Scandinavian Working Papers in Economics
Memorandum,
Oslo University, Department of Economics
No 11/2010: Employee Stock Options
Øystein Børsum
Additional contact information
Øystein Børsum: Dept. of Economics, University of Oslo, Postal: Department of Economics, University of Oslo, P.O Box 1095 Blindern, N-0317 Oslo, Norway
Abstract: An entrepreneur with information about firm quality seeks financing from an uninformed investor in order to pay a worker. I show that if the worker, too, knows the true quality of the firm, then certain long term wage agreements can credibly signal firm quality. Such wage agreements have a low initial wage and are equity-like in the sense that future pay is tied to firm performance, because only a worker in a good quality firm would be willing to defer compensation to an uncertain future, getting paid only if the firm succeeds. Moreover, in an important pooling equilibrium, all firms use equity-like wage contracts. The model provides an economic rationale for the use of stock options among regular, non-executive employees, in particular in small, knowledge intensive firms (such as in the ”new economy”) where workers are more likely to have information about the true quality of the firm.
Keywords: Financing; Asymmetric information; Signaling; Employees; Compensation; Stock options
35 pages, January 3, 2011
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Memo-11-2010.pdf
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