In Tough Times, Abandon Your Employees
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It's practically an article of faith in the business community that you deserve an 'attaboy' for laying a bunch of people off if it increases profit. But stiff the shareholders? Oh, the humanity! We're developing morals all of a sudden!
If all's fair in business, why don't we treat the shareholders as suckers, too? If enough of them get together, they can vote to fire you, but short of that, why do they deserve additional respect?
Obviously, there is a balance to these things. You're both contributing and leeching with a failed business. Monopolies are the same as well. Each one can be abused or used to create a contribution or to coopt value. What really matters is when you're all said in done, is everyone, including the employees, better off?
The way to fight this is twofold:
1) Make it easier for people to start new companies and competitors. This serves both employees and customers. As a customer I get the best price when I have multiple people competing for my business. As an employee, I'm best treated and paid when there are multiple people bidding for my service.
2) Increase the penalty for legal violations, and make examples of people who violate the spirit of the law as well as the letter. Don't invite CEOs of companies who dodge taxes "To the letter but not spirit" of the law to the White House.
Um, no. At publicly-traded U.S. companies, executive compensation is set in the first instance by the compensation committee of the board of directors [1]. The law requires only that shareholders be allowed to vote on non-binding "say on pay" resolutions at least every three years (or more often if the shareholders so vote) [2].
It's been suggested that executive compensation naturally and inexorably ratchets upward because:
+ Comp committee members don't want to be sued by shareholders for negligence or gross negligence in setting executive comp. (That's just what happened when Disney was required to pay ex-CEO Michael Ovitz a $140 million severance package even though he'd been on the job only a year or so when he was shown the door [3].)
+ So, comp committees rely on survey reports about existing executive compensation levels in the relevant industry, market segment, etc. (They also hire professional consultants to provide documentation and political cover.)
+ Comp-committee members are supposed to be independent, that is, not beholden to management. BUT, board members tend to be supportive of management: They might well have been recruited by management. Business friendships develop among management- and non-management board members as well as with senior executives. The board as a whole feels it's a team; its members naturally want to be perceived as team players (they probably wouldn't be on the board in the first place if that weren't the case).
+ Here's where it gets interesting: Comp-committee members like it when they can tell company executives, your comp is in the top half for our industry. They might also honestly think that their company's executives deserve to be paid at least in the top half of the "comparables," that is, above either the average or the median for the company's industry segment. So consider what happens mathematically to executive compensation across the board when lots of comp committees have this mindset: The mid-range of the compensation band floats upward over time.
+ As the mid-range of the band rises over time, future compensation committees may feel pressure to raise executive compensation to keep up with the Joneses, that is, with the rising mid-range.
[1] http://www.wlrk.com/webdocs/wlrknew/wlrkmemos/wlrk/wlrk.1833...
[2] http://www.law.cornell.edu/uscode/text/15/78n-1; see also http://www.sec.gov/rules/final/2011/33-9178-secg.htm
[3] http://www.integrogroup.com/data/File/white-papers/exec_comp...
Let's get back to the original question, though, which is about why shareholders have so much power. My contention is that shareholders (Via the board) have the most direct influence on senior executive compensation. Yes, it's indirect. Yes, there are biases that push it upwards. But this doesn't change that shareholders have much more influence.
A bondholder doesn't get a direct say unless they have covenants that protect them. (At least until a default)
Non-management companies don't get a direct say either. They can vote with their feet but that's about it.
Communities rarely get a direct say.
So what we're left with is companies deciding, "Do I act enlightened about caring for more than shareholder interests?" The way to encourage this from an employee's point of view is competition between firms for their services. Your (detailed and correct!) analysis doesn't change any of this.
Typically, institutional investors vote the bulk of the shares in a U.S. public company's election. The investment managers and governing bodies at such institutions often don't have strong feelings about things like limiting executive compensation.
