Working Paper No. 1168

Stock Option Taxation: A Missing Piece in European Innovation Policy?

Published: May 12, 2017, revised November 2017 and February 2018Pages: 24Keywords: Entrepreneurship; Innovation; Institutions; Tax policy; Stock options; Venture capitalJEL-codes: L26; H25; H3; K34

Stock Option Taxation: A Missing Piece in European Innovation Policy? Magnus Henrekson and Tino Sanandaji

Europe continues to lag behind the U.S. in venture capital (VC) activity and in the creation of successful startups, and has recently been surpassed by China. This is despite the fact that many European countries have deep financial markets, strong legal institutions and high R&D spending.

We point to the tax treatment of employee stock options as an explanation for the stronger growth of the U.S. VC sector. As a response to high uncertainty and transaction costs, VC financiers have developed a model in which founders and key recruitments are compensated with stock options under complex contracts. Low tax rates on employee stock options further raise the relative returns of working and investing in innovative entrepreneurial firms, and shift financial capital and talent to that sector.

We measure the effective tax on stock options in VC-backed entrepreneurial firms in a number of developed economies. Countries with lower stock option taxation have higher VC activity and more high-growth expectation entrepreneurial activity. Based on these associations and the theoretical and empirical literature, we argue that more lenient taxation of gains on employee stock options can be a strategy for European countries to catch up in entrepreneurial finance. This tax policy would narrowly target entrepreneurial startups without requiring broad tax cuts. The favorable tax treatment of stock options allows the state to promote firms that rely on entrepreneurial finance and make use of these types of contracts without lowering taxes for other sectors of the economy.

Magnus Henrekson


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Interdisciplinary European Studies

The European Union and the Return of the Nation State


This book explores the complex and ever-changing relationship between the European Union and its member states. The recent surge in tension in this relationship has been prompted by the actions of some member state governments as they question fundamental EU values and principles and refuse to implement common decisions seemingly on the basis of narrowly defined national interests.

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