Many firms issue stock options to all employees. We consider three
potential economic justifications for this practice: providing
incentives to employees, inducing employees to sort, and helping firms
retain employees. We gather data on
firms' stock option grants to middle managers from three distinct sources, and use two methods to
assess which theories appear to explain observed granting behavior.
First, we directly calibrate models of incentives, sorting and
retention, and ask whether observed magnitudes of option grants are
consistent with each potential explanation. Second, we conduct a
cross-sectional regression analysis of firms option-granting choices.
We reject an incentives-based explanation for broad-based stock option
plans, and conclude that sorting and retention explanations appear
consistent with the data.