Having Your Options and Eating Them Too: Fences, Zero-Cost Collars and Executive Share Options
Company & Securities Law Journal, Vol. 18, pp. 277-282, June 2000
Posted: 16 May 2001
The vast majority of senior executive remuneration packages in Australia contain share options issued under an Executive Share Option Plan ("ESOP"). It is common for these option entitlements, particularly at the chief executive and chief operating officer levels, to dwarf the cash component of the package.
ESOP options perform the important economic function of aligning executive self-interest with the interests of shareholders. This alignment endures only for so long as the options are retained by the executives. Accordingly, an ESOP will invariably prescribe a vesting period during which the participating executives are not permitted to exercise or transfer their options.
This article examines how options, in particular option strategies known as "fences" and "zero-cost collars", can be used by executives to extract value or lock-in gains in respect of ESOP option entitlements during a vesting period. The article also considers the regulatory constraints on the use of these strategies. The authors conclude that the substantive disclosure rules of the Australian Corporations Law do not apply to cash-settled fences/zero-cost collars. In addition, the prohibitions against insider trading can be avoided by an appropriately structured fence/zero-cost collar.
Finally, the article discusses the corporate governance concerns arising out of the use by executives of fences and zero-cost collars. These option strategies effectively decouple the interests of executives from those of shareholders and consequently destroy the economic rationale for the grant of ESOP options to executives.
Note: This is a description of the paper and not the actual abstract.
JEL Classification: G18, G34, K22
Suggested Citation: Suggested Citation