An empirical study of executive option grants around initial public offerings

•This paper finds a dramatic increase of option grants around IPO offer date.•IPO option grants are correlated with insiders selling secondary shares and reducing ownership stake in the offering.•IPO options, however, are not a management self-serving mechanism.•IPO options fail to align executive interest with shareholders for better performances.

From insider trading filings, we compile a comprehensive sample of executive options granted to executives and board members around initial public offerings (IPOs) from 1996 to 2008 and find a spike of option grants around IPOs. Using this sample, we investigate the determinants of IPO options and their effects on IPO pricing and long term performance. We find that granting IPO options is correlated with insiders selling secondary shares and reducing ownership stake in the offering. This evidence suggests that IPO options are likely substitutes for insiders’ diluted ownership due to IPOs. IPO options, however, are not a management self-serving mechanism as we find no significant relation between IPO options and underpricing, nor do they align executive interest with shareholders for better performance as we find that IPOs with IPO options do not have better long-run stock returns or operating performance than IPOs without IPO options.