DPRIETI Discussion Paper Series 12-E-011

Stock Options and Productivity:
An empirical analysis of Japanese firms
MORIKAWA Masayuki
RIETI

The Research Institute of Economy, Trade and Industry

http://www.rieti.go.jp/en/

RIETI Discussion Paper Series 12-E-011
February 2012

Stock Options and Productivity: An empirical analysis of Japanese firms
MORIKAWA Masayuki (RIETI)

Abstract
This paper analyzes the relationship between the use of stock options and productivity
by employing firm-level panel data from the Basic Survey of Japanese Business
Structure and Activities. According to the analysis, the use of stock options has apositive impact on firm productivity. Productivity steadily increases after the adoptionof stock options. In addition, we found suggestive evidence that R&D investment
increases after the introduction of stock options. These results imply that the
deregulation on the use of stock options in 1997 and the subsequent legal reforms have
had positive contributions to the productivity performance of Japanese firms.
Keywords：stock options, productivity, R&D investment
JEL classifications：D22, D24, G34, M52

RIETI Discussion Papers Series aims at widely disseminating research results in the form ofprofessional papers, thereby stimulating lively discussion. The views expressed in the papers aresolely those of the author(s), and do not represent those of the Research Institute of Economy,
Trade and Industry.



I would like to thank Masaharu Hanazaki, Yoko Konishi, Hirohiko Nakahara and Taisuke
Uchino, and the seminar participants at RIETI including Reiko Aoki, Yasuo Goto, Yoshinori
Komiya, Heog Ug Kwon, and Atsushi Nakajima for their helpful comments and suggestions. I
also would like to thank Willem Thorbecke for his detailed comments to improve the paper.This
research is supported by the JSPS Grants-in-Aid for Scientific Research (B, 23330101).
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1. Introduction

This paper presents an empirical analysis on the relationship between stock options andproductivity in Japanese firms. Stock options are pecuniary incentives that give
executives and employees the right to buy the firm’s stocks at a predetermined priceduring a prescribed period of time. The effect of stock options is generally understood toprovide effects such as mitigating agency problems caused by the separation ofownership and management, promoting risk-taking by business managers, andenhancing the effort of executives and employees. This is a long-standing system in the
United States, but was only introduced to Japan in 1997 after an amendment of theCommercial Act. A proper tax treatment for stock options was introduced in 1998.
Further, at the beginning of the 2000s, the following revisions of the Commercial Act
were made: removal of the upper limit of stock options, expansion of the coverage of
people who are entitled to stock options, simplification of the legal procedures for
granting stock options, etc.
The Ministry of Economy, Trade and Industry (METI) has conducted a survey on the
adoption of stock options for about 30,000 large and medium-sized Japanese firms in“the Basic Survey of Japanese Business Structure and Activities” since

fiscal year

1997 when stock options were widely introduced. The number of firms which adopted
stock options continued to increase by the mid 2000s and since that time has remained
the same or decreased slightly. The recent figure is about 1,500 firms, which is about 56% of the total firms surveyed (see Table 1). As described later, listed firms comprised alittle less than half of the total firms adopting stock options and a considerable numberof unlisted firms adopted stock options. METI added a survey item on the coverage ofthe people granted stock options in the Survey between 1998 and 2005. According to thesurvey results, 70% or more of the total firms which adopt stock options have granted
stock options to both executives and employees.
If stock options enhance incentives for executives and employees and promoteresource allocation by business managers on profitable investments, they are likely tocontribute to productivity growth in firms as a result. They may also provide effects to
expand relatively high-risk investments including R&D investment.

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Although there have been some studies on the determinants and the effects of stock
options in Japan, to the author’s knowledge an analysis on the relationship between
stock options and productivity has not yet been conducted. Moreover, past studies haveused financial data of only listed firms and the large scale data collected in the Basic
Survey of Japanese Business Structure and Activities were not fully utilized. Basedupon this background, this paper analyzes the relationship between stock options andproductivity (total factor productivity (TFP) and labor productivity (LP)) based on thepanel data from the Survey mentioned above. Furthermore, we will analyze therelationship between stock options and R&D investments which is a typical high-risk
investment, compared to ordinary equipment investment.
The results of the analysis can be summarized as follows: 1) Adoption of stock
options increases TFP by 5-8% and LP by 5-10%, when the firm fixed-effects andendogeneity of the stock options are controlled for. 2) A comparison with the period

before and after stock options were introduced demonstrates that the productivity
growth rate before the introduction of stock options was not high compared to that forfirms that did not introduce stock options. However, the productivity growth rate
accelerated after the introduction of stock options and continued to increase every year
since then. 3) R&D intensity (R&D investments / total sales) increases after the
introduction of stock options. These results imply that withdrawal of the ban on stock
options in the late 1990s and subsequent improvement of their systems made acontribution to the performance of Japanese firms.
The rest of this paper is structured as follows. Section 2 briefly surveys past studies.
Section 3 describes the data used and the method of analysis. Section 4 presents theresults, and Section 5 concludes with policy implications.

