Beginning of Stock Option-Based Compensation in Japan : A Test of Alternative Theories

Japanese companies are increasingly adopting stock option based compensation for executives and employees as a part of their efforts to regain profitability and capital market orientation after the burst of bubble economy. To analyze the economic justifications of option grants in Japanese companies, we use the framework of three different theories i.e., agency theory, retention and sorting model, and the financial and ownership structure of a firm. We use a cross sectional data of 12,896 firm-year observations of 1,612 listed companies of Tokyo Stock Exchange from the year 1997 to 2004. While, the agency theory fairly succeeds in defining the executive stock options, the employees' stock options are most consistent with the explanation of the retention and sorting motives. Determinants of the financial and ownership structure show mix results