Employee stock-option and share-ownership effects on innovation

Abstract

This study empirically examines the effects of full-time employees’ stock options and their share ownership on innovation. Based on data gleaned from 284 firms among China’s innovative industries, we test four hypotheses via fixed-effect regression, applied to unbalanced panel data over the time period of 2009–2014. The results show that both full-time employees’ stock options and their share ownership positively effects innovation. And said positive effects persist across business-enterprise ownership, as opposed to state- owned organizations. The study provides insightful knowledge of the roles that full-time employees’ stock options and their share ownership play in innovative industries. While ownership could be a crucial innovation determinant, besides its qualifications, the study also offers policymaking guidelines for practice as well as implications for future research.

Keywords

Full-time employees stock options stock ownership patent ownership types

Mr. Muhammad Usman is a PhD. Business Administration candidate at Department of Accounting, School of Management and Economics, Beijing Institute of Technology, Beijing, China. He previously worked as lecturer. He graduated in Master of Commerce from Hailey College of Commerce, University of the Punjab, Lahore, Pakistan. His current research interest areas are executives, top management team and employees compensations and firm innovation policies.

Dr. Shufang Xiao is a Professor in Department of Accounting of School of Management and Economics, Beijing Institute of Technology. She is master advisor of the accounting profession and Certified Accountants. Her research interests are Theory and methods of financial management, Theory and methods of accounting, Equity-based incentives, Dividend Policy, Accounting information disclosure and earning management. She has memberships of China’s non-professional Certified Public Accountants, Chinese Accounting Society and Editorial Board member of “cutting-edge company series” published by the development of China Publishing Company.

Ms. Weiwei Li is a graduate student of major in accounting from School of Management and Economics, Beijing Institute of Technology, Beijing, China. Currently, she is working in one of the Big Four auditing firm as a controller of internal auditing and assurance management. She has research interests in areas of corporate governance, employee compensation and corporate innovation management.

1 Introduction

In the current competitive world economy, innovation is crucial to boosting long-term business growth and survival. Based on human contributions, innovation emerges from active, engaged, self-motivated people, who generate and convert new ideas into value-added products, i.e., goods and services. Especially in the case of high-technology firms, motivated and innovative employees and partners are the source of business self-development, growth, productivity, profitability and prosperity. Motivated full-time employees play admirable roles in firm growth, competitiveness and innovation performance [1]. Indeed an important question arises in business research: how full-time employees can be inspired to innovate?

This article examines the effects of full-time employees’ stock options and their share ownership on innovation. Such positive effects persist across business-enterprise ownership, as opposed to state-owned organizations. The study provides insightful knowledge of the roles that full-time employees’ stock options and their share ownership play in China’s innovative industries. While ownership could be a crucial innovation determinant, besides its qualifications, the study also offers policymaking guidelines for practice as well as implications for future research.

As compare to conventional investment decisions of tangible assets, corporate innovation is associated with high chances of failure because of many risks and unpredictable conditions [2]. So, in such conditions the traditional style of bonus incentives pay based on performance is insufficient to encourage employees for innovation. Thus, better firms’ innovation performance in true sense is required an incentive scheme that encourage long-term firm success and tolerance of failure [3]. In the arrangements of constant liberalization in marketplace, regulatory authorities in China introduced a set of guidelines named as “Regulation of Equity Incentive Plans” to permit corporates to adopt employees’ stock option incentives schemes. In China, adoption of these schemes began in 2006.

Following previous literature and empirical research, expected positive influence of full-time employees’ stock options on firms’ innovation due to three reasons. First, innovation in nature risk-taking project [2]. Stock option creates risk taking behavior among full-time employees because it positively linked employees’ wealth with return volatility of stock. Second, innovation inherently risky adventures, so success of innovation crucially depends on tolerance behavior for failure and rewards schemes to encourage for long-term success [1]. Stock options incentives do not possess the downside risk for employees, because in case innovation does not get success then fall in stock price will not impact their wealth. Third, firm innovation requires long time period, passes through multi-stages and needs labor-intensive [2]. Generally, stock-options schemes have long time period of vesting and on average long-term expiry. In further, stock ownership also motivate employees for long term corporate innovation. Because in general, stock bonus in nature is long-term incentives as compare to typical cash bonus, in case if an employee does not sell his shares immediately [4].