2. Literature Review

As Core et al. (2003) and Hanazaki and Matsushita (2010) present a detailed survey on
theoretical and empirical studies on stock options, we only briefly review past studies
that are closely related to the analysis in this paper. A large number of studies have been‐3‐

conducted on the effects of stock options in Europe and the U.S., such as 1) the effects
on share price (Brickley et al., 1985, etc.), 2) the effects on accounting profits (DeFusco
et al., 1990; Chen and Lee, 2010, etc.), and 3) the effects on risk taking behavior(DeFusco et al.1990; Rajgopal and Shevlin, 2002; Chen and Lee, 2010, etc.). Recent
research often investigates the effects of broad-based stock options not limited to
executive but available for all employees (Core and Guay, 2001; Oyer and Schaefer,2005; Hallock and Olson, 2010, etc.). Core et al. (2003) present a comprehensive surveyof theoretical and empirical studies on a compensation plan for executive and employees
based on shares including stock options and conclude that there is no theoretical or
empirical consensus on how stock options and managerial equity ownership affect firm
performance. They suggest that the optimum level of incentives for executives may varyby firms and that the current level of incentives may be too high or too low dependingon the firm characteristics.
A small number of studies that focus on the relationship between stock options andproductivity include Jones et al. (2010) and Sesil and Lin (2011). 1 Jones et al. (2010)
estimate a Cobb-Douglas production function by fixed-effect estimation using panel
data of listed firms in Finland (1992~2002), and conclude that no statistically significant
relationship was identified between stock options for employees and productivity. Sesiland Lin (2011) also estimate a Cobb-Douglas production function to evaluate the effectsof stock options for executives and those for employees on productivity in the current
year and the following 5 years, based on the panel data collected from 632 high-techfirms in the United States. Their results show that stock options for executives havepositive effects (+18%) on productivity in the year of the introduction of stock options,that those effects lasted for 5 years, and that broad-based stock options for people
including employees have a positive effect (+9%) on productivity in the year of theintroduction of stock options but that the effect does not persist. Based on these results,
they conclude that although the adoption of stock options is beneficial for the
productivity of firms, it is necessary to grant broad-based stock options to employees as
frequently as stock options for executives in order to sustain a long-term effect frombroad-based stock options. Furthermore, Bulan et al. (2010) analyze the relationshipbetween the sensitivity of compensation for managers including stock options tobusiness performance and productivity among manufacturers in the U.S. and indicate
1

Palia and Lichtenberg (1999) analized the relationship between managers’ ownership of shares
and TFP (but not stock options).
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that when the value of stock options for managers is more sensitive to the volatility ofstock return, TFP of the firm is higher. In other words, they suggest that stock options
prevent a decline in productivity due to managers’ risk aversion.
In Japan, Nagaoka (2005) and Uchida (2006) empirically analyze the determinants of
the introduction of stock options using firm-level data after the withdrawal of the ban on
stock options in 1997 by the amendment of the Commercial Act. Nagaoka (2005), using
data for 3,176 listed firms (including 391 firms that introduced stock options) between
1997 and 2000, finds that the R&D intensity of the firms which adopted stock options ishigh at the time of the introduction of stock options and the growth rate of the numberof employees is very high. Nagaoka (2005) also estimates a probit model and amultinomial model. The results indicate that stock options are used more often by fastgrowing young firms and less in regulated industries and by the firms with concentrated
ownership structure, and that there is no significant relationship between R&D intensity
and the introduction of stock options. Uchida (2006) analyzes the determinants (firmcharacteristics) of the adoption of stock options by estimating a probit model based on adata between 1997 and 2000 collected from firms listed in the First Section of the Tokyo
Stock Exchange. The results suggest that there is a negative relation between leverageand the probability of firms’ use of stock options, that such a relation is more marked
for firms in a certain affiliated group (Keiretsu) or associated with main banks, and thatindependent firms which are more concerned about the shareholder wealth are more
likely to use stock options. Although these studies analyze the determinants of theintroduction of stock options, the effects of stock options on business performance are
not examined.
Kubo and Saito (2008) analyze the sensitivity of compensation for presidents,
including stock options, of Japanese firms, to the firm value based on a panel data for
115 firms between 1977 and 2000. The results indicate that the sensitivity ofcompensation for presidents of Japanese firms to the firm value is not only significantly
low compared to the U.S. firms but decreased after 1990. They state that these results do
not stem from the movements in overall share price. Their results imply that stock
options have not been effective enough as an incentive for managers of the Japanesefirms.
With respect to the effects on firm performance, Kato et al. (2005) analyzed theeffects of stock options on share price and accounting performance based on the data‐5‐

