As a three-time CEO, I’ve had a lot of experience with incentive stock options and have been appalled by how poorly they are understood by the average employee. Many employees fixated on the number of shares they were granted, rather than the percentage of shares outstanding. They would multiply their number of shared granted by some arbitrary share price to determine how much money they might make. “All my shares for $10” was a common refrain.
One example stands out to me, even though it happened more than a decade ago. After a poor first year, our company had to raise additional capital. Because the terms of the new money were much worse than the previous capital round, we had to dramatically increase the number of shares issued from 10M to 40M. The board realized that this 4X dilution could be devastating on employee morale and tried to partially mitigate the impact by issuing new options to all employees.
After I explained the situation at an All Hands meeting, a senior engineer came to my office to thank me for the additional grant which increased his ownership from 40K to 60K shares. In his mind, he now had a greater likelihood of buying a house in Silicon Valley. I tried to explain to him that his ownership had gone from 0.4% to 0.15% but he didn’t agree. In his mind, the 40M shares showed that the company was more valuable and therefore his shares were also worth more.
Although I didn’t know it at the time, that engineer was exhibiting the numerosity heuristic. People tend to equate bigger numbers with bigger quantities, even if they have different denominations. According to the authors,
When consumers evaluate the difference between two attribute levels, they may pay more attention to the number of units rather than the type of units, such that they appreciate a 24-month warranty difference more than a two-year warranty difference because they rely on the number of units rather than their type.
In “How to Make a 29% Increase Look Bigger: Numerosity Effects in Option Comparisons”, Pandelaere and Briers use a series of experiments to systematically show that numerosity can impact consumer preference. We will likely pay more for a 7-day vacation than a one week vacation, and we will complain less about a flight that is delayed for 1 hour than for 60 mins. We even believe that there is a larger quality difference between two items rated 700 and 830 (on a 1000 point scale) than the same items rated 7.0 and 8.3 (on a 10 point scale).
Marketers, take note. Numbers can persuade and apparently size does matter.
Oh, yeah. And I’m to start giving out annual bonuses in pennies rather than dollars.