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Henderson, M. Todd --- "Insider Trading and Executive Compensation: What We Can Learn from the Experience with Rule 10b5-1" [2012] ELECD 613; in Thomas, S. Randall; Hill, G. Jennifer (eds), "Research Handbook on Executive Pay" (Edward Elgar Publishing, 2012)

Book Title: Research Handbook on Executive Pay

Editor(s): Thomas, S. Randall; Hill, G. Jennifer

Publisher: Edward Elgar Publishing

ISBN (hard cover): 9781849803960

Section: Chapter 15

Section Title: Insider Trading and Executive Compensation: What We Can Learn from the Experience with Rule 10b5-1

Author(s): Henderson, M. Todd

Number of pages: 21

Extract:

15 Insider trading and executive compensation: what
we can learn from the experience with Rule 10b5-1
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 share-
holder­owners 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 sharehold-
ers. This type of "fraud" is, of course, only possible if markets ...