collected from about 350 listed firms which adopted stock options between 1997 and2001. They present evidence that the adoption of stock options in Japanese firms had
positive effects on share price and ROA. However, the periods of their research was
until around 2000, which are not long enough to identify the medium- and long-term
effects of stock options. Recent research by Hanazaki and Matsushita (2010)
comprehensively analyze the determinants of the introduction of stock options and theeffects of stock options on firm profits and risk-taking behaviour based on a panel dataof Japanese listed firms between 1997 and 2006. The results show that firms of whichlarge foreign ownership and firms of which have relatively low leverage are more likely
to adopt stock options. The results also show that the use of stock options has limited
effects on the firm’s profitability (ROA and ROE) and that the effect of stock options on
the firm’s risk-taking is not observed. From these results, they concluded that the
adoption of stock options in Japanese firms does not have either significant positiveeffects or negative side effects.
To summarize, the results of past Japanese studies on the effects of stock options onfirm’ profits are divided. There has been no empirical study on the relationship between
stock options and productivity in Japan. In addition, although a small number of studies
have been done on the effects on productivity even in Europe and the U.S., theconclusions are not uniform across studies. This paper aims to analyze empirically themedium- and long-term effects of the introduction of stock options on firm productivity
and risk-taking (proxied by R&D investments) using a large sample of firms coveringboth listed and unlisted firms.

3. Data and Methodology

The analysis in this paper uses a panel data between 1994 and 2009 from the Basic
Survey of Japanese Business Structure and Activities conducted by METI. The Basic
Survey of Japanese Business Structure and Activities, an annual survey begun in 1991,
accumulates representative statistics on Japanese firms with 50 or more regular
employees, including those engaged in mining, manufacturing, electricity and gas,
wholesale, retail, and several service industries. Over 25,000 firms are surveyed every‐6‐year. The purpose of this survey is to capture a comprehensive picture of Japanese firms,
including their basic financial information, composition of businesses, R&D activities,
IT usage, and foreign direct investments. As the sample firms are coded by using
perpetual numbers, it is easy to construct a firm-level longitudinal data set. This Survey
collects information on the adoption of stock options each year from 1997 to thepresent. 2 The specific questionnaire is very simple: “Are stock options introduced inyour firm?” In this paper, a dummy variable (sopt) is used as an independent variable,
which takes a value 1 for firms answering “Yes” for the above question.
Firstly, the relationship between stock options and productivity was analyzed basedon the above data set. Value-added based TFP and labor productivity (LP) are our main
dependent variables, where value-added, capital (total tangible assets), labor (total
hours), and cost of shares of capital and labor are used for constructing theseproductivity measures. The TFP is calculated in a nonparametric manner that uses ahypothetical representative firm as reference. Specifically, the input and output of ahypothetical representative firm are calculated as the geometric means of those of all
firms and the cost shares of labor and capital are calculated as arithmetic means at thebase year (2001). The TFP for each firm are calculated relative to the hypotheticalrepresentative firm. This is called as the index number method which is often used for
TFP measurement in recent studies. 3 LP is measured as value-added output per hour
(used as a logarithmic form). When LP is used as dependent variable, the capitalintensity (lnkl) is used as a control variable. Although LP is an incomplete productivity
indicator compared to TFP, it has an advantage that measurement errors are relatively
small.
The baseline estimation methods employ pooled OLS and fixed-effect (FE) estimators.
The firm size (the log of the number of regular employees: lnemp) and year dummies areused as control variables. In addition, three-digit- industry dummies are used in the OLS
2

A questionnaire on the subjects granted stock options (executives and/or employees) wereadded between the 1998 and the 2005 surveys.

3

The formula for calculating value-added is as follows: ‘Value added = Operating profit +Rental expense + Total labor cost + Depreciation expense + Taxes and dues’ which is adopted
in the report of the Basic Survey of Japanese Business Structure and Activities (taxes and dues
are not included in 1994 as such data is unavailable). Working hours by industry andemployment type are taken from the Monthly Labor Survey. Value-added deflator in “National
Accounts” is used for creating real value-added and deflator on gross capital formation is used
for creating real capital stock.
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estimations. To summarize, the baseline equation to be estimated is expressed below.
The equation (1) shows OLS estimation and the equation (2) shows FE estimation. The
period of the analysis is from 1994 to 2009. Although stock options were introduced
only after 1997, we use data back to 1994 in order to analyze the productivity before theintroduction of stock options.

yit = α + ß soptit + γ Xit + dkΣk industry dummies + λt + εit(1)yit = α + ß soptit + γ Xit + λt + ηi + εit(2)

In these equations, yit denotes productivity indicators (TFP, LP), Xit denotes control
variables (firm size and capital intensity), λt denotes year dummies, ηi denotes firm
fixed-effects, and εit is an i.i.d. error term.
In addition to the baseline estimation, the interaction term between stock options andlisting is added in order to observe the different effects of stock options on whether thefirm is listed or not. Needless to say, the effectiveness of stock options as an incentive
device depends on the market value of the stock. Therefore, the effectiveness may belimited unless the firm is listed or is expected to be listed in the near future. As data
about the listing status of firms is unavailable in the Basic Survey of Japanese Business
Structure and Activities, the variable for listing dummy is constructed by using a
converter of the Survey and the securities identification codes of listed firms.4 Securities
identification codes in the “Corporate Financial Data Bank” by the Research Institute of
Capital Formation of Development Bank of Japan are used. The listed firms include alllisted firms on the first and the second sections and emerging markets of the Tokyo,
Osaka and Nagoya Stock Exchange, and other local stock exchanges.
There are often problems in relation to whether a causal relationship can be inferredfrom regression analysis due to endogeneity in variables related to corporate
4

