The New York Times weighs in with an interesting article on the hedging practices of Goldman Sachs employees, regarding their holdings of the company stock, which accounts for a large portion of personal wealth in many cases. Regulatory filings show that from July 2007 through November 2010, "at least 135 partners used options to protect themselves from stock drops or to profit if shares held steady." One executive had "at least 32 such arrangements." Shareholder advocates, pay critics and regulators are keenly interested. The Federal Reserve might soon take up the issue. 

Obviously, the intent of stock-based compensation is to expose executives to losses as well as gains. Does erasing or reducing the chances of losses on their stock also erase some incentives? 

You can argue it several ways. On the one hand, it would appear to undercut the whole premise of stock-based compensation and might encourage executives to take undue risks. CEO Lloyd Blankfein and nine other top officers are prevented from hedging their holdings, a wise move.   

As for the other executives, one could also argue that most execs have the right, like any other investor, to hedge or generate income off their holdings. (Restricted stock cannot be hedged.)

Hedging is not always easy--or cheap. At Goldman, options were the method of choice. Some may have bought puts or executed a "bear spread." Many at Goldman apparently also used covered calls to lock in income and potentially offset losses on their holdings. Covered calls do not strike me as a classic hedging strategy but rather a move to generate income based on stock holdings. The Goldman executives were essentially betting the stock would stay below a certain level. If the stock hit the strike price, they would be obligated to sell the stock. 

Hedging basically comes down savvy use of options, which takes time. Unless Goldman Sachs is giving them a sweetheart deal, hedges can also be very expensive. One issue for Goldman is these hedges are more likely in times of volatility. Executives could easily expend a lot of office hours constructing the perfect trade--at a time when they are most needed on core business issues. I doubt the company will ban options trading but I'm sure many banks will revisit this issue. And I'm sure boards will continue to ponder innovative pay structures. - Jim