This study contributes in corporate literature by three ways. First, it gives insight knowledge of crucial role of full-time employees in firm innovation successes. Second, it shows the motivation impact and importance of stock options as well as stock ownership by full-time employees on firm innovation. Third, this study perform separate analysis of state and non- state controlled firms, to show the impact of two unique and major ownership types of Chinese firms. Remaining arrangement of article is designed into four further parts. It follows as literature and hypotheses, data and methodology, results of analysis and at the end finally conclusion of study respectively.

2 Literature review and hypotheses

This study contributes to the literature of corporate incentives and innovation output. It has already been found that multiple managerial incentives used for motivation to innovate [1]. The current study thereby examines the effects of full-time employees’ stock options and their share ownership on firm innovation. By examining these relations, the literature is arranged into three different parts. First is assessed how full-time employee stock options drive firms’ innovation. Second, literature is pertaining to the effects of full-time employee share ownership on the innovation progress of business enterprises. Third, discussed is the state and non-state ownerships of firms in China.

2.1 Full-time employee stock option and firm innovation

Our study focuses rank-and-file employees’ contribution in firm innovation progress that is yet in literature an underexplored research topic. Firms granted stock options to all their employees for getting many economic benefits. For instance, in situation of financial constraints and capital requirements, firms use more stock option incentive schemes to retain a type of greater productive employees and to increase value of firm [5]. Based on heterogeneous nature and beliefs of employees, firms awarded stock options to employees to attract productive, valuable and optimistic employees who effort to increase market value for the sake of increase in their stock options value [6]. Employees’ stock options create sensitivity of pay for performance among employees of rank-and-file which consequently leads better monitoring, mutual cooperation and high operating firm performance [7].

Empirical evidence shows that there is positive association among stock options of full-time employees and firm innovation, such positive relation is stronger in case when firms broadly grant stock option, weaker free-riding and innovation heavily depends on employees [8]. In an investigation of comparison between firms awarding stock option and firms without awards, it is found that firms’ performance in shape of ROE is high in those firms which are awarding stock options to their employees [9]. Our study considers stock options holding incentives for risk taking as well as tolerance of failure, team-work and perspective of long-term planning among employees to stimulate serious efforts for innovation. Thus, the following hypothesis is examined.

H1: Other things remaining constant, full-time employee stock option incentive is positively associated with firm innovation.

2.2 Full-time employee ownership and firm innovation

Full-time employee stock ownership drives full-time employees to link their wealth to that of firm shareholders. They thereby try to improve the value of their personal wealth and align their interests with those of shareholders, by handling risky projects to optimize their respective firms’ long-term performance. The impact of employee stock ownership plans (ESOPs) on firms’ long-term financial decisions reduces risk-averse administrative behavior or short-termism, so that managers select value-adding capital expenditures and R&D decisions [10]. An ESOP creates a self-ownership behavior, encourages enthusiasm in collegial problem solving, and unselfishly creating information and sharing knowledge.

For example, employees’ stock ownership encourage employees for information sharing and put more efforts which in result it improves firm productivity level and increase firm performance [11]. In empirical study, positive relation of employees’ stock ownership and firm innovation has been found and it supports cut-off agency cost as well as alleviation of agency conflicts among employees and firm shareholders [12]. Finally, employees holding shares of their own firm potentially motivated to avoid behavior of risk averse and align human contributions with fortune of their employers [13].

H2: Other things remaining constant, full-time employee stock ownership is positively associated with firm innovation.

2.3 State and non-state controlled ownerships

Firms under different ownerships exhibit arrangements of dispersed ownerships which suggested different employees’ incentive plans and deal with different purposes of profit maximizing and shareholders intentions. The influence of stock options plan depends on firms’ different ownership types. It is expected that impact of full-time employees stock options grant will be greater in non-state-owned corporates as compare to government controlled state-owned firms. Firms listed in China have a unique character in their ownership types, while usually the largest shareholding entities controlled firms [14]. In case of state-owned the controlling authority is government or agencies of government, whereas profit maximization purpose function may be offset. Government controlled corporations have different agendas and political intentions such as society welfare and insuring a level of employment in urban areas. Moreover, job selection and promotion of managers in state-owned corporates all depends on political connections, administrative scheme and not just only on performance.

