Employee Stock Options and Investment





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    • Babenko is at Arizona State University; Lemmon is at the University of Utah; and Tserlukevich is at Arizona State University. We thank the seminar participants at the University of Wisconsin, University of Miami, University of Utah, Australian National University, Hong Kong University of Science and Technology, Nanyang Technological University, University of British Columbia Winter Finance Conference, University of Lausanne, Cornell University, Queensland University of Technology, Melbourne University, University of Southern California, and University of Michigan.


Exercises of employee stock options generate substantial cash inflows to the firm. These cash inflows substitute for costly external finance in those states of the world in which the demand for investment is high. Using the fact that the proceeds from option exercises exhibit a distinct nonlinearity around the point where options fall out of the money, we estimate that firms increase investment by $0.34 for each dollar received from the exercise of stock options. Firms that face higher external financing costs allocate more of the proceeds from option exercises to investment.