The Efficiency of Stock-Based Incentives: Experimental Evidence

This paper reports the results of laboratory experiments in which subjects are offered contracts structured like equity compensation packages, which result in subjects receiving cash payments that are a function of their effort and random factors. We compare the experimental outcomes from alternative contractual forms to theoretical benchmarks and report the efficiency of the contracts to provide evidence on whether options or stocks that have same economic cost to the employer yield the same or different effort levels from the managers. We find that subjects choose higher effort levels with options when the optimal effort level is low, but choose lower effort levels with options when the optimal effort level is high. Both contracts elicit lower levels of effort than is optimal given risk-neutrality. We also find that subjects adjust their effort choices with experience in a way that reflects some learning..