Equity Management and the Foundations of Ownership

The goal of managing a company’s equity is fundamentally a job of managing ownership, but what is ownership? 

This isn’t a question you ask everyday as a productive manager of equity. If you’re checking the state-specific withholding for an option exercise, you’re not likely to be wondering “what is an option for, actually? Why does this ownership matter, really?” 

But it’s useful to step back at times and ask these core questions. If the system isn’t serving its fundamental goals, what’s it doing at all? 

In this spirit, we’ll ask a couple foundational questions for equity management – what is ownership and why does it matter? 

To start to answer them, we’ll introduce two prominent models for understanding ownership:

1. Psychological ownership – how cognitive processes related to ownership motivate us in our everyday lives.

2. The legal-economic model of ownership – how a system of enforceable rights can enable more productive group activity.

These models look at ownership from different angles – but they also overlap in important ways. And they both have many applications to managing equity. 

As the aphorism goes, “all models are wrong, some are useful.” Neither model here is an exception. We’ll also highlight some useful connections between each model and the jobs of managing equity.

Part 1 / The Motivating Force of Psychological Ownership

“Chop your own wood and it will warm you twice.”

          - Henry Ford

The psychology of ownership starts early and reaches far. Children develop a sense of what they own – “mine!” – as toddlers. Many of history’s great revolutions and the global conflicts of today have their basis in the ownership of land and resources. 

As early as William James, psychologists have suggested that our concept of “self” may be little more than the sum of the tangible and intangible things we think of ourselves as “owning” – our bodies, homes, creations, relationships, our roles and attachments in social groups. On this view, our sense of personal identity is co-extensive with what we think of ourselves as owning.

Theories of ownership in psychology suggest that our sense of ownership can be created from multiple sources. These sources include, for example:

• Exerting control over something.

• Investing oneself in something. 

• Building a deep understanding of something.

While there is still much to learn, existing evidence suggests that once created a sense of psychological ownership has the potential to inspire great motivational force. 

For example: 

• Ownership over the means of how we do something has been shown to be associated with higher degrees of intrinsic motivation.

• Psychological feelings of ownership correlate with organizational commitment, job satisfaction, and positive work behavior.

• Employee equity ownership has been shown to drive a number of motivation-related outcomes.

Psychological Ownership in Equity Management

A core goal in equity compensation is to align company partners and team-members with company goals:

• First – to help hire.

• Second – to help align interests and motivate toward the shared goal of increasing company value. 

• Third – to help retain ongoing services. 

At the core of each is a set of  individual interests and motivations. Many of them depend at least in part on a sense of ownership. Understanding the root psychological sources of ownership – and how they motivate behavior – can help across all three.

Part 2 / The Legal Building Blocks of Ownership

“Ownership is [...] the greatest possible interest in a thing which a mature system of law recognizes.”

          - A.M. Honore 

Ownership is also a foundational concept in the theory of law, finance and economics. It shows up right in the definition of an asset –  “a resource with economic value that an individual, corporation, or country owns.”

The development of legal systems to create and enforce nuanced forms of ownership has helped support tremendous economic growth. Without legal ownership, companies as we know them don’t exist. These systems of legal ownership are one of the foundational economic innovations of modernity. 

Traditional ownership theory in law and economics breaks ownership into a bundle of rights – the traditional metaphor represents this as a bundle “sticks”.

This legal model of ownership takes the general notion of “ownership” and zooms in to reveal various individual rights that are bundled together into the whole of ownership. 

The key right “sticks” in this bundle of ownership include:

• The right to control and exclude others from something you own

• The right to use and enjoy profits from something you own

• The right to transfer ownership and use in the property you own

The idea underlying this legal concept of ownership is that “ownership” is the composition of these rights (as well as certain others, including certain duties to care for the property.) 

Legal theorists also go further to model the rights underlying ownership themselves – posting these rights as relationships between people, relationships between people and things, and as expectations about property.

In this rights-based model, ownership is not a simple binary – it is multifactorial and nuanced. It has to be in order to support the complexity of the modern economic world: the intangible rights in intellectual property and complex contractual innovations like derivatives.

Legal Ownership in Equity Management

As applied to equity management, most impactful ownership changes in equity can be seen as changes to the rights in this bundle of rights that make up ownership.

• For example, the vesting of shares represent a change in certain rights to those shares. So does the receipt of an offer letter including equity, or the formal grant of an equity award. The repricing of options or the extension of an exercise period are changes to specific rights within a bundle. 

• In all of these cases, the underlying building blocks of ownership are rights – and changes to specific rights are the drivers of equity management jobs.

• Further, many of the compliance requirements underlying equity management can be viewed as “rights of the government” – rights to receive reports and filings; collect fees and taxes; and prohibit certain types of behaviors. 

The rights-based model can be a valuable conceptual tool to ground each equity management job.

Conclusion

Both the psychological and legal models of ownership offer frameworks to understand the underlying drivers of equity management systems. For those interested, both have well-developed literatures that further develop the concepts referenced. 

Practically, each can be turned to as a source of first principles within a realm of great technical complexity. Complex tax rules can be viewed as rights of the government; vesting schedules can be grounded back to their ability to retain and motivate.  At best, each model can serve as a conceptual toolkit to both understand why existing equity management systems work the way they do – and how they can work better.