MN-TU, WTAL and Regret-Minimization Regimes: Complexity and Alternative Risk Premia From Optimal Exercise of Equity-Based Incentives.

Abstract

Equity Based Incentives (“EBIs”) remain the dominant form of incentives in many developed and developing countries; and thus have significant effects on the quality-of-life and subjective well-being of individuals in both small and large firms. The timing of exercise of EBIs and the associated legal and economic ramifications have generated substantial debate. This article: i) critiques existing academic thought on information (disseminated primarily through the Internet) and exercise of employees‟ incentive contracts within the context of industry competition, ii) shows how Equity-Based Incentives (“EBIs”) cause information asymmetry, and vice versa (even with substantial Internet access/penetration), iii) introduces the optimal conditions for exercise of EBIs by „insiders‟ in an era of Internet access; and introduces new methods/conditions to control the monetization of EBIs by executives/employees; and introduces new distribution-free methods/models for the prediction and prevention of the monetization of EBIs; and these models can incorporate estimates of future states of the subject company, behavior patterns (of investors and employees) and the Stock markets and some of the conditions introduced herein are or can be transformed into alternative risk premia strategies; iv) explains how the option exercise decision is part of, and affects capital budgeting decisions of firms; v) applies MN-Transferable-Utility, and introduces the “Flexible Utility Framework” which implicitly assigns a dynamic utility function to specific instances; vi) introduces a new distribution-free approach to modeling risk and behavior. Most of the monetization of EBIs is executed with swaps, forward contracts, futures contracts, Indexed Annuities, equity-linked Annuities, regular loans and insured loans that are secured with EBIs. The analysis of optimal exercise of EBIs may help in formulation of appropriate policies for taxation of EBIs, regulation of securities markets, employee compensation and regulation of competition.