Pledge (and Hedge) Allegiance to the Company

Abstract

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?

Topics, Issues and Controversies in Corporate Governance and Leadership: The Closer Look series is a collection of short case studies through which we explore topics, issues, and controversies in corporate governance. In each study, we take a targeted look at a specific issue that is relevant to the current debate on governance and explain why it is so important. Larcker and Tayan are co-authors of the book Corporate Governance Matters, and A Real Look at Real World Corporate Governance.

Keywords: executive compensation, equity hedging, equity pledging, hedging, pledging

JEL Classification: G30, G34