The basic theory of why companies issue stock options to their employees is fairly simple: The more that a firm's stock price increases, the greater the profit from exercising those options, creating what employers hope is a valuable incentive that will motivate employees to focus on making the company more successful and more profitable.
But new Wharton research shows that managers may not view stock options as an incentive at all. In a paper titled, "Stock Option Exercise and Gift Exchange Relationships: Evidence for a Large US Company," management professor Peter Cappelli and Martin J. Conyon, a senior fellow at Wharton's Center for Human Resources, found the practice impacted employee performance after workers earned a sizable payoff from exercising their stock options. Even then, the employees viewed the options not as an incentive, but as a gift they felt compelled to repay by working harder.
"The reciprocity effect we found is really bigger than the incentive effect," Cappelli says. "We found that when the company does well and the share price goes up and people make more money, their performance in the next period goes up as well. The story reminds us that the workplace is a psychological place and a social place, as well."
Indeed, the patterns uncovered by Cappelli and Conyon might cause companies to reconsider the ways that stock options are used. As outlined by the paper, the stock option arguably functions more as a lottery, with those employees who were lucky to sell their shares at exactly the right time delivering the expected better performance, while others do not.
"The story is not that people work harder to make the share price go up," Cappelli noted. "It is that if the share price goes up and people make money, they feel an obligation to work harder. That's a bit of a surprise."
The Impulse to Give Back
Boosting the research effort was a large amount of data provided by a major American public corporation. The firm granted stock options to the 4,500 employees -- primarily store managers -- based solely on their level within the company hierarchy, as opposed to job performance. Because these lower-level managers were largely responsible only for the sales performance in individual stores, there was little chance that their day-to-day work would actually directly influence share price, or that the manager would perceive such an impact.
The issue is significant because over the last two decades, American firms have both greatly increased use of a stock option plan as a form of employee compensation, and broadened the class of eligible employees to include more than just the most elite executives. According to the National Center for Employee Ownership, only one million US employees held stock options in 1990. That figure has since skyrocketed to nine million workers now participating in roughly 30,000 different plans.
Despite the wide number of stock option plans, the philosophy behind each of these programs is essentially the same. The company grants employees the option to sell a set number of company shares when the price of the stock goes above a fixed level within a fixed period of time. Of course, the higher the stock price, the greater a profit an employee sees -- either on paper or in cash if he or she immediately sells those shares. Thus, leadership at firms offering this benefit expect it to result in better employee performance, or creative ideas to boost profits and sales in ways that would have a positive effect on the stock.
Past studies have shown some positive effects from stock option programs -- particularly when it comes to retaining employees in a more competitive labor market. But experts have long questioned the options' role as a workplace incentive, since the connection between any individual's job performance and the company's share price is highly abstract, as opposed to a manager's bonus for meeting a specific sales or cost-cutting goal. "Think about how hard an individual manager would have to work to drive the share price of their company up," Cappelli points out. "There is so little connection between your efforts and share prices."
Cappelli and Conyon's hypothesis was based upon the notion that the gains from stock options are not necessarily expected, and therefore act as more of a gift from the employer than as an incentive. To test this theory, they first examined decades of research into how gifts affect human behavior.
Anthropologists studying Stone Age cultures, or more modern but primitive social structures in remote areas, have found examples of a so-called "gift economy," in which an abundance of food or other material is shared, causing recipients to feel a moral obligation to give back. Other studies demonstrate that this basic tendency of human nature extends into more advanced and sophisticated social settings, and that the impulse toward "reciprocity" often becomes a moral imperative, even with no express obligation to offer something in return.
To fully demonstrate their hypothesis, the researchers hoped to show that the larger the perceived gift, the greater the subsequent improvement in employee performance. Cappelli says the data made available by the unnamed company afforded a unique opportunity to examine the links between exercising stock options and worker performance. The firm evaluates its managers on a numerical scale every year, he notes, looking at both objective performance outcomes such as store sales, as well as subjective evaluations. These worker ratings could then be plotted against financial data from the exercise of the stock options.