Thus, intention and efforts of managers in state-controlled firms will be diverted towards government satisfaction rather than protecting shareholders’ interests, payment of incentives in such conditions will not give desire results [15]. More specifically, state-controlled corporates are larger in scale as compare to privately-owned corporates, so individual efforts have low impact on firm overall performance. Relatively smaller proportion of stock options and percentage other employee benefits are gained by employees in state-owned corporations as compare to private firms. Positive benefits associated with firm option grants are normally found in non-state controlled firms while not in state-owned firms [16]. Empirical research shows positive link of employee stock options with ROE performance and this linkage is stronger in privately controlled corporations [9]. In field of firm innovation same evidence found that innovation performance of state controlled enterprises is less as compare to privately owned firms [17]. In most cases non-state controlled enterprises have greater propensity of getting patents than state-owned firms [18]. There is rapid increase in applications and the grants of patents in China, so it’s interesting to answer the question which kind of firms contribute more in innovation process. Thus, this study expected and tested the following hypotheses.

H3: Other things remaining constant, positive association among full-time employee stock option incentive and firm innovation is stronger in non-state controlled firms.

H4: Other things remaining constant, positive association among full-time employee stock ownership and firm innovation is stronger in non-state controlled firms.

3 Research methodology

3.1 Data and methodology

In this study data is collected from two big Chinese databases that are China “Stock Market & Accounting Research” (CSMAR) and Wind. Firms having A-shares category and listed stock on Shanghai and Shenzhen stock exchanges were selected. Further, this research study target high-tech industries sector. Study selected the definition of previous research as well as high-tech industry defined by ‘China Securities Regulatory Commission’ (CSRS). As mentioned in literature of this study equity incentives were started in 2006 but practically adopted by such incentive schemes in 2008. Thus, this study finally collected the unbalanced data for the time period 2009 to 2014. Generally, stock options for full-time employees are introduced by few firms, so this study first identified firms having employees’ stock options. After cancelation of ST and *ST firms, firms having missing data and outlier values, at the end got 284 firms for final analysis of this study hypotheses. Stata.12 version is used for analysis and applied fixed effect multiple regression models.

3.2 Regression models and variables of the study

This study used two main models of equations for analysis of four hypotheses. First model tested H1 and H2, while H3 and H4 theory and justification of ownership impact is tested by second model. Two models of equations are given as: $\begin{matrix} PAT = α + β 1 FESO + β 2 FESOW + β 3 SOF \\ + β 4 ROA + β 5 LEV + β 6 GRW + β 7 ESH \\ + β 8 DL + β 9 OT + β 10 IDM + β 11 YDM + ɛ \end{matrix}$ $\begin{matrix} PAT = α + β 1 FESO + β 2 FESOW + β 3 SOF \\ + β 4 ROA + β 5 LEV + β 6 GRW \\ + β 7 ESH + β 8 DL + β 9 IDM + β 10 YDM + ɛ \end{matrix}$

Dependent variable: Patent (PAT) = LN (1 + year the total number of patent applications). Independent variables: Full-time employees’ stock options (FESO) = at the end of year full-time employees staff awarded shares/total number of shares, Full-time employees’ stock ownership (FESOW) = Proportion of full-time employees share ownership/total number of shares. This article introduced two kinds of controlling factors which are related to firms and executives characteristics, such as: Size of firm (SOF) = The final total assets of the logarithm value, Return on assets (ROA) = Net income/average total assets, Leverage (LEV) = The final asset-liability ratio, Growth (GRW) = Growth rate of total assets, Executive stock options (ESH) = At the year ends, executives shareholding quantity/total number of shares at the end of that year, Duality (DL) = value one if CEO also board chairman, if not then zero, Ownership types (OT) = value one if firm under control of state, if not then zero, industry dummies (IDM) = Effect of different industries within high-tech sector are controlled by using dummies, Year dummies (YDM) = Effect of different years variables data also controlled by year dummies. Here following Fig. 1 explains the hypothesized relations among independent and dependent variables of this study. All four hypotheses of our study are proved.

Fig.1

Hypothesized relations among study variables.

4 Results of data analysis

4.1 Descriptive statistics

Descriptive statistics which includes values of mean, standard deviation, maximum and minimum of all key variables of study are explained in Table 1. Total numbers of observations of this study are 652.

