Buildingonthethemethatoptionholdersgainwhenequity
becomesmorerisky,wewouldanticipatemoredebtinfirms
with more options outstanding. Higher financial leverage
increases the volatility in stock prices and should also
increaseequityvalue.Thereisonecountervailingfactor.As
wenotedearlier,theexercise ofequity optionscreates tax
deductionsforfirmsandreducestheeffectivetaxrateforthe
nearterm.Thismayreducethetaxbenefitsfromtheuseof
debt. The net effect will determine whether debt ratios
increase ordecrease asa consequence.Graham,Lang,and
Shackelford (2004) find that firms that issue employee
optionshavelittledebtandarguethatthetaxsavingsfrom
optionexpensingthatthesefirmsgainreducethetaxratesand
thus the potential benefits to borrowing.
31
Dividend Policy
The use of employee options can have significant
consequencesforbothhowmuchfirmsreturntostockholders
andtheformofthatreturn(dividendsorstockbuybacks).On
thefirstissue,wewouldexpectmorecashtobereturnedto
stockholdersinfirmswith optionsthanfirmswithoutthese
options;cash, afterall,isazero-riskinvestmentandmakes
optionsontheequitylessvaluable.Onthesecond,wewould
anticipatethatlessofthecashwillbepaidoutindividends
andmorewillbeusedforstockbuybacks.Dividendsreduce
thestockpricewhereasanequivalentstockbuybackreduces
shares outstanding and may well lift the stock price.
Thereissomeevidencethatfirmswithsignificantemployee
optionsoutstandingaremorelikelytobuybackstockthanto
pay dividends. Fenn and Liang (2001) note that dividend