Academic journal article Federal Reserve Bank of New York Economic Policy Review

The Effect of Employee Stock Options on the Evolution of Compensation in the 1990s

Academic journal article Federal Reserve Bank of New York Economic Policy Review

The Effect of Employee Stock Options on the Evolution of Compensation in the 1990s

Article excerpt

* As the labor market tightened in 1999, the growth rate of compensation per hour (CPH) unexpectedly slowed.

* The decline in CPH may be attributed to the rapid increase in new employee stock option grants relative to the realization of options awarded before 1999.

* Employee stock options are captured in the CPH measure on the exercise date, not on the date granted, and the options' value can change considerably over the several years that can elapse between these dates.

* A recalculation of CPH that reflects the value of options on the grant date suggests no downturn in compensation growth in 1999.

From an economic standpoint, the 1990s were a remarkable period. On the one hand, the decade produced the longest-running U.S. expansion. On the other hand, a by-product of this continued economic growth was a sharp tightening of the U.S. labor market. This growing scarcity of available workers raised the concern that accelerating wage demands would develop, possibly leading to renewed inflation.

The 1990s were also noteworthy for the emergence of two "wage puzzles." The first puzzle is associated with the 1992-95 period, when nominal compensation per hour (CPH) growth declined and the unemployment rate fell rapidly (Chart 1). (1) One explanation for this occurrence is that "worker insecurity" early in the expansion accounted for the tepid pay demands during this period. (2) From 1995 to 1998, the puzzle ceased to exist, as compensation growth accelerated and the unemployment rate fell below the 4 percent barrier. However, the second wage puzzle appeared in 1999, when compensation growth fell back below the 5 percent level despite continued labor market tightness during the year.


In this article, we examine the wage-puzzle phenomenon of the 1990s. Specifically, we explore whether changes in pay structure can account for the behavior of CPH during the decade. Labor markets have changed considerably over the past twenty years: workers today receive a higher portion of total compensation in such nontraditional forms as profit sharing and stock options. (3) CPH captures profit-sharing payments and stock option realizations. However, employee stock options are reflected in total compensation on the date they are exercised--not on the date granted--and several years can elapse between these dates. Accordingly, the growing use of these stock options could be affecting the time that tight labor markets are reflected in CPH growth.

By analyzing the existing data, we determine how CPH growth is affected by the use of employee stock options. However, given the limitations of these data, we focus primarily on the second wage puzzle, that of the late 1990s. We find evidence that employee stock options may have had an appreciable impact on CPH during this period. In particular, when we recalculate compensation to reflect current stock option grants--rather than current realizations--we conclude that there was likely no downturn in CPH growth in 1999. (4)

The article is organized as follows. We begin by describing the essential institutional details of employee stock options necessary for our empirical work. We then discuss empirical models of stock option grant and realization decisions. Next, we use these estimates to assess the effect of stock options on compensation per hour. We conclude by addressing some general labor market implications of stock options.


Employee stock options are the right to purchase a given number of shares of company stock at the "strike" price between the vesting date and the expiration date of the options. (5) The vesting period is the interval between when a company grants the option and when the employee can first exercise the option. If the current market price for a vested option exceeds the strike price, the option is "in-the-money." If in-the-money options are exercised (that is, if the employee decides to purchase the underlying shares), the gain to the employee is the difference between the current market price and the strike price multiplied by the number of shares exercised. …

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