Hedging Executive Compensation Risk via Investment Banks

Allowing CEOs to hedge the risk in the compensation contracts their firms give them has been controversial because such hedging permits the executives to undo some of the incentive effects of those contracts; it also results in a divergence between the compensation firms pay their senior executives and the compensation those executives effectively receive. We analyze the personal hedging activities of CEOs and identify when firms may gain or lose by allowing or prohibiting such hedging. We also describe variations in CEOs' demands for various compensation hedges, and how firms will restructure their CEOs' compensation contracts in anticipation the CEOs will engage in such hedging.