Table 1
Descriptive statistics

Variables symbol Obs. Mean Std. Dev. Min Max

PAT 652 2.37 1.59 0 6.03

FESO 652 0.02 0.12 0 0.09

FESOW 652 27.49 18.00 0 65.42

SOF 652 21.59 0.97 0 25.08

ROA 652 11.72 7.42 2.02 63.01

LEV 652 34.12 18.01 2.22 84.80

GRW 652 22.79 12.84 18.12 315.20

ESH 652 0.18 0.28 0 0.98

DL 652 0.41 0.49 0 1

OT 652 0.28 0.37 0 1

Variables symbol	Obs.	Mean	Std. Dev.	Min	Max
PAT	652	2.37	1.59	0	6.03
FESO	652	0.02	0.12	0	0.09
FESOW	652	27.49	18.00	0	65.42
SOF	652	21.59	0.97	0	25.08
ROA	652	11.72	7.42	2.02	63.01
LEV	652	34.12	18.01	2.22	84.80
GRW	652	22.79	12.84	18.12	315.20
ESH	652	0.18	0.28	0	0.98
DL	652	0.41	0.49	0	1
OT	652	0.28	0.37	0	1

4.2 Correlation analysis

To determine issue of multicollinearity, correlation analysis among crucial variables of study was performed, as all given correlation values in Table 2 show less than 0.6. Further, Variance Inflation Factor (VIF) analysis was used. As all values are less than five, so ultimately there is no as such multicollinearity issue among the independent variables of this study.

Table 2
Correlation analysis

Variables VIF 1 2 3 4 5 6 7 8 9 10

1.PAT – 1

2. FESO 1.115 0.043 1

3.FESOW 1.265 0.274^* –0.196^* 1

4.SOF 1.743 0.270^* –0.172^* 0.262^* 1

5.ROA 1.586 –0.155^* 0.060^* –0.503^* –0.150^* 1

6.LEV 1.583 0.160^* –0.107^* 0.151^* 0.568^ –0.191^* 1

7.GRW 1.056 –0.012 0.031 –0.079^ 0.025 0.148^*** 0.043 1

8.ESH 1.427 –0.371^* 0.115^* 0.037 0.243^* 0.012 –0.229^* 0.007 1

9.DL 1.324 0.034 0.071^ 0.020 –0.161^** 0.053^* –0.178^ 0.038 0.481^ 1

10.OT 1.171 0.099^* –0.252^* 0.154^* 0.360^* –0.003 0.217^* –0.042 –0.192^* –0.137^*** 1

Variables	VIF	1	2	3	4	5	6	7	8	9	10
1.PAT	–	1
2. FESO	1.115	0.043	1
3.FESOW	1.265	0.274^***	–0.196^***	1
4.SOF	1.743	0.270^***	–0.172^***	0.262^***	1
5.ROA	1.586	–0.155^***	0.060^*	–0.503^***	–0.150^***	1
6.LEV	1.583	0.160^***	–0.107^***	0.151^***	0.568^**	–0.191^***	1
7.GRW	1.056	–0.012	0.031	–0.079^**	0.025	0.148^***	0.043	1
8.ESH	1.427	–0.371^*	0.115^***	0.037	0.243^***	0.012	–0.229^***	0.007	1
9.DL	1.324	0.034	0.071^**	0.020	–0.161^**	0.053^*	–0.178^**	0.038	0.481^**	1
10.OT	1.171	0.099^***	–0.252^***	0.154^***	0.360^***	–0.003	0.217^***	–0.042	–0.192^***	–0.137^***	1

Note: The ^***,^**,^* show level of significance at 1%, 5% and 10% level of significance.

4.3 Regression results

Table 3 shows the regression analysis results. Study applied two different models of regression equations to determine the study hypotheses. First regression model based is used for full sample, after controlling other factors results prove H1 and H2, as clearly full-time employees’ stock options (FESO) as well as full-time employees’ stock ownership (FESOW) are positively associated with innovation firms’ performance. Coefficient values of FESO and FESOW are significant positively at 1% and 5% respectively while 0.131 adjusted value of R-square of first regression model of study. Second regression model is applied on two sub-samples of 57 state-controlled corporates and also 595 corporates of non-state-controlled firms in high-tech industry of China. Results prove H3 and H4 of our study that impact of full-time employees’ incentive of stock options and their ownership of firms’ share on firm’s innovation are stronger under non-state-controlled firms. Whereas, 0.190 and 0.169 are adjusted values of R-square of two sub-samples of state and non-state controlled firms respectively.