Sometimes, but not always, institutional investors follow the recommendations of proxy advisory services such as ISS and Glass, Lewis (http://en.wikipedia.org/wiki/Proxy_firm). Those services have started to pay more attention to executive compensation in recent years. But as I understand the law, SEC regulations still relegate shareholder "say on pay" votes to non-binding advisory status.
Probably because it doesn't have much effect on their returns.
I'd love to someone to try to prove me wrong, though. Start up a Vanguard-like fund that only invests in companies that pay their CEOs below average, or some similar metric. It just might turn out that there's a bunch of ten-dollar bills on the street we are all missing and the economy as a whole would be better off if they turn out to be right.
Either way, it would be valuable data.
This is how it works, in order to sell securities in your company to people who aren't part of the company (stock), you have to pledge a 'fiduciary responsibility' to those people. This is a pledge that you aren't going to just take their money and burn it up in a bonfire or blow it on hookers and cocaine in Vegas. If you violate your pledge the SEC can (and sometimes does) come and put you into jail.
Now all bets are off if you tell those security buyers in your prospectus, "Proceeds of this sale will be used to buy hookers and cocaine at a venue of the director's choosing." then well, said what you were going to do with it so the shareholders (people who gave you the money) really can't complain can they?
Then there is another part of the equation is that the governance, or "how the company is run" is controlled by the companies by-laws. And in those by-laws there are things that are decided on by a shareholder 'vote'. Usually simple majority but sometimes 2/3rds or some other number. Those things, one of which is who sits on the board of directors, allow "influence" of other things (like who the CEO is). But let's take a moment to look at that.
So the Board of Directors hires and fires the CEO and determines the CEO's compensation (often all of the senior employees compensation but that is a different story). Since who is on the board is a function of nomination and shareholder voting every 'n' years (where n is in the bylaws) If you have enough stock in the company you can suggest who you are going to vote for (or not vote for) in the board election and influence who is on the board. And you tell people who want to be on the board and are courting your vote, what you look for in a board member (like say "Someone who can help find a decent CEO to run this place.") This is how 'activist' shareholders make trouble for the company. And using that influence you influence the CEO and senior staff of the company.
So it is very much true that you have to think about share holder value as part of your fiduciary duty, and you have to insure that enough voting shares support your current plans such that any attempt to derail then will be safely voted down.
That is why it isn't a "meme" it is an actual thing.
Enforced "selectively" by the SEC...
People get fired all the time based on bullshit performance improvement plans that come down to "pissed off the manager". I've personally been put on PIP the day after saying some impolitic things because of, officially, a bunch of 2 year old tickets in the bug tracker that were never going to be fixed.
Fudging your justifications is a time-honored tradition. How come people are so loathe to do it when 'the shareholders' are involved?
EDIT: Was googling and found this:
http://truthonthemarket.com/2010/07/27/the-shareholder-wealt...
There's apparently precedent for very wide latitude given to 'business judgment'. You can do whatever you want as long as you say "I thought I was enhancing shareholder value in the long term" afterwards.
This does not explain the meme I referenced above which seems to go way beyond legal CYA into actual moral beliefs in business culture.
There was a reason it was called : "Public Company Accounting Reform and Investor Protection Act" you see protecting the Investors was another way of saying "protecting the shareholders" and the only protection they care about is that the securities they hold in a company don't lose value.
My experience when I rolled over my 401k into a self managed IRA, one where my financial advisor is buying / selling securities to maintain a specific mix but actually holding the securities in my name, was that I got to see just how many lawsuits were being filed on behalf of shareholders who felt they weren't being protected enough.
That said, the fact that you were poorly managed has more to do with your management than with the concept of shareholder value. Management is hard, its different than a job where you design/build/program things, and peoples ability to do it varies widely. I can certainly understand the idea that a poor manager had developed a crutch of using 'shareholder value' as an excuse for their actions, just like some use 'because I'm the boss' for theirs.