A converter for firm numbers and securities identification codes in the Basic Survey ofJapanese Business Structure and Activities was provided by the Quantitative Analysis andDatabase Group of RIETI. The number of listed firms which corresponded to securities
identification codes was about 2,500.
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governance.5 However, generally, it is very difficult to find an appropriate instrument.
The effect of stock options is not an exception for the causality issue. This paper tries tocheck the robustness of the results of the baseline estimation, using stock options in theprevious year as an instrumental variable for estimation.
Next, we analyze the effects of the adoption of stock options on firm’s risk-taking
behavior, using R&D investment as a proxy for high-risk investment. It is a well-known
fact that R&D investments have higher risk and higher return than ordinary equipment
investments. For example, Coles et al. (2006) suggest that the sensitivity ofcompensation for CEOs to the volatility of share price has a positive effect on R&D
investments. Himmelberg and Petersen (1996) indicate the high sensitivity to internalfunds (cash flow) of R&D investments, of which risk and profitability are hard toevaluate from outside. Specifically, we use R&D investments and equipment
investments divided by firm sales as dependent variables in the regressions. The same
explanatory variables and estimation methods as those for productivity regressions (seeequations (1) and (2)) are used.
However, the estimation method described above is based on the assumption that theeffects of stock options are stable regardless of the number of years after the adoption.
In addition, a higher growth rate in productivity trends and a higher increase in R&D
intensity of the firms which adopt stock options may overstate the estimated effects ofstock options. For these reasons, in this paper, the year when each firm introduced stock
options is used as the base year and the figures of productivity and R&D investments
during the 3 years before that year and each year after the introduction are analyzed. In
this case, fixed-effect estimator is employed.

yit = α + ß soptyearit + γ Xit + λt + ηi + εit(3)

The dummy variable soptyearit denotes the number of years after the introduction ofstock options. The dummy soptyeari0=1 for the firm-year when stock options is first
introduced, and soptyeari1=1 for the firm-year when the firm continues to adopt stock5

See Roberts and Whited (2011) for problems of endogeneity related to research on corporate
governance.
‐9‐options in the next year. In presenting estimation results, 1, 2, 3, 4, and 5 or more years
after the introduction of stock options will be expressed as sopt1, sopt2, sopt3, sopt4,
sopt5+. For example, for a firm which introduced stock options in 2001, sopt1 and sopt2
are the dummies for 2002 and 2003 of the firm. As the objective of this estimation is tocompare the performance trends before and after the time of the introduction of stock
options, the dummies for 1, 2, and 3 years before the introduction of stock options arealso used (expressed as sopt_1, sopt_2, sopt_3). The specific year of the introduction ofstock options varies depending on the firm. For example, for a firm which introduced
stock options in 2001, sopt_1, sopt_2, sopt_3 are dummies for 1998, 1999, and 2000 of
the firm.

4. Results

Before presenting the regression results, the basic characteristics of the firms which
introduce stock options and those which do not introduce stock options are comparedbased on the data set from 1997 to 2009 (see Table 2). The firms which introduced stock
options are larger in size, higher in productivity (TFP, LP) and higher in the ratio of
R&D investments-sales ratio and equipment investments-sales ratio, compared to thosewhich did not introduce stock options. There are statistically significant differences at
the 1% level in all these attributes. It is also found that the firms that introduced stock
option have a higher foreign ownership ratio (8.38%) than those which did not introduce
stock options (1.64%). On the other hand, the average year of the foundation of thefirms that introduce stock options is 1960, while that of those which do not introduce
stock options is 1957. Although the difference is statistically significant at the 5% level,
the difference is quantitatively small. We do not find a strong tendency of introducing
stock options among younger firms. In fact, a large number of traditional large firms
introduced stock options.
Listed firms comprise about 45% of the firms which introduced stock options in thesample. The remaining 55% are unlisted firms. 6 As stock options have little value if
6

As described already, as the data of whether the firm is listed or not is unavailable in the Basic
Survey of Japanese Business Structure and Activities, the information which corresponds to‐ 10 ‐

shares are non-marketable at the time of the exercise of the right, it is expected that the
majority of the firms which introduced stock options would be listed firms. However, in
reality, there are quite a few unlisted firms which introduced stock options.

