Who benefits from a bull market? an analysis of employee stock option grants and stock prices

Stock option grants to top executives and to employees below the top executive ranks have risen rapidly with stock prices in recent years. This paper examines the growth in stock option grants at S&P 1500 companies between 1996 and 1999, and estimates the pay-for-performance sensitivities of the value of new option grants for top executives and, separately, for employees below the top executive levels. In our framework, options are a reward for past performance, leading to a positive relationship between firms' stock prices and the value of new option grants. We find substantial sensitivities for both sets of employees, but they are larger for employees below the top executive levels. Moreover, in contrast to top executives, the sensitivities for employees below the senior management levels do not differ by whether firm stock prices have risen or fallen. The greater sensitivity of option grant values to stock prices for employees below the top ranks is consistent with greater demand for options following price increases, and less willingness to accept options when past performance has been poor. We also find that new grants at larger firms are related to industry performance, consistent with more competitive markets for top executive talent to manage large organizations as industry conditions improve.