Companies offer stock options to rank-and-file employees to deter them from reporting financial misconduct, according to a new study that may have implications for regulatory efforts to encourage whistleblowing.

The study found firms involved in financial reporting violations granted more rank-and-file options during periods of misreporting than a control sample and that those firms were more likely to avoid whistleblower allegations.

“Employees are less likely to blow the whistle about corporate misconduct if they benefit from it,” the paper concludes, adding that “when a higher share of their compensation is tied to firm performance, employees are more likely to facilitate (either directly or indirectly) wrongdoing.”

Researchers from Arizona State University, Rutgers Business School, and Columbia Business School used a sample of 784 shareholder actions involving 663 companies for their study, which is expected to be published in an upcoming issue of the Journal of Accounting and Economics.

They focused on stock options in part because financial misreporting usually involves overstating performance to boost the price of a company’s shares, directly tying an employee’s expected gain from a portfolio of options to the continuation of the misconduct.

According to the study, misreporting firms grant rank-and-file options averaging 2.49% of total shares outstanding during the period that begins with the violation period and ends with discovery of the misreporting, compared to the 1.62% granted by control firms to their rank and file employees.

Moreover, misreporting firms that experienced an employee whistleblowing event granted options averaging 1.37% of total shares outstanding during the violation period, compared to 2.44% for companies that avoid whistleblowing events.

“The 78% higher usage of rank and file options in misreporting firms without whistleblowing is both statistically and economically significant,” the study says.

The researchers said their findings “are particularly relevant and timely, given recent legislative efforts to provide financial incentives to encourage employees to blow the whistle on corporate misdeeds.” While the Dodd-Frank law provides financial incentives to encourage whistleblowing, “our findings suggest firms can offer financial incentives to discourage whistleblowing,” they conclude.

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2 responses to “Stock Options Help Firms Keep Workers Quiet”

  1. I’m seeing support for the conclusion that companies engaging in financial reporting violations make broad based stock grants to encourage employees to remain silent about violations. There appears to be a correlation, but not seeing the causation. There are other possible reasons for these findings. For example, companies may be using grants as a recruitment, retention, and motivation tool and thus need to make larger grants compared to competitors and during this time period.

    Bruce Brumberg, Editor
    http://www.myStockOptions.com

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