My goal was to point out that there are rules and regulations in place that put officers and executives at a company at risk of sanction, either financial or criminal, if they do not actively protect the interests of the people who have invested in their company, their shareholders.
And I see your points. I'm just taking issue with the fact that business culture seems to value protecting shareholders as a moral imperative to the extent that you're obligated to be a sociopath towards your employees, customers and society at large. It seems to me that this moral imperative goes beyond legal issues and into the actual ethical system of the business community.
B-corps (benefit corporations) are a new idea where the charter of the company can include optimizing for things other than pure shareholder value, such as social responsibility, commitment to workers etc. Sort of a merge of profit and not-for-profit:
What you call "meme", most people call "law".
Directors and Officers of a corporation have a fiduciary duty to shareholders by law. They do not have a fiduciary duty to employees of the corporation.
Ideally, stiffing the shareholders would be impossible. In practice bad management actors find plenty of ways to do that every day.
Welch had a very solid run, and accordingly, his theories and practices were seen to have been validated by his success.
A lot of interesting chickens came home to roost after he left, however, and in recent years, history is starting to look a lot less kindly on his track record, and on Shareholder Value theory in general. That being said, it's still the rule of the game in the F500, because it's an ideology very favorable to the financial institutions on the 'shareholder' side.
...the trouble began in 1976 when finance professor Michael Jensen and Dean William Meckling of the Simon School of Business at the University of Rochester published a seemingly innocuous paper in the Journal of Financial Economics entitled "Theory of the Firm: Managerial Behavior, Agency Costs and Ownership Structure."
The article performed the old academic trick of creating a problem and then proposing a solution to the supposed problem that the article itself had created. The article identified the principal-agent problem as being that the shareholders are the principals of the firm—i.e., they own it and benefit from its prosperity, while the executives are agents who are hired by the principals to work on their behalf.
The principal-agent problem occurs, the article argued, because agents have an inherent incentive to optimize activities and resources for themselves rather than for their principals. Ignoring Peter Drucker's foundational insight of 1973 that the only valid purpose of a firm is to create a customer, Jensen and Meckling argued that the singular goal of a company should be to maximize the return to shareholders.
To achieve that goal, they academics argued, the company should give executives a compelling reason to place shareholder value maximization ahead of their own nest-feathering. Unfortunately, as often happens with bad ideas that make some people a lot of money, the idea caught on and has even become the conventional wisdom.[1]
[1] http://www.forbes.com/sites/stevedenning/2011/11/28/maximizi...
... the best managers are those who meet expectations. "During the heart of the Jack Welch era," writes Martin, "GE met or beat analysts' forecasts in forty-six of forty-eight quarters between December 31, 1989, and September 30, 2001—a 96 percent hit rate. ...
So, you're right, the theory became a hot topic (and eventually into corporate gospel) in the '80s.
As a strawman, consider a company A which sells a cure for virus B. They can "make customers" by giving away free blankets that are carrying the virus. They should be a great company according to Drucker but the effect of their success is that nobody wants to be associated with them and so their 'value' goes down.
Rather than create a problem in solve it, I read Jensen as articulating how external interest to the company with a single metric (share price) can moderate the behaviours of an otherwise free market entity in a way which reflects the values of the wider group of people. Thus allowing a 'publicly' held company to achieve its goal in a morally superior way to a company that was not required to seek approval from the general public. This very closely mimics the behaviour changes in democratic societies (elected by the public) and theocratic or monarch type societies where the set of people that need to be 'ok' with the action of the leaders is much more constrained.
So what did you get out of Jensen?
Of course, I don't mean to imply that it's doing the employee a favour to lay them off - but the choice typically isn't between business as usual or mass lay-offs for the fun of it, it's between high probability of failure and a lower probability of failure (with a shot at turning the business around).
Forcing shareholders to prop up a failing business to save a few jobs for a short time is more than a little counter-productive.
This is tough to hear, but it is the truth.
