Report

The effect of employee stock options on bank investment choice, borrowing, and capital

Abstract: In this paper, we test the hypothesis that granting employee stock options motivates CEOs of banking firms to undertake riskier projects. We also investigate whether granting employee stock options reduces the bank's incentive to borrow while inducing a buildup of regulatory capital. Using a sample of 549 bank-years for publicly traded banks from 1992 to 2002, we find some evidence that the bank's equity volatility (total as well as residual) and asset volatility increase as CEO stock option holdings increase. In addition, it appears that granting employee stock options motivates banks to reduce their borrowing, as evidenced by lower levels of interest expense and federal funds borrowing. Furthermore, we show that banking firms that grant more options to their employees build up more capital in future years.

Keywords: Stock options; Bank stocks; Bank directors; Bank employees; Employee fringe benefits; Bank capital;

Bibliographic Information

Provider: Federal Reserve Bank of New York

Part of Series: Staff Reports

Publication Date: 2007

Number: 305