Abstract Nonqualified options minimize the joint tax liability of executives and their firms when the corporate tax rate is high and executives have a short holding period for stock obtained from option exercise. Otherwise, Incentive Stock Options (ISOs) are tax advantageous. We test the proposition that joint tax minimization explains the choice between ISOs and nonqualified stock options by examining a sample of 337 option grants by 187 firms during the early 1980s. We find that ISOs (or a mixture of ISOs and nonqualified options) are the overwhelming choice of our sample firms, despite their corporate tax disadvantage. These results are consistent with joint tax minimization only if executives have long holding periods for stock acquired through option exercise, and the holding period is not adequately controlled for by our empirical proxies. An alternative explanation is that option choice is made to minimize the executive's tax burden, without regard for the corporate tax implications.
Austin et al. (Tue,) studied this question.