Chapter 9

Question 1

What is executive equity ownership?

Answer 1

executives who hold considerable personal wealth will be more ethical if they have a stake in the organization

-discourages self-interest behaviour

Question 2

Equity ownership and firm performance

Answer 2

• modest research shows that equity ownership is related to higher market valuation

Question 3

Target ownership plans

Answer 3

this is when executives are required to hold a minimum of stock

retention approach: x amount of stocks are vested
fixed number of shares
multiple annual compensation

Question 4

what is the relationship between equity ownership and risk taking?

Answer 4

risk taking is influenced by potential payoff

direct stock holding: one for one stock profit and executive is motivated to grow

stock options grants (encourages risk taking): non-linear movement of value and increases volatility. Make more risky decision

Question 5

Standard Litmus Test

Answer 5

the test that distinguishes risk from acceptable risk given the risk profile of the firm

Question 6

What is accounting manipulation?

Answer 6

inflate stock prices to achieve bonus targets

• this is possible when executives hold a considerable amount of stocks in the company

Question 7

Diversification of equity of executives

Answer 7

selling shares
hedging a porition
pledging a portion

Question 8

What is Hedging?

Answer 8

hedging is offsetting risk by adverse movement of price

and

hedging follows a period in which stock price has run up and precedes periods of underperformance

Question 9

Positive of Hedging

Answer 9

• diversification without immediate sale
• tax advantageous
• minimize public scrutiny

Question 10

Negative of Hedging

Answer 10

unwinds equity incentive to perform

more costly to the company

difficult to explain to shareholders

Question 11

Pledging

Answer 11

an executive pledge shares as collateral for a loan that proceeds of which are used to purchase additional assets

Question 12

positive of pledging

Answer 12

diversification

tax advantageous

low interest rate

Question 13

negative of pledging

Answer 13

changes incentive structure imposed on management

Question 14

Who is an insider?

Answer 14

anyone part of the executive team, employee advisor, family connected to executives who has access to information about the company that’s not accessible to the public

insiders always have information trading advantage

Question 15

What is the blackout window?

Answer 15

50 calender days prior or after information of earnings, new product, acquisition is released to the public where trading is illegal

Question 16

what are the forms of insider trading?

Answer 16

1. members of organization
2. Friends and family
3. Goverment officials
4. Professionals/Consultants

Question 17

What is price sensitive information

Answer 17

information directly or indirectly related to a company which if published is going to materially affect the price of securities of a company for better or worse

1. mergers
2. accounting problem
3. declaration of dividend
4. major expansion plans
   5 changes in policies

Question 18

Purpose of Insider Trading Regulation

Answer 18

1. provide fariness
2. assure market integrity
3. Protect property
4. reduce cost of capital