Abstract The Tax Reform Act of 1986 (TRA86), by causing the highest corporate tax rate for corporations to be higher than the highest individual rate, gave corporations a tax incentive to issue Nonqualified Stock Options as opposed to incentive Stock Options (ISOs). Nevertheless, some firms continue to issue new ISOs, despite the tax cost of doing so. We hypothesize that firms with the greatest investment opportunity sets are most likely to issue ISOs in order to tie employees to the firm. Our empirical. results are consistent with this hypothesis. We also show that these firms also use other, less costly mechanisms, such as pension plans and salary deferrals to tie their employees. Consistent with the tax incentive hypothesis, fewer firms In our sample issued ISOs after TRA86 than before.
Balsam et al. (Mon,) studied this question.