4-1. Stock Options and Productivity

This subsection presents estimation results obtained from the regression equations
described in the previous section. The relationship between stock options andproductivity is shown in Table 3. The result of OLS estimate show that the TFP of thefirms that adopted stock options is 8.7% higher after controlling for the firm size,
industrial sector, and year dummies, while the result of FE estimate show that the TFP
of such firms is 4.6% higher. The coefficient of the FE result is about half of that of the
OLS estimate, which implies that the unobserved firm characteristics which adopted
stock options are positively related to productivity: more productive firms tend to use
stock options. The labor productivity advantages of firms that adopted stock options are
9.3% in the OLS estimate and 5.4% in the FE estimate. The size of the estimatedcoefficients is almost the same as that of the TFP. When three-digit industry dummies
are added to the FE estimation (not reported in the table), the coefficients of stock
options are 0.042 in TFP and 0.049 in LP.7
When the sample firms are divided into manufacturing and non-manufacturing firms,
the estimated effects of stock options on TFP and LP are both about 1% higher inmanufacturers than in non-manufacturers. However, a positive relationship between
stock options and productivity is observed both in manufacturing and nonmanufacturing firms (see Table 4).

securities identification codes is used. As the matching may not be perfect, listed firms with theratio of 45% may be an underestimate.
7

Value-added includes wages. If stock options are granted instead of wages to employees, thecalculated productivity will be lower. In this case, the effects on stock options can beunderestimated.
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As mentioned already, there are quite a few unlisted firms among the firms that
adopted stock options. In order to detect if there are any differences in the effects ofstock options on productivity in relation to whether the firms are listed or unlisted, adummy for listed firms and the interaction term of stock options and the dummy for
listed firms are added as independent variables in the FE estimations. The results
indicate that the coefficients of the interaction terms are significant and relatively highpositive value (see Table 5 and Figure 1). The effects of stock options on TFP is about
3% for non-listed firms and about 7% for listed firms (LP is about 3% for non-listed
firms and about 8% for listed firms). The effects of stock options on productivity
performance are stronger for listed-firms. However, it should be noted that the
introduction of stock options has a positive effect on productivity even for non-listed
firms.
Next, the results of instrumental variable estimation (IV) and IV fixed-effects
estimation (IVFE) are presented, where the adoption of stock options for the previous
year is used as an instrument for the current stock options. Once stock options are
introduced, they often continue to be adopted for the following several years. Therefore,
the explanatory power of the first stage regression to explain the adoption of stock
options is high.8 As shown in Table 6, the coefficients are relatively larger than those
without instrumental variable. The results of IVFE show that the adoption of stock
options increased TFP by about 8% and LP by about 10% (Table 6, columns (3) and (4)).
When the sample firms are divided into manufacturing and non-manufacturing firms, theeffects of the adoption of stock options on TFP are about 10% for manufacturers andabout 7% for non-manufacturers, and the effects on LP are about 11% for manufacturers
and about 9% for non-manufacturers. The effects on productivity in manufacturing firms
are somewhat larger than those in the simple FE estimates (see Table 7).
The unobservable time-invariant firm characteristics are controlled in FE estimates.
However, regardless of whether the firm introduced stock options or not, there may be atrend difference in the productivity growth rates between the firms which adopted stock
options and those which did not adopt stock options. To investigate this possibility,
productivity performance during the period of 3 years prior to the introduction of stock
options is compared to that of the several years after the introduction. The results are8

As described later, the effects on productivity become larger as the time passed after the
introduction of stock options. This suggests that there are lagged effects of stock options on
productivity. Therefore, the lagged stock options may not be an ideal instrument.
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shown in Table 8 and Figure 1. They show that although the growth rate of productivity
was not very high before the introduction of stock options, it increased after the
introduction and continued to increase as the years passed. Productivity in the firms
which introduced stock options more than 5 years before experience about 11-13%
increases. This suggests that the firms which introduced stock options are not thosewhich already had higher trend productivity growth, but that the growth rate ofproductivity accelerated by the introduction of stock options. Although this analysis
does not completely eliminate the possible endogeneity bias that the firms introduce
stock options by anticipating an increased growth rate of their productivity, it strongly
implies a causal relationship between the introduction of stock options and productivity
performance.
As Kubo and Saito (2008) indicated, the sensitivity of executive compensation
including stock options of Japanese firms to business performance is very low. However,
the effects of incentives depend both on 1) the sensitivity of compensation to businessperformance, and 2) the sensitivity of efforts made by executives and employees tochanges in compensation structure. In addition, stock options can have effects topromote risk-taking by increasing not only the sensitivity of compensation to the levelof business performance but also the sensitivity to the volatility of business performance(equity risk) (Guay, 1999; Coles et al., 2006, etc.). Although this paper does not directly
test these arguments, it implies that the sensitivity of efforts to compensation can behigh and/or stock options can have effects to change behavior of risk-averse managers.

4-2. Stock Options and R&D Investment

This subsection reports the results on whether the adoption of stock options has effects
on the increase of corporate risk-taking by focusing on R&D investments. The results of
the OLS estimates show that R&D intensity (the ratio of R&D investments to sales) is
0.77% higher for firms which adopted stock options whereas the results of FE estimatesindicate a value of 0.09% which is relatively low (see Table 9, columns (1) and (2)).
However, the sign of the coefficients is positive and highly significant from statistical‐ 13 ‐

