Secret Compensation

Abstract

Compensation is the principal means by which companies in the United States seek to motivate managers to act in the best interests of shareholders. The emphasis on stock options as a component of executive pay in the United States also, however, encourages opportunistic behavior by managers. Exercise prices of executive stock options are typically established as the company's stock price on the date the options are granted. Managers can therefore enhance the value of their option awards by timing grant dates to precede the release of favorable corporate news. In fact, evidence suggests that they do so. There has been considerable uncertainty over whether such behavior constitutes insider trading. This Article attributes such uncertainty to gaps in current law. In particular, insider trading doctrine easily handles open-market transactions, but it does a poor job of addressing situations in which managers deal with their own corporations, such as in the case of executive stock option grants. In these circumstances, numerous questions arise, including whether the corporation or its shareholders have been deceived. Drawing on current doctrine and the purposes of the insider trading laws, this Article suggests that both executives and boards of directors have at least some disclosure obligations to shareholders regarding the compensatory element of favorably timed grants. Moreover, it may well be that such grants are subject to the same "disclose or abstain" rule applicable in the traditional insider trading context.

Keywords: Executive compensation, insider trading law, discolsure obligations