An equity swap wherein one of the parties is a person (usually a manager or senior management member) employed by the company whose equity is involved. The manager’s holdings of his company’s shares are naturally exposed to downside risk over the lockout period, and therefore would try to mitigate that risk in any viable way.
In an executive equity swap, a manager enters into a bilateral agreement whereby his stock holdings (in his company) are deposited with an investment or commercial bank which undertakes the role of dealer. For a preset period of time, the bank gets the total return from the deposited stock, and the manager receives the return of an alternative investment, less annual commission fees. The alternative investment could be a fixed-income security, or more likely, a broad-based market index.
This swap allows the buying user to reduce price risk on the swapped share. If the share price goes up, the bank will get the increase in equity. But if the share price falls, the bank is bound to replenish any decrease in equity for the sake of the depositor (the swap buyer).