Some might say that the company was wrong, and that may be true, but if the company is wrong about who it fires and hires, it will no longer be a company.
Your company is extracting value from you, that is how they make money.
If you are not looking for a way out or up, then you are going to lose.
Managing your career is something people just don't think about enough.
They like to think, "If I am loyal and work hard, then I will always have a job."
That's bullshit. I have known lots of people who worked hard and were loyal, but still got axed because they didn't create enough value.
This article has a "it's not fair" quality to it.
Well, no shit it's not fair.
Because we spend so much time at work, we project loyalty and security onto our company. We are fooled into thinking they are loyal to us.
So Its also naïve to think you're fired because you're not a profitable employee. Sometimes you get fired because it makes a large equation work out better.
Only they (companies) do expect it, and even get it. Because the employees are dependent on them, and not vice versa.
Those that say: just quit and get another job (mostly white, upper-middle class), have never been in the situation of having to keep a job to feed a family and/or mortage while not being someone coveted by recruiters.
If people spent even just a few moments thinking about their own future and prospects they might decide against purchasing a home, having kids, getting a new car and so on.
"Why don't they just leave?" is not a valid argument.
A consequence of reducing your long term career risk may be that you will have lower income (at least in the short term). You may believe that individuals have the right to maximize their short term income; but does this desire impose a responsibility on their employer not to fire the profit maximizing individual?
Sure, they can sacrifice all their lives -- including the American dream of their own family, home and car -- just to be better positioned with employers. No biggie.
Besides, I'm not saying sacrifice anything... if they wish to have the family, home and car they should seriously think if they can afford it.
Because it's a way more effective strategy if you practice the cut-throat approach while portraying a fuzzy, caring public image. To some extent, you can have your cake and eat it too.
This is an incredibly naive conclusion, one that I would argue could only be reached without any critical analysis whatsoever.
For one, record profits can be ephemeral. Many companies thrive and dive based on the business cycle. As we saw in 2008, the dynamics of a company can change relatively quickly, so record profits today don't guarantee record profits, or even a profit at all, tomorrow. Building a strong cash position and/or returning capital to investors in one form or another often prove crucial to a company's long-term ability to survive and grow.
More importantly, it's critical to recognize that a loyal employee isn't necessarily a good employee, or a necessary employee. At large companies, particularly outside of technology, you can often find plenty of "loyal" employees: workers who have been on the job for more than a decade who would love nothing more than to stay in that job for decades to come. Some percentage of these employees, however, are better at doing what it takes to secure their jobs than they are contributing to the ongoing success of the company. Others, while dedicated and hard-working, may simply lack the skills required to contribute as the company evolves. Companies are not static; as they grow and market conditions change, it may be necessary to hire in some areas, and fire in others.
The author of this post might as well have used the title, "In tough times, abandon tough decisions."
So when companies do decide that cutting costs is more important than keeping employees, they message that in one way to employees, and in another way to analysts and investors. Employees and the general public who sympathizes with them might call that duplicitous and slimy, but it's a response to the balancing act the companies have to perform.
Do customers/clients choose to do business with an ethical company over an unethical one? If not, maybe the bigger problem is that the employees of the world choose to do business with companies that are not good to employees.
If ethical behavior was an important factor in customer's choices I'm sure we'd see less unethical behavior by businesses. However, Walmart, Goldman Sachs, McDonalds, etc all continue to thrive after their unethical behavior is made very public.
In the case of Goldman Sachs, consumers are not involved, the company has so much power, no one in government dares to strongly enforce the laws, short of a slap on the wrist. In a utopian "ethical" world, GS would have been dead in the 1930s...
Remember: profits aren't included in the salary number, as that's a cost. So "record profits" aren't going to executives - that would be salary or options. And they usually aren't distributed as dividends. They go into the corporate bank account, namely the rainy day fund of the company. And the reason they are going into the rainy day fund of the company is that businesses in general expect many costs to come over the next few years, from the QE tapering to Obamacare.
