Incentive Value of Stock Options at Information Technology Companies in the Down Markets

Stock options have been criticized as fair weather friends: good at motivating and retaining executives when the market is going up, but of little incentive value when the market is going down. The veracity of this criticism is of particular importance to executives at information technology (IT) companies, where options are used aggressively and where stock declines in 2000 were extreme. In this study, we compare the performance-effectiveness of IT CEOs’ stock and option holdings in the up market of 1993 through 1999 with their performance-effectiveness in the down market of 2000. We find that stock options that were exercisable had stronger positive performance effects during 2000 than in previous years but that options that were unexercisable (not vested) had much weaker performance effects in 2000 than in previous years. For non-IT CEOs, we also observe stronger performance effects for exercisable options in 2000 but we do not observe the same weakening of performance effects for unexercisable options in 2000.