THE CHOICE OF INCENTIVE STOCK OPTIONS VS NONQUALIFIED STOCK OPTIONS: A MARGINAL TAX RATE PERSPECTIVE

A number of recent studies examine why firms make changes in stock options plans. Previous researchers have had mixed results in explaining the role of taxes in forming stock option contracts. This dissertation extends prior research by providing evidence on how firms' marginal tax rates and unsystematic risk affect stock option granting policies. It is argued that low marginal tax rate firms grant Incentive Stock Options and high marginal tax rate firms grant Nonqualified Stock Options during the period 1981-1984 to minimize the joint taxes of the firm and the executive. However, the evidence presented here indicates that estimated marginal tax rates at exercise do not affect the firm's stock option granting policies. In addition, firms' unsystematic risk does not appear to affect granting policies. Rather, high marginal tax rate firms appear to be granting ISOs regardless of the tax implications.