Jaffer, Ashraf Amirali
(2007)
The economic consequences of compensating employees with tradable securities and its implications for disclosure.
PhD thesis, London School of Economics and Political Science.
Abstract
There is little economic theory that supports designing compensation packages to include a market-traded component. Any contract based on tradable securities can potentially be replicated with non-tradable securities that would give the employer tighter control on the incentives and trading activities of the employee. Indeed, it seems paradoxical to compensate employees with tradable securities only to impose restrictions that prohibit them from taking advantage of the tradability feature. This thesis provides insights into the role and economic consequences of disclosures aimed at reducing the ability of employees to gain from insider trading. To analyze the impact of compensating employees with tradable securities I use a principal-agent framework where insider trading is captured by the notion of contract renegotiation. In the first analytical piece I show that in certain situations allowing the agent to trade anonymously on his private information increases production and, more importantly, is socially desirable compared to the case where the agent's trades are required to be publicly disclosed. The intuition for this result is that the bid-ask spread imposed by the market maker makes it costly for the agent to sell his shares and get full insurance if he shirks. The consequence of the positive incentive effects for the agent makes the overall economy better off. In the second version of my model I attempt to capture the SEC notion of insider trading where a manager has material non-public information prior to trading his equity claims. In this piece I allow the agent to collect private information prior to his trading. I identify three information structures and compare the production in the economy where the agent gathers private information prior to trading, to a scenario where private information acquisition is prohibited. I show that it is not at all clear-cut that private information collection by employees is always detrimental to the firm. Rather, situations may arise where private information collection and insider trading by employees results in higher production in the economy and can be socially desirable. Hence the thesis attempts to provide some potential economic reasons for employees to be compensated with tradable securities.
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