Chapter 1

If the overall stock market is extremely volatile, and if many analysts foresee the possibility of a stock
market crash, how might these factors influence the way corporations choose to compensate their
senior executives?

One way to read this is that the compensation goal of a corporation (through its board) is to provide
appropriate incentives for senior executives, in a way that is fair to shareholders and is aligned to the
company’s strategy in a time of market turmoil.

In this case, what a responsible board will do really depends a lot on the particulars of a company.
Some may continue to need to look for growth, others will need to hunker down, some will need to
focus on core activities, others may need to be opportunistic.

In this light, some companies might choose to move away from highly leveraged award types like
options, which during these circumstances can either reward “nothing” - i.e., just reward the
volatility - or even reward inappropriate “aim for the fences” risktaking. Maybe equity grants with
long vesting periods will provide a better retention and risk-mitigation incentive (but this will depend
on the company, of course). Performance awards that have absolute as well as relative hurdles can
help prevent rewarding executives when shareholders had a negative outcome, even if the company
did a bit better than peers.

Another way, unfortunately, to read this is that the compensation goal of a corporation is to ensure
that pay levels remain at a consistent (high) level no matter how the market and the company
perform. In these cases, we see volatility-rewarding structures like options and stock-based equity
awards whose target award is counted in number of shares rather than dollars, generous severance
provisions that accelerate vesting of equity or provide high cash payouts, and/or shifts towards
lower-risk cash (higher salaries, bigger target bonuses).

We see companies in both camps.

Chapter 2

The probability distribution of a less risky return is more peaked than that ofa riskier return.
What shape would the probability distribution have for (a) completely certain returns and (b)
completely uncertain returns?