Equity illusions

Abstract

Although equity-compensation grants for rank-and-file employees are common in startups and are considered an ingrained part of their business culture, little is known about how employees approach this form of compensation. We begin filling this gap by examining employees’ financial literacy regarding equity compensation and their willingness to forgo cash compensation for startup equity. Using a survey and a combination of natural language processing and machine learning techniques with conventional regression modeling, we find that employees commonly respond to economically irrelevant signals and misinterpret other important signals. The findings suggest that employees harbor a range of “market illusions” regarding startup equity that can lead to inefficiencies in the labor market, which sophisticated employers can legally exploit. The results raise questions about the protection of employees in their investor capacity in a market where highly sophisticated repeat players, such as venture capital investors, interact with unorganized and uninformed retail investors.