Research Handbook on Executive Pay
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Research Handbook on Executive Pay

Edited by Randall S. Thomas and Jennifer G. Hill

Research on executive compensation has exploded in recent years, and this volume of specially commissioned essays brings the reader up-to-date on all of the latest developments in the field. Leading corporate governance scholars from a range of countries set out their views on four main areas of executive compensation: the history and theory of executive compensation, the structure of executive pay, corporate governance and executive compensation, and international perspectives on executive pay.
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Chapter 15: Insider Trading and Executive Compensation: What We Can Learn from the Experience with Rule 10b5-1

M. Todd Henderson


M. Todd Henderson Executive compensation experienced something akin to a Glorious Revolution in the past thirty years with the change from primarily cash compensation to primarily equity-based compensation. (Such compensation, in the form of stock options of various kinds, today accounts for nearly 70 percent of total pay, compared with less than 5 percent just 20 years ago.) Paying corporate executives with firm stock helps align the interests of shareholder–owners and managers, and therefore is believed to give stronger incentives for shareholder wealth creation (Jensen & Murphy 1990). It is, in short, a method of reducing the problems created by the separation of ownership and control inherent in the modern firm (Berle & Means 1932). But compensating executives with firm stock has costs too, one of which—trading by insiders—is the subject of this chapter. There are two potentially large costs from insider trading. The first is what we might call short-termism. Executives looking to maximize the value of their shares may engage in conduct that increases the stock price in the short run at the expense of the long term so that they can profit from trading in firm stock. This cost is not dependent on the managers having private information when they trade, but is instead premised simply on different time horizons between managers and shareholders. This type of “fraud” is, of course, only possible if markets work imperfectly and enforcement against accounting manipulations, disclosure misstatements, and so on is also costly and imperfect. For instance, managers in...

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