Privatizing the gains, socializing the losses

Posted By Blake Hounshell Saturday, July 19, 2008 - 4:35 PM Share

Gretchen Morgenson gets it right:

Of course, people prefer rising stock prices to declining ones. Wouldn't it be wonderful if shares never fell? But such actions call into question the claim that ours is a free-market system. More and more, our version of free markets holds that they are free only when asset values rise. When they fall, the markets must be managed.

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JCUSHMAN

5:33 PM ET

July 19, 2008

stock option valuations

A similar effect with stock option valuations has served to make many CEOs wealthy. The idea that took off in the 80s was that executives would manage more effectively and with less oversight if they had a stake in the success of the company. They were therefore given the option to buy the company's stock at the current price any time in the future, meaning if it went up, they'd make money. The trouble was, if the stock went far below the option price, the incentive was gone. Executives in those companies successfully argued that the options should be revalued to the lower price, so their incentive to perform came back. The result, of course, was guaranteed wealth for the executives via a sort of ratchet effect -- in good times, they'd reap the profits, and in bad times, they'd get the chance to make even more next time.

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