standpoint.9 The reason that the coefficients in OLS and FE are very different seems tostem from the firm characteristics that the level of R&D intensity of the firms which
adopted stock options is high without the adoption. Although the figure 0.09% seems
small, it should be noted that the sample mean of the R&D intensity is 0.55%. The
figure 0.09% in FE estimates indicates that the adoption of stock options increases R&D
investments by about 15% on average, which is economically sizable. However, thefitness of the whole regression is not good, implying that the factors which determine
R&D investments are not fully incorporated in this equation.
In contrast to the results for R&D investment, for ordinary equipment investments,
although the results of OLS estimates show that the equipment investments is high infirms which adopted stock options, the results of FE estimates show that there is no
significant relationship between these two variables and the sign of the coefficient isnegative (see Table 9, columns (3) and (4)). This indicates that taking firm fixed-effects
into account, the adoption of stock options does not increase ordinary equipment
investments.
When estimation is conducted by including the interaction terms between the
adoption of stock options and the dummy for listed firms, the coefficient for theinteraction term is positive and significant for R&D equation, but the coefficient ofstock options becomes insignificant (see Table 10, column (1)). This indicates that theeffects of stock options on R&D investments are limited only to the listed firms.
In order to remove possible endogeneity bias, we conduct IV and IVFE estimations
using the lagged stock options as an instrumental variable for current stock options. The
results show that the coefficient of stock options is about twice larger than that in thesimple FE estimates (see Table 11), and that the adoption of stock options increases
R&D intensity by about 0.2 %, which is 33.5% to R&D intensity of the sample mean.
Finally, similar to the productivity estimations, changes in R&D intensity before andafter the introduction of stock options are estimated, taking into account that the firms
9When the sample firms are divided into manufacturing and non-manufacturing firms, thecoefficient in FE estimates is 0.0014 for manufacturers and 0.0005 for non-manufacturers, andthe coefficient in IVFE estimates is 0.0031 for manufacturers (all of these are statisticallysignificant at the 1% level) and in 0.0006 for non-manufacturers (insignificant at the 10% level).
This indicates that the effects of stock options on R&D investments are larger for
manufacturing firms.
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which adopted stock options had not only a high level of R&D intensity but a high trend
growth of R&D intensity before the adoption of stock options. The results are shown in
Table 12. The slightly increasing trends in productivity were observed before theadoption of stock options. Although it is not as clear as the case of productivity due tolarge fluctuations by years, R&D intensity increases in the following year of the
adoption and 5 or more years after the adoption.
The results described above imply that the adoption of stock options can have effects
to promote R&D investments, which have higher risk and higher return compared toordinary equipment investments.

5. Conclusion

This paper presents an empirical analysis on the relationship between stock options andproductivity based on the panel data of the Basic Survey of Japanese Business Structure
and Activities. The first objective of this study is to investigate factors that affectdifferences in firm-level productivity. The second objective is policy evaluation about
the effects of legal reforms. In Japan, stock options were introduced in 1997 after arevision of the Commercial Act. Since then, METI has been committed to improve thestock option systems for more than 10 years. This is an empirical study to investigate
into the effects of such reform of the system on Japanese firms. The novelty of thisresearch is that we analyse the medium- to long-term effects of the adoption of stock
options on productivity using a large firm-level panel data covering both listed andunlisted firms.
The results suggest that the adoption of stock options have a positive effect on firm’s
productivity and that the quantitative magnitude on TFP and LP is about 5-10%. The
increasing trends are also observed in productivity as the time passed after the
introduction of stock options. There are quite a few unlisted firms among the firms
which adopted stock options. With respect to whether there are any differences in
effects of stock options on productivity between listed and unlisted firms, larger effects
in listed firms are observed. The firms which adopted stock options increase R&D‐ 15 ‐

investments, while such relationship is not found in ordinary equipment investments.
This implies that the firms increase high-risk investments, triggered by the introductionof stock options. Generally speaking, as R&D investments lead to productivity growth
for medium- and long-term, the increase in R&D investments can be one of theimportant channels which enhance firm productivity.
According to past studies, the optimum incentives level for executives and employees,
including stock options, is not uniform across firms and depends on the firm
characteristics. The implication is that the adoption of stock options is determined as aresult of a rational choice of the optimum contract for each firm, thus it is unrelated tobusiness performance. However, the analysis of this paper shows that stock options havepositive effects on productivity performance in Japanese firms. Possible reasons include
the fact that the introduction of stock options, which were banned before 1997, allowed
firms suitable for using such incentives to adopt stock options actively. If managers ofJapanese firms were overly risk-averse, use of compensation scheme which promoterisk-taking of managers have desirable effects on firm performance.
Regarding policies, the reforms of the laws and regulations related to corporate
governance including the revision of the Commercial Act and the introduction of the tax
system for stock options during the past 15 years have provided an opportunity to makeuse of incentive schemes for managerial risk-taking and investment for productivity
growth.
It should be noted that there are some limitations to the analysis in this paper. Firstly,
the firms that adopted stock options may have implemented various managerial reforms
in parallel with the introduction of stock options. Therefore, the relationship between
stock options and productivity observed in this paper may include the effects of othermanagerial reforms omitted in the analysis. Secondly, although we have checked forpossible endogeneity bias of the results by employing IV estimations, the instrumental
variable used is a lagged endogenous variable, which is not an ideal instrument. Thirdly,
the measure of stock options used here is a dummy variable of whether stock options are
adopted or not, and we do not consider the size of stock options granted due to the data
limitation. Finally, the analysis in this paper focuses only on stock options, but
incentives for executives and employees include the ownership of shares–the ownershipof shares by executives, Employee Stock Ownership Plans (ESOPs), etc.–aside from‐ 16 ‐

stock options. In spite of the need for further research, we believe the analysis in thispaper helps to deepen our understanding on the effects of stock options.

