Law Commons^™

Executives And Hedging: The Fragile Legal Foundation Of Incentive Compatibility, David M. Schizer

Faculty Scholarship

Options are granted to executives to inspire better performance by tying pay to the employer's stock price. Yet this incentive rationale no longer holds if executives can use the derivatives market to simulate a sale of their options, a practice known as hedging. This Article evaluates the effectiveness of existing legal constraints on hedging by executives, including limits derived from contract, securities and tax law. Although investment bankers have been searching for ways around these constraints, the bottom line is that, at least for now, executives are unable to hedge option grants: While contractual limits are rare, the securities law …