Otherwise businesses would spend those "record profits" on hiring and expansion, or on salary increases to retain top talent, or on acquisitions. I think the fundamental misunderstanding here is that "record profits" have anything to do with executive salaries. Salaries are a cost.
Visual analogy: this is like reducing your marginal headcount and husbanding your corn with the expectation of a massive storm on the horizon. It does NOT mean you are feasting on your corn after kicking out marginal producers.
There's an association and correlation, though. It's easier for executives to ramp up their compensation if the company is profitable. So if an executive can do something short-sighted that improves profits in the short term, or even something degenerately risky that may turn a huge profit.
Principal and agent usually break (that is, their interests diverge) at the second moment (risk/variance). Everyone wants profit/expectancy (first moment). There's no tension there; who doesn't want to make money? Risk is a nother matter. Principal usually wants as little risk per unit upside as possible; agent typically wants more risk because upside leads to higher compensation but the difference between a small down year and a big one is minimal.
For example, a hedge fund manager collects 2% of assets managed and 20% of profits. (If profits are below zero, redemptions happen and that often kills the fund.) So a return of -30 and -10 have the same effect-- shit year, no bonus, everyone gets fired-- but the difference between +10 and +30 is huge. That's why a lot of these firms take degenerate bets. Someone else eats most of their losses, but they get a lot if they win.
Executives work the same way. They push for huge initiatives that add risk to the business. Big wins makes them rich, little wins make them comfortable; the difference between little losses and big losses, for them, is zero. They have no reason not to take big risks with the company.
Large-scale cost-cutting is especially good from an executive perspective because the benefits are immediate but the problems it causes tend to show up in the long term, giving the executive time to flee if the results are bad.
That isn't necessarily true. A company's expansion does not always require the expansion of its work force and increased profit can reflect many things: higher productivity, lower cost of goods sold, increased revenue from higher margin lines of business, accounting and tax events, etc.
This said, it is important to recognize that while profit describes where a company has been, head count is in many respects a forward-looking figure based on future expectations. Who you hire and fire today often has a lot less to do with what's happening now than what a company expects will happen tomorrow, good or bad.
It's expensive and risky to let someone go for cause. It's cheap and virtually risk free to do a mass layoff due to a decline in business.
Too bad the lesson was forgotten globally by the ruling class.
It's built into the system, less of a plague and more of necessary requisite for capitalism.
If you have labor shortage the economy cannot grow as fast as possible. If you have big surplus - then you have big demand slump that moves you to a deflation spiral.
1. Reducing headcount without reducing complexity will fail. Reducing operational complexity is hard because it requires that the top executives get access to information that the mere process of looking for will tip people off, and because it gets political rapidly. Layoffs need to happen quickly, the theory goes, so it's easier and better to just cut away 10% of the people in one fell swoop and, later on, reduce complexity. However, the complexity reduction often never occurs. According to typical executive thinking, it can't happen before the layoff-- it'd tip people that something's going on-- but after the layoff, people tend to see the first-order immediate problem (high costs) as solved and therefore don't handle the deeper issue (high complexity) that got the company in trouble in the first place. Thus, fewer people have to do more work; they do a worse job of it, and the higher defect rate leads to even more complexity, and everything goes to hell.
2. Plenty of companies are dishonest about layoffs and dress them up as aggressive "performance" reviews. I won't list names, but there are plenty of dishonest technology companies that claim to have never had a layoff because what the psychopaths in charge actually did was dress one up as performance-based firings, with kangaroo courts ("performance improvement plans") and all. At least banks are honest; they say, "business was shitty this year and we let people go". But there are so many tech companies that don't want the press of an honest layoff (they even pretend to be constantly hiring, to present an image of unyielding growth) so they lie and call it "performance". An existing stack-ranking regime helps. What these companies are really doing is throwing their own people under the bus to preserve their own reputations, and they shouldn't be surprised when people fuck them right back for it.
;)