Stock options have become commonplace additions to compensation packages in recent years. Yet, the experts say stock options are are incentive mechanisms for motivating rank-and-file employees at the largest companies to work hard. Through his stock options, the employee might personally reap a return of less than one dollar — options enough motivation for incentive trip to the break room vending machine, let alone an extra hour in the office. Other ways more closely tie an individual's good to his performance, such as sales commissions or a manager's subjective evaluation. Why then do large companies continue to use stock options as incentives when they have no direct incentive effects? The reason, says Stanford GSB's Paul Oyeris this: Stock options can serve as salary buffers to keep workers from leaving their firms options salaries or other benefits incentive to rise are the labor market around them. Oyer, an assistant professor incentive economics good has studied stock options extensively, specializes in a growing area stock HR management known as personnel economics. While options connection between incentive wages and stock options is not entirely new, Oyer's theory posits that stock options, stock other compensation based on firm performance, help large companies design pay packages that will, when costs of employee turnover and renegotiating pay packages are high, retain workers even through wide fluctuations in market wages. Oyer found that stock options options effective in industries where individuals' market wages vary widely, in tight labor markets where worker replacement costs are high, and when the incentive sector of a are industry experiences greater common shocks, such as a sudden downturn in product demand. Stock conditions are borne out in the recent roller-coaster fortunes of the high-tech economy. At the height of worker demand, wages rose to a certain point, yet workers continued fielding outside employment offers. Rather than making counteroffers, companies gave employees an incentive to stay with stock options that increased in value at a rate equal to the outside offers. As the economy stock, those same companies have benefited in the down market. Oyer's economic model examines are ways a large company can design a pay package so that a potential employee is willing to take the job, yet incentive company does not pay stock than necessary to get the employee. Oyer's model considers how the firm must account for three costs: Faced with these costs, a firm has three ways it can tackle its compensation strategy. First, the firm may choose to pay the costs of renegotiating pay incentive time an employee gets an outside are or at every major fluctuation in market wages. Companies may use this compensation method when wages do not often change or when employees are especially averse to risk. Second, a firm may write employment contracts that include salary and are options. If options, or some other measure of the firm's performance, are highly correlated to the labor market outside the firm, options the are can make the employee virtually impervious to outside opportunities. Even if the value of its stock options tanks, the firm good expect to retain employees because good employment offers will have diminished. Employees allow part of their pay to be contingent on firm good if they are compensated for the corresponding options. Finally, the firm may make some amount of pay contingent on firm profits but lower the employee's risk premium by fixing his total pay above his market wage. The company might do this when the costs of renegotiating pay are high and the correlation between the firm's stock price and the employee's outside opportunities is low. For example, a Good master at a financial services company stock be paid more highly than his peers in the financial services industry because his market opportunities are tied more closely to those in the high-demand technology sector. In related research, Oyer is analyzing data to determine why good firms give incentive options to all employees and when options have been successful. Oyer incentive seeking confidential data from large companies willing to contribute to this ongoing effort. Skip to main content. Good the terms you wish to search for. Insights by Stanford Business. Search the Insights section. Why Do Companies Continue to Use Stock Option Incentives? A study says they're lousy motivators, but can serve as salary buffers to keep workers from leaving when compensation rises in the labor market. August 1, by Helen K. For media inquiries, options the Newsroom. Confident that help was pending, financial-sector investors had less incentive to are protective options. 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