Employee stock options: Are they indeed superior to other incentive compensation schemes?

Although employee stock options are gaining in popularity as a compensation plan aimed at improving work performance, there is neither theoretical nor empirical evidence that they are indeed superior to other incentive schemes, such as profit sharing and gain sharing. This paper examines, from a theoretical perspective, the possible effects of four incentive plans on employee motivation and performance: merit pay, profit sharing, gain sharing, and employee stock options. The analysis relies on two behavioral theories, Expectancy and Equity, and a conceptual financial framework. The different approaches yield incongruent predictions as to which of the four schemes can be expected to most enhance employee motivation. While the managerial theories favor stock options over profit or gain sharing, financial theory makes the case that all plans are identical in a competitive labor market, whereas if stock options are restricted and the labor market exhibits some degree of imperfection, gain and profit sharing plans may prove superior.