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SSRN

Columbia Law School

1999

Tax Law

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Full-Text Articles in Law

Executives And Hedging: The Fragile Legal Foundation Of Incentive Compatibility, David M. Schizer Jan 1999

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

Faculty Scholarship

In the capital markets, the 1990s have been the decade of executive stock options and the derivatives market. Legal scholars and economists have begun to realize that, in combination, these two trends raise a serious concern. Options are supposed to inspire better performance by tying pay to the stock price. Yet, what if an executive could use the derivatives market to simulate a sale of her option – a practice known as "hedging" – without violating her contract with the firm? The incentive justification for option grants would no longer hold.

This Article demonstrates that the tax law helps avert this consequence ...