‐ 17 ‐

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‐ 19 ‐

Table 1. The number of firms adopting stock options
Fiscal year
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009

Number of firms with stock
options
544
639
827
1093
1188
1483
1492
1729
1701
1626
1613
1590
1505

Ratio to total
firms
2.1%
2.4%
3.2%
4.0%
4.2%
5.4%
5.6%
6.1%
6.1%
5.8%
5.5%
5.6%
5.4%

(Note) Author’s calculation from the Basic Survey of Japanese Business Structure
and Activities (METI).

Table 2. Characteristics of firms which adopt stock options and those which do not
adopt stock options
Firms with stock
options

Firms without stock
options

Ln (Number of employees)

5.863

5.157

***

TFP

0.143

-0.070***LP-2.968-3.174***R&D investments/sales

0.015

0.005

***

Equipmentment
investment/sales

0.040

0.033

***

Foreign ownership ratio

8.38

1.64

***

Year of establishment

1959.5

1957.2**(Note) *** Significant at 1%; ** significant at 5%; * significant at10%.

‐ 20 ‐

Table 3. Stock options and productivity

sopt
lnemp

(1) TFP
OLS
0.0867(0.0043)0.0499(0.0008)

lnkl
year dummies
industry dummies
Number of obs
R-squared

yes
yes
377,760
0.1849(2) TFPFE***
0.0456(0.0039)*** -0.1438(0.0024)(3) LP(4) LP
OLS
FE***
0.0928***0.0535***(0.0042)(0.0038)***
0.0697*** -0.2155***(0.0008)(0.0024)0.1156***0.0793***(0.0006)(0.0013)
yes
yes
yes
no
yes
no
377,760
377,760
377,760
0.04430.25000.0955(Note) OLS and FE estimates with standard errors in parentheses. * significant at 10%;** significant at 5%; *** significant at 1%. Adjusted R-squared for OLS estimates,
R-squared (within) for FE estimates.

Table 4. Stock options and productivity (manufacturing vs. non-manufacturing firms)(1) TFP
FE

sopt
lnemp
lnkl
year dummies
Number of obs
R-sq: within(2) TFP(3) LP(4) LP
FE
FE
FE
NonNonManufacturing
Manufacturing
manufacturing
manufacturing0.0519***0.0420***0.0586***0.0505***(0.0060)(0.0049)(0.0059)(0.0047)-0.1049*** -0.1507*** -0.1675*** -0.2308***(0.0042)(0.0028)(0.0042)(0.0028)0.0875***0.0714***(0.0023)(0.0014)
yes
yes
yes
yes
190,833
186,927
190,833
186,9270.08240.03300.1301
0.0917(Note) FE estimates with standard errors in parentheses. * significant at 10%; **significant at 5%; *** significant at 1%.

‐ 21 ‐

Table 5. Stock options and productivity (listed vs. unlisted firms)

sopt
sopt_list
list
lnemp
lnkl
year dummies
Number of obs
R-sq: within(1) TFPFE
0.0302(0.0050)
0.0387(0.0077)-0.0184(0.0103)-0.1439(0.0024)(2) LPFE***
0.0332***(0.0048)***0.0508***(0.0075)*
0.0053(0.0101)***-0.2157***(0.0024)0.0793***(0.0013)yes
yes
377,760
377,760
0.04440.0956(Note) FE estimates with standard errors in parentheses. * significant at 10%;** significant at 5%; *** significant at 1%.

Table 6. Stock options and productivity (IV estimation)

sopt
lnemp
lnkl
year dummies
First-stage F static
Number of obs
R-squared(3) TFP(4) LP(2) LP
IVFE
IVFE
IV
***
0.1176***0.0838***0.0989***(0.0059)(0.0080)(0.0078)***
0.0720***-0.1411*** -0.2134***(0.0009)(0.0026)(0.0026)0.1162***0.0835***(0.0007)(0.0014)
yes
yes
yes
yes
2935.97 ***2915.64 ***6074.00 ***5718.20 ***321,823
321,823
321,823
321,823
0.03360.07770.18550.2551(1) TFPIV
0.1088(0.0060)
0.0514(0.0009)(Note) Lagged stock options are used as instrumental variable. Standard errors inparentheses. * significant at 10%; ** significant at 5%; *** significant at 1%.

