Principal-agent theory suggests that equity incentives should lead to greater effort from employees when effort is both costly and unobservable. However, due to free rider problems, this incentive effect may be limited when a firm employs a large number of workers. It is not clear then, why publicly-traded firms that employ many workers would choose to compensate their employees with company stock. I provide a possible explanation that is consistent with several empirical findings. Utilizing a

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... odel of employee bargaining power and inter-firm competition, I find a unique, pure strategy equilibrium where each competing firm offers an equity stake to its employees provided employee bargaining power is sufficiently low and interfirm competition is sufficiently intense. This outcome arises because offering employees an equity stake improves wage efficiency and allows each firm to become more competitive with its rival. However, the equilibrium is a Prisoner's Dilemma for the firms' owners as they, and in some cases their employees, would be better off had the owners been able to commit to compensating employees with wages only. I thank Viktoria Diser, Bjorn Jorgensen, Brian Mittendorf, N. V. Ramanan, and seminar participants at the 2014 AAA Management Accounting mid-year meeting, the 2013 Beyster Symposium, and the University of Toronto for helpful comments. I am grateful for funding from the University of Toronto and the Louis O. Kelso and Accurate Equity Fellowships which fund research on employee ownership. All errors are my own.