Abstract
Executives of many publicly held firms agree to compensation packages that create immense exposure to their employer’s stock. Corporate boards, aspiring to motivate executives to make value-maximizing decisions, often tie an executive’s earnings to stock price performance through stock or option awards. However, this engenders a significant ethical dilemma for many executives who are uncomfortable with sizable, firm-specific risk and desire to reduce it through hedging activities. Recent research has shown that executive hedging has become more prevalent. In essence, managers are unwinding the acute economic incentive to act in the best interest of the owners. This appears to violate the spirit of the compensation contract and from a normative standpoint, is not how executives should act. In this article, we describe how some executives are acting in regard to this issue (descriptive ethics), how they should act (normative ethics) and how they can be helped to get from what they are doing, to what they should be doing (prescriptive ethics).
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Notes
These studies include: Bolster et al. (1996), who discuss the use of equity swaps; Bettis et al. (2001) provide empirical evidence of the use of equity collars by executives; O’Brian (1997) outlines the use of secured lending arrangements as a hedging instrument. Bettis et al. (2010) provide evidence of the use of prepaid variable forward contracts and exchange trusts as hedging instruments.
Facts for the Quaker Oats acquisition of Snapple were taken from case study number 1-0041 from the Tuck School of Business at Dartmouth.
Ownership of firm securities by executives and other insiders as well as transactions in firm securities by insiders are subject to mandatory reporting through the SEC Forms 3, 4, and 5. Changes in ownership of firm securities by insiders are reported on the SEC Form 4 and must be reported within 2 business days after the transaction date.
Bodzin, Steven, and Dan Lonkevich. "Chesapeake CEO Sold `All' Stock to Meet Margin Calls." Bloomberg. 10 Oct. 2008.
Data taken from compensation profile available at Forbes.com.
Greenberg, Duncan. "Riches-to-rags Stories: Fallen Billionaires." Forbes. 18 June 2007.
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Dunham, L.M., Washer, K. The Ethics of Hedging by Executives. J Bus Ethics 111, 157–164 (2012). https://doi.org/10.1007/s10551-011-1198-x
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DOI: https://doi.org/10.1007/s10551-011-1198-x