NCPA - National Center for Policy Analysis


July 22, 2004

Many business use stock options to attract, retain, and motivate their employees. Unfortunately, this is inefficient, according to a report by the National Bureau of Economic Research.

  • Companies paying stock options in lieu of cash are in effect, borrowing from employees, receiving their services today in return for payouts in the future.
  • But risk-averse undiversified employees are poor sources of capital, especially compared to professional investment services.
  • Additionally, options may attract highly motivated personnel, but they can only benefit a stock's price if they are in a place to improve the company's performance, which most are not.

There are superior methods of motivation, says NBER. Pensions, pay raises, and bonuses are likely to promote employee retention as well if not better than stock options and at a more attractive cost.

Companies continue to use stock options inefficiently, because there are no accounting costs and no cash outlay. No matter how expensive stock options are in economic terms; in accounting terms, stock options are cheap. NBER recommends mandating options as an accounting expense.

Source: Matt Nesvisky, "The Trouble with Stock Options," NBER Digest, March 2004; based upon, Brian Hall and Kevin Murphy, "The Trouble with Stock Options," National Bureau of Economic Research, Working Paper No. 9784, June 2003.

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