2.Riskinessoffirm.Riskierfirmsshouldbemorelikelyto
use equity options than safer firms. While most securities
becomelessvaluableasriskincreases,optionsbecomemore
valuable.Thisisespeciallytrueifthemarketisoverassessing
the risk in a company, since this firm’s options will be
overvalued by the employees receiving the options.
4
3.Marketvaluationoffirm.As wewillsee,thereisa tax
advantage thataccrues to firms that useequity options as
compensation.Firmsthattradeathighmultiplesofearnings
willgetamuchbiggertaxadvantagefromusingoptionsas
compensation.
Noneofthesecharacteristicsisstaticandtheywillchangeas
firmsmovethroughthelifecycle.Wewouldexpecttosee
optiongrants,asapercentofoutstandingstock,tobegreatest
at young, risky firms with high market valuations, and to
decline as growth levels off, cash flows increase, and
valuationscome downto earth.Cisco Systemsprovidesan
interesting case study of this transition, with Figure 11.3
reportingonoptionsgrantedasapercentoftheoutstanding
stockeveryyearfrom 1993 to2005.Cisco’soptiongrantsas
a percent of outstanding stock has declined from above 5
percentin 1995–1997toabout 3 percentin the2002–2005
period.The value ofoption grants peaked in 2000,at the
height ofthe stockmarket bubble, and hasdeclined fairly
dramatically since.
FIGURE 11.3Cisco Option Grants, 1993 to 2005
Source:Cisco 10-K filings.