Closer Look Series: Topics, Issues and Controversies in Corporate Governance, No. CGRP-11, By David F. Larcker, James Irvin Miller Professor of Accounting, Director of Stanford Graduate School of Business Corporate Governance Research Program And Brian Tayan, MBA ’03, Stanford GSB;, Date: 10-11-2010
Companies include equity in a compensation package to align the interests of management with those of shareholders. It is not uncommon for an executive who has been employed at a company for many years to accumulate a substantial dollar ownership position in the company. With a concentration of wealth in a single financial asset, the executive may want to limit his or her exposure by hedging a portion of the position through financial instruments or pledging shares as collateral for a loan.
While there are many reasons why a board may want to allow an executive to hedge or pledge an equity ownership position, there are also many reasons why this may be a cause for concern. We examine these issues in detail.
Can boards explain why they do or do not allow executive hedging? If an executive has hedged the equity position, why does the board continue to grant new equity and not cash?