in workplace engagement and productivity leading to value gained. Unfortunately, that method of measuring is extremely difficult to perform accurately (Pendleton , 2006). The value of work performance before and after an employee receives a stock incentive is not something that can be easily appraised. Pendleton (2006) wanted to investigate employee engagement at multiple levels of the professional hierarchy. There was little to report in regard to relative individual performance increases at each level but there were other abstract results. The author concluded that despite difficulties with finding definitive results on the dollars and cents impact of the incentive, stock options can lead to more engagement in the workplace. Employees tend to think/act more long-term and cooperatively than if they were incentivized in comparison, with less long-term types of structures.

What does this mean Owners?

Problems linking stock option incentives to realized increases in revenue or other reasonable scales were also evaluated (Park and Song, 1995). There is a strong correlation between an average increase in worker performance and the use of stocks as a means of incentives. However, the extent of the effectiveness of this type of incentive plan is heavily impacted by the ownership structure of the company among other factors, not solely the incentive itself. It was also found that this specific employee incentive plan was not only used to increase employee performance but was also as a way to protect the owners from a takeover of the company (this is true for the companies that participated in the study at hand). This means that this type of incentive plan could be an incredible net gain for owners of a company. It not only helps increase employee performance in certain environments, but also mitigates the cost by serving as a tool to manipulate shares in a way that creates stability for the leading group.

 In Conclusion

As a way to incentivize in a workplace, using company stock options has had mixed results in terms of its quantitative effectiveness. When combined with other factors, there do appear to be some gains to be made. Though, it’s difficult to find a clear impact once those factors are controlled for. That is not to say that the impact is nonexistent, rather that, to measure it is problematic. In comparison, qualitative results are much more evident. The studies we looked at showed clear gains in employee short-term and long-term engagement, cooperation, and loyalty. Depending on the intention of those potentially distributing the shares, there is also a strong case to be made that there are also structural benefits to be had, making it a win-win-win for the owners, managers, and employees alike. With that being said, it’s safe to say that although the effects may be hard to quantify, offering longer term incentives like stocks will likely result in a positive outcome of employee engagement.

References

Agrawal, A., et al. Employee Stock Options: Are They Indeed Superior to Other Incentive Compensation      Schemes? Journal of Business and Psychology, Kluwer Academic Publishers-Plenum Publishers, Mar. 2002, link.springer.com/article/10.1023/A:1012820923455#citeas.

Blasi, J., Freeman, R., Mackin, C., & Kruse, D. (2008). Creating a Bigger Pie? The Effects of Employee Ownership, Profit Sharing, and Stock Options on Workplace Performance. The National Bureau of Economic Research. doi: 10.3386/w14230

Hallock, K. F., & Olson, C. A. (2006, January 23). The Value of Stock Options to Non-Executive Employees. Retrieved January 29, 2020, www.nber.org/papers/w11950

Park, S., & Song, M. H. (1995). Employee Stock Ownership Plans, Firm Performance, and Monitoring by outside Blockholders. Financial Management, 24(4), 52. doi: 10.2307/3665950

Pendleton, Andrew. Incentives, Monitoring, and Employee Stock Ownership Plans: New Evidence and Interpretations. Wiley Online Library, John Wiley & Sons, Ltd, 15 Sept. 2006, onlinelibrary.wiley.com/doi/full/10.1111/j.1468-232X.2006.00450.x.