Abstract: This paper investigates how the growth of stock option programs has affected
corporate payout policy. Given that earnings per share (EPS) is widely used in
equity valuation, some corporations may opt to repurchase shares to avoid the
dilution of EPS that results from past stock option grants. Executives may also
prefer distributing cash by repurchasing shares or retaining more earnings, as
opposed to increasing dividends, to enhance the value of their own stock
options. This paper tests the importance of these two hypotheses using
cross-sectional and panel data on stock option programs. I find that stock
options granted to top executives affect payout policy differently than do stock
options granted to other employees. Option grants in general are associated
with increased share repurchases and increased total payouts. However, the
larger is the executives' holding of stock options, the more apt the firm is to
retain more earnings and curtail cash distributions. Analysis of panel data for
a sample of large firms suggests that firms conduct an ongoing repurchase of shares over the
life of an option that undoes much of the dilution to EPS that results from
past stock option grants.
Keywords: Share repurchase, stock option, payout policy
Full paper (168 KB PDF)
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Last update: May 31, 2000
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