What Do Your Employees Know About Where The Stock Price Is Headed?

What Do Your Employees Know About Where The Stock Price Is Headed?

UNIVERSITY PARK, PA-A new study suggests that employees who hold stock options exercise them as if they can peer into the future.
The study, "Information Distribution Within Firms: Evidence From Stock Option Exercises," was co-authored by Steven J. Huddart, associate professor of accounting in Penn State's Smeal College of Business. The study also found that low-level employees are at least as good at predicting price movements as employees who are much more senior.

Huddart and co-author Mark Lang at the University of North Carolina at Chapel Hill examined the stock option exercise decisions of over 50,000 employees at seven corporations to provide evidence on the distribution of price-relevant, non-public information among employees. Specifically, the study examines whether employees' decisions to exercise stock options predict subsequent stock returns. It is believed to be the first investigation to focus on the distribution of price-relevant information outside the executive suite.

"We found that when option exercise-adjusted for factors already known to affect employee decisions-is low, stock returns in the coming six months are 10 percent higher than when option exercise is high," says Huddart.

In addition, Huddart says, the study found that the exercise decisions of relatively junior employees contain at least as much price-relevant information as the exercise decisions of more senior employees.

"Lower-level employees, collectively, may know more than the smaller group of senior employees, and option exercise may serve to aggregate the price-relevant component of this information," says Huddart.

"Another possibility is that the most senior employees face constraints that limit their ability to profit from private information that lower-levels employees do not face."

Stock option exercise, Huddart explains, is a valuable signal to top management if it conveys information not available from other sources.
"High option exercise by a salesperson might indicate he has a pessimistic view of future sales. While it may be impossible to infer value-relevant information from the exercise decisions of an individual employee, the aggregated exercise decisions of many employees do, on average, contain substantial information about firm prospects," says Huddart. "Since the cost of gathering the data is likely to be low and it conveys information about the corporation's near term prospects, corporate management may benefit from tracking stock option exercise."

Huddart and Lang will present this research at the Journal of Accounting & Economics' conference on "Accounting and Economics in the New Economy." The conference takes place June 29 at MIT.