Insider Trading in Derivative Securities: An Empirical Examination of the Use of Zero-Cost Collars and Equity Swaps by Corporate Insiders

Executive Equity Compensation and Incentives: A Survey

“…However, the fact that secret hedging activities are likely to run afoul of SEC disclosure rules suggests that this behavior is not expected to be widespread. The small sample size in Bettis et al (1999) is consistent with the hypothesis that this behavior is limited, or that firms and CEOs are engaging in this behavior and not filing required SEC disclosures.…”

“…Contracting over firm-specific wealth would not seem to pose much of a problem because these amounts are readily observable, given U.S. disclosure and insider-trading laws. For example, the SEC legally requires that insiders disclose their own firm stock holdings, option exercises, direct purchases and sales of stock, and any indirect "quasi-sales" of stock through synthetic instruments such as caps or collars (Bettis, Bizjak, and Lemmon 1999). As a result, the majority of costs from implementing wealth-based contracting are likely to stem from the absence of information on the manager's outside wealth, which he or she is under no legal obligation to disclose.…”

“…Finally, recent research by Bettis et al (1999) as well as considerable anecdotal evidence indicate that some CEOs use derivative securities such as caps and collars to hedge firmspecific risk. Consistent with the predictions of efficient wealth-based contracting, caps and collars can be an effective way to allow executives to rebalance firm-specific risk in cases where their firm-specific wealth grows beyond the level implied by an efficient contract.…”

Institutional Investors and Executive Compensation

“…For example, Ofek and Yermack (2000) report evidence that managers alter their portfolios in response to the composition of their pay packages. Similarly, Bettis, Bizjak, and Lemmon (2001) provide evidence that managers counteract the effects of existing holdings through hedging transactions. For their sample of corporate insiders, zero‐cost collars and equity swaps cover over a third of the insiders' equity holdings.…”

Are Stock Options the Managers' Blessing? Stock Option Compensation and Institutional Controls

“…The effect is small (an increase of 9'500 US $ in basic salary for one million in stock options), but nevertheless statistically highly significant (t=20.0). Second, even if other components of pay would be adjusted downwards, managers could apply hedging strategies against a possible drop in share prices or other forms of risk (Bettis et al 1999, Osterloh 1999, p. 190, Perry and Zenner 2000 (Economist 7.8.1999, p. 19). In fact, according to the consulting firm Smithers & Co., if all the liabilities engaged in via option plans in 1998 were deducted from the profits made in the same year, this would have resulted in 50% lower profits (Murray 1999).…”