Executive Loans

Abstract

This paper analyzes the characteristics and impact of loans made to executives for stock purchase, option exercise, and relocation. We find that loans made to assist executives in purchasing stock or exercising options are larger and have higher interest rates than relocation loans. All types of loans, however, are issued at below-market interest rates, on average. We also find that while stock purchase loans are given to managers with low existing ownership, option exercise loans are given to managers with high existing ownership and high cash compensation. Finally, our results indicate that executive stock ownership increases following stock purchase and option exercise loans. For managers as a whole, a loan that enables a manager to buy 100 shares of stock results in only an eight share increase in ownership. However, the relation between ownership changes and stock purchase loans is much stronger for low ownership managers.

Full text

Page 1

Executive Loans




First version: August 2002
This version: February 2003

















Key words: executive loans, executive compensation, ownership
JEL Classification: G30; G32; G38; J33

Page 2

Executive Loans

Abstract

for purposes of
ist executives in
s than relocation
n average. We
sting ownership,
and high cash
reases following
option exercise loans. For managers as a whole, a loan that enables a
manager to buy 100 shares of stock results in only an eight-share increase in ownership.
However, the relation between ownership changes and stock purchase loans is much stronger for
low ownership managers.

This paper analyzes the characteristics and impact of loans made to executives
stock purchase, option exercise and relocation. We find that loans made to ass
purchasing stock or exercising options are larger and have higher interest rate
loans. All types of loans, however, are issued at below-market interest rates, o
also find that while stock purchase loans are given to managers with low exi
option exercise loans are given to managers with high existing ownership
compensation. Finally, our results indicate that executive stock ownership inc
stock purchase and

1

Page 3

Executive Loans




First version: August 2002
This version: February 2003

















Key words: executive loans, executive compensation, ownership
JEL Classification: G30; G32; G38; J33

Page 4

Executive Loans

Abstract

for purposes of
ist executives in
s than relocation
n average. We
sting ownership,
and high cash
reases following
option exercise loans. For managers as a whole, a loan that enables a
manager to buy 100 shares of stock results in only an eight-share increase in ownership.
However, the relation between ownership changes and stock purchase loans is much stronger for
low ownership managers.

This paper analyzes the characteristics and impact of loans made to executives
stock purchase, option exercise and relocation. We find that loans made to ass
purchasing stock or exercising options are larger and have higher interest rate
loans. All types of loans, however, are issued at below-market interest rates, o
also find that while stock purchase loans are given to managers with low exi
option exercise loans are given to managers with high existing ownership
compensation. Finally, our results indicate that executive stock ownership inc
stock purchase and

1

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Executive Loans
1.
t recruitment and
sultants William
M. Mercer, Inc., nearly 25 percent of major public companies now give loans to executives
(Leonhardt, 2002), up from 14 percent in 1999 and 8.4 percent in 1994 (Lublin, 2001). The
se to one-half of
largest companies offer loans to executives (Schwanhausser and Davis, 2002). These
loaning stock in the
company.
The benefits to these loans are clear. Stock loans can help to solve the problem of
o increase their
executives. For
der must pay income taxes on the difference
betwse. However, if
executives buy shares with borrowed money instead of receiving options, the profit is considered
hen used to buy
when the stock
price is falling. Loans also drain corporate cash reserves, sometimes when it is needed the most.
Finally, the loans can keep shareholders from knowing when executives are effectively selling
shares in their own company. For example, Kranhold and Schroeder (2002) report that Enron
lent Kenneth Lay $81 million in 2001. Lay would borrow from a company-sponsored personal
Introduction
In the 1990s, personal loans to executives became a popular managemen
retention tool for many companies. According to New York compensation con
practice is even more prevalent in Silicon Valley, where it is estimated that clo
the 150
s are most often made to assist executives in buying homes or purchas
aligning managers’ interests with those of shareholders by allowing them t
ownership in the company’s stock. In addition, the loans offer tax advantages to
example, when stock options are exercised, the hol
een the option’s exercise price and the share price at the time of exerci
an investment gain and is taxed at the lower capital gains rate.
While the loans do provide benefits, these same loans have costs too. W
stock, non-recourse loans give managers incentives to pursue risky strategies

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