Are Corporate Executives Privvy To Stock Exchange Secrets?

What might these stock exchange secrets be?

In late (Sept-Oct) 2006 it began to appear as though company executives had found a new and secret method to make extra money from the companies that they manage.

A back dating of options scandal and the way these are reported in company accounts blew the lid off US corporate secrecy. The scandal centred around ways for executives to award themselves and their colleagues stock options and then backdate this award to a date more profitable! More amazingly, this appears to have been entirely legal.

What is not legal is reporting them in the same way that any other option is reported. There were a number of high profile resignations in the hope that this would help the executives to avoid prosecutions. In one company, it appears as though stock options were awarded to someone who is deceased.

Whilst this may have made thousands or millions of dollars for the executives involved, this is not really a sure fire path for profits for an average investor. In fact, it has not proved to be a sure fire path to profits for the execs either.

What this does highlight is the disconnect between the goals of managers and the goals of the owners. Whilst many managers will own company stock, it is likely to be a very small percentage of the whole. This means that nefarious activities will damage the 'general' shareholding population more than a manager. Unfortunately, these appear to be risks that management are willing to take.

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There are of course many other problems with company management owning corporate stock. Even if they are not allowed to purchase for themselves or their family, there are always ways around this for a committed insider. Knowing how your firm is performing is vital information which may well influence a share price. However, the opposite (knowing how you are performing and what impact this is having upon your close competitors) also offers ways to gain for an executive.

The modern world of spread betting has even made it possible to take a chance on a company share price without the need to own stock. Spread betting has also made it far easier to 'sell short' a position on a company and thus benefit if the news is bad. This is similar to the emergence of betting exchanges that have made it possible for people (sometimes even owners and trainers) to bet on horses to lose.

It is hard to imagine that there are corporate executives out there who have not played this game. In other words, it will always be possible for insiders to benefit from stock exchange secrets. For example, it would seem that the management of the American energy company Enron knew exactly what they were doing while they built a huge corporation. In the end, the debts that had been hidden off their balance sheet brought them down - along with employees and shareholders.

Another example is Lehman Brothers. Since the collapse of the investment bank a number of books have been written explaining the story of the bank's failure. It seems that upper management played a very large part in expanding the company too far at the wrong time (is there ever a right time for over expansion?). In contrast, another investment bank, Goldman Sachs, was positioning itself to profit from the folly of it's competitors. Clearly then, executives do know something about their industry.

The opportunity to be able to gain from significant upside without having much or any of your own money invested is a criticism often used against the hedge fund industry. We might call this paraproprietary control - in other words, there are people in charge that are not the actual owners. Finding a way for these skilled managers to share in the risk taking as well as the financial rewards when they are successful will likely remain as one of the main challenges in financial services.

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