‐ 22 ‐

Table 7. Stock options and productivity (IV estimation, manufacturing vs. nonmanufacturing firms)(1) TFP
IVFE

sopt
lnemp
lnkl
year dummies
First-stage F static
Number of obs
R-sq: within(2) TFP(3) LP(4) LP
IVFE
IVFE
IVFE
NonNonManufacturing
Manufacturing
manufacturing
manufacturing0.1008***0.0711***0.1116***0.0890***(0.0117)(0.0109)(0.0114)(0.0106)-0.1033*** -0.1515*** -0.1638*** -0.2331***(0.0044)(0.0031)(0.0045)(0.0031)0.0959***0.0733***(0.0026)(0.0016)
yes
yes
yes
yes
3535.61 ***2388.18 ***3327.80 ***2249.01 ***
156,393
165,430
165,430
156,3930.0636
0.03400.10410.0883(Note) Lagged stock options are used as instrumental variable. Standard errors inparentheses. * significant at 10%; ** significant at 5%; *** significant at 1%.

‐ 23 ‐

Table 8. Productivity before and after the introduction of stock options

sopty_3
sopty_2
sopty_1
sopty0sopty1sopty2sopty3sopty4sopty5+lnemp
lnkl
year dummies
Number of obs
R-sq: within(1) TFPFE
0.0127(0.0058)
0.0152(0.0059)
0.0255(0.0061)
0.0231(0.0053)
0.0527(0.0068)
0.0716(0.0081)0.0851(0.0095)
0.1000(0.0113)0.1109(0.0093)-0.1445(0.0024)(2) LPFE**
0.0140**(0.0057)***
0.0169***(0.0057)***
0.0295***(0.0059)***
0.0285***(0.0052)***
0.0627***(0.0066)***
0.0838***(0.0079)***
0.0959***(0.0093)***0.1116***(0.0110)***0.1256***(0.0091)*** -0.2164***(0.0024)0.0792***(0.0013)yes
yes
377,760
377,760
0.0447
0.0960(Note) FE estimates with standard errors in parentheses. * significant at 10%;** significant at 5%; *** significant at 1%.

‐ 24 ‐

Table 9. Stock options and R&D investments

sopt
lnemp
year dummies
industry dummies
Number of obs
R-squared(1) R&D(2) R&D(3) Equipment(4) Equipment
OLS
FE
OLS
FE
0.0077***0.0009***0.0052*** -0.0001(0.0001)(0.0001)(0.0006)(0.0007)0.0029***0.0004***0.0035***0.0060***(0.0000)(0.0001)(0.0001)(0.0004)
yes
yes
yes
yes
yes
no
yes
no
437,895
437,895
384,517384,5170.16320.00070.08480.0035(Note) OLS and FE estimates with standard errors in parentheses. * significant at 10%;** significant at 5%; *** significant at 1%. Adjusted R-squared for OLS estimates,
R-squared (within) for FE estimates.

Table 10. Stock options and R&D investments (listed vs. unlisted firms)

sopt
sopt_list
list
lnemp
year dummies
Number of obs
R-squared(1) R&D(2) Equipment
FE
FE
0.0000-0.0005(0.0002)(0.0009)
0.0025***0.0009(0.0003)(0.0013)-0.0020***0.0071***(0.0003)(0.0016)0.0004***0.0060***(0.0001)(0.0004)
yes
yes
437,895
384,5170.00090.0035(Note) FE estimates with standard errors in parentheses. * significant at 10%;** significant at 5%; *** significant at 1%.

‐ 25 ‐

Table 11. Stock options and R&D investments (IV estimation)

sopt
lnemp
year dummies
First-stage F static
Number of obs
R-sq: within(1) R&D(2) R&D
IV
IVFE
0.0100***0.0019***(0.00021)(0.00028)
0.0030***0.0003***(0.00003)(0.00009)
yes
yes
3606.21 ***7228.51 ***373,887
373,8870.17440.0007(Note) Lagged stock options are used as instrumental variable. Standard errors inparentheses. * significant at 10%; ** significant at 5%; *** significant at 1%.

Table 12. R&D intensity before and after the introduction of stock options

sopty_3
sopty_2
sopty_1
sopty0sopty1sopty2sopty3sopty4sopty5+lnemp
year dummies
Number of obs
R-sq: within(1) R&D(2) Equipment
FE
FE-0.0008***0.0015(0.0002)(0.0010)-0.0007***0.0028***(0.0002)(0.0010)-0.00030.0019*(0.0002)(0.0011)0.00000.0024***(0.0002)(0.0009)
0.0015***0.0005(0.0002)(0.0012)0.0010***0.0021(0.0003)(0.0014)0.0003-0.0026*(0.0003)(0.0016)0.0013*** -0.0065***(0.0004)(0.0018)
0.0025*** -0.0019(0.0003)(0.0015)0.0004***0.0060***(0.0001)(0.0004)
yes
yes
437,895
384,5170.00090.0036(Note) FE estimates with standard errors in parentheses. * significant at 10%;** significant at 5%; *** significant at 1%.

‐ 26 ‐

Figure 1. Productivity effects of stock options (listed vs. unlisted firms)(Note) FE estimation results. Firm size and year dummies are controlled. The vertical axis
indicates productivity (log points).

Figure 2. Productivity before and after the introduction of stock options(Note) FE estimation results. Firm size and year dummies are controlled. The vertical axis
indicates productivity (log points).

‐ 27 ‐