Table 3
Results of regression analysis

Variables Regression Results of Three Different Samples

All Firms State-Owned Firms Non-State-Owned Firms

FESO 0.127^* 0.322 0.126^*

FESOW 0.207^ 0.513^ 0.238^*

SOF 0.242^* –0.137 0.270^*

ROA –0.017 0.101 –0.016

LEV 0.004 –0.447^* 0.060

GRW –0.012 0.260^* –0.038

ESH 0.013 –0.291 0.017^*

DL 0.061^* –0.046 0.052^*

OT 0.014 – –

IDM Yes Yes Yes

YDM Yes Yes Yes

R-Square 0.147 0.320 0.181

Adj. R-Square 0.131 0.190 0.169

F-Statistics 9.177^* 2.459^ 14.396^***

No. of observations 652 57 595

Variables	Regression Results of Three Different Samples
FESO	0.127^***	0.322	0.126^***
FESOW	0.207^**	0.513^**	0.238^***
SOF	0.242^***	–0.137	0.270^***
ROA	–0.017	0.101	–0.016
LEV	0.004	–0.447^***	0.060
GRW	–0.012	0.260^*	–0.038
ESH	0.013	–0.291	0.017^*
DL	0.061^*	–0.046	0.052^*
OT	0.014	–	–
IDM	Yes	Yes	Yes
YDM	Yes	Yes	Yes
R-Square	0.147	0.320	0.181
Adj. R-Square	0.131	0.190	0.169
F-Statistics	9.177^***	2.459^**	14.396^***
No. of observations	652	57	595

Note: The ^***,^**,^* show level of significance at 1%, 5% and 10% level of significance.

5 Conclusion

This study focuses on issue of full-time employees’ motivational factors for successful and long-term achievement of firm innovation performance. This article used patent that a firm applied in a year for measuring firm innovation performance. Mainly two motivational factors are under investigation. First, full-time employees’ stock options (FESO) = at the end of year full-time employees staff awarded shares/total number of shares. Second, full-time employees’ stock ownership (FESOW) = Proportion of full-time employees shares ownership/total number of shares. Collection of data is done from high-tech industry sector of China. Total 284 firms’ unbalanced data of 2009 to 2014 time period is collected and analyzed.

In main analysis, two motivational factors of full-time employees and their impact on innovation were examined. In further two sub-samples of data sets of state as well as non-state controlled ownership impact has been investigated. Analysis results prove stock options and also stock ownership by full-time employees have positive significant influence on innovation performance of firms. Moreover, it also prove non-state corporations have stronger impact.

Empirical result findings of this study gives contribution in corporate literature and strategic research by three ways. First, this study discussed important role of full-time employees in long-term success of innovation performance. Second, most of past studies have been found executives’ stock options as motivational and risk-taking factor, this study gave insight knowledge and empirically proved the role of stock options and as well as ownership of full-time employees on innovation performance of firms. Third, it was included in part of analysis the unique kinds of Chinese firms’ main control and ownership types to differentiate the impact of main results.

This article will help policy makers and practitioners to understand how an appropriate design of employees’ stock options and their stock ownership mechanism could productively contribute in firm innovation performance. Further, researchers can get insight knowledge how the impact of full-time employees can varies among different ownership enterprises. Thus, results of sub-samples analysis show that innovation performance can be more pronounced in those enterprises where contribution of employees input for innovation performance is more important. Collectively, results of this study show full-time employees are most important input part of firm innovation and thus it enriches theory of stockholders in corporate finance. This study limits it up to two motivational factors of full-time employees to take risk and work for firm long-term successful innovation performance of firms. Future studies might be examined and identified more factors to encourage and motivate firms’ full-time employees for their contribution in process of innovation.

Footnotes

Acknowledgments

The authors thank the financial support provided by the National Natural Science Foundation of China (2011–2015, project code: 71172171: Equity Incentive and Manager Opportunistic Behavior: A Managerial Power Perspective); NSFC (2017–2020, project code: 71672010: Mechanism and empirical evidence of equity compensation contracts’ effect on corporate innovation), NSFC (2016–2018, project code: 71502014: The Research on Enhancing the Capability of Corporate Innovation: Institutional Investor Activism’s Perspective) and NSFC (2014–2017, project code: 71372015: The Motivation Mechanism and Consequences of Whole Listing by Reverse Takeover).

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Variables	Regression Results of Three Different Samples
	All Firms	State-Owned Firms	Non-State-Owned Firms
FESO	0.127^***	0.322	0.126^***
FESOW	0.207^**	0.513^**	0.238^***
SOF	0.242^***	–0.137	0.270^***
ROA	–0.017	0.101	–0.016
LEV	0.004	–0.447^***	0.060
GRW	–0.012	0.260^*	–0.038
ESH	0.013	–0.291	0.017^*
DL	0.061^*	–0.046	0.052^*
OT	0.014	–	–
IDM	Yes	Yes	Yes
YDM	Yes	Yes	Yes
R-Square	0.147	0.320	0.181
Adj. R-Square	0.131	0.190	0.169
F-Statistics	9.177^***	2.459^**	14.396^***
No. of observations	652	57	595