No value: Investing, CEO pay and the economy
economist.com
economist.com
Management operates the company for the benefit of the owners. Preempting the owners' decision to sell by making the company a less attractive target should not be within their remit.
If a company's "owner" is mainly short-term money, then any publicly traded company is vulnerable to takeovers that destroy long-term value in favor of extracting cash in the short term.
For example, imagine a scotch distillery. For the last couple hundred years they've been reliably producing scotch, with their most common version aged 12 years. They've got solid people, many of whom spend their whole careers there. They have a very well-regarded brand; sales and profits are solid and consistent.
A corporate raider buys them. They immediately stop putting new whiskey in barrels, fire anybody who has been there more than a few years, and start selling off property and distilling gear. This frees up a lot of cash, making quarterly results look great. They then increase sales volume 3x by buying inferior whiskeys and selling it under their brand while increasing marketing. Quarterly numbers look even better. The raiders load the company up with debt, extracting cash, then take the company public. There is some grumbling from whiskey aficionados that it's "not the same", but the public, looking at the strong numbers and the beloved brand name, eagerly buys the stock.
A few years later, as the aging whiskey runs out and the lowered quality harms the brand, sales fall. Interest rates go up, making the debt hard to manage. The house of cards comes tumbling down and the company declares bankruptcy. People mourn the loss of a once-great distillery, many good people are out of jobs, and a lot of stockholders take a loss on their tax forms. The raider uses its now-larger cache hoard to repeat the process elsewhere.
An outcome like that is within the current rules of business, and is depressingly common. But it's not why we as a society provide for and support the whole notion of companies. Sure, sometimes takeover defenses are management getting comfortable. But "management operates the company for the benefit of the owners" is an ideological statement, not a descriptive one.
That just means companies have to be valued high enough so they're not vulnerable to the 'raiders'. However, if that's not the case then there may be a fundamental problem with the long term prospects of the company. It may be better indeed to use the capital of it for something else.
I get that economic theory can be a useful way to look at actual productive relations in the world. But it's just a theoretical model. If we find that following the theory leads us to behaviors that destroy the things economics was created to describe, we should stop to ask ourselves whether we could use a better theory.
If you're going to make $100m from a scam, you can afford to make it look pretty convincing. Way more convincing than the average amateur investor will be able to ferret out. There's an inbuilt information asymmetry.
The theory of public stock markets is that they are well-regulated enough for individuals to invest safely. Either we make that true or we should close the markets to unlicensed amateurs. Blaming victims is always popular, but it never leads to change. (Which is a big part of why it's popular.)
I would argue executives should receive stock with long vesting schedules (as in 30 years) not options. However, options are nominally cheap up front so they tend to look more appealing for boards.
I wonder what situations this would apply well to? It doesn't greatly bother me that CEOs of oil companies are profit-driven, but the concept of rewarding someone's work by enriching the people that they love, rather than just creating short-term incentives, would fit especially well with nonprofits and NGOs, which oftentimes seem like their primary mission is to justify their continued existence.
Maybe the best thing to do is to abandon performance-based compensation entirely, because it can't be done over long timescales and over short ones it is an abomination.
Note that plenty of founder CEOs are happy to accept near-infinite delays in payment. 90% of Jeff Bezos's wealth is still in Amazon stock despite being there 20 years. And Amazon has been kicking the asses of its competitors for decades precisely because it has been willing to make very long-term investments.
With Bezos, we are talking about amounts of money so large that I (and I assume you) can't truly conceive of them. If 90% of his net worth is Amazon, Jeff Bezos has ~$3 billion dollars invested in companies other than his own. He's plenty diversified and if that 3 billion is properly managed, he'll never want for anything, ever. Even if Amazon stock falls to 1/10th of its value, Bezos's life won't appreciably change, he'll just have slightly less leeway when building his multi-million-dollar cave clocks.
I'll note that the companies of the post-war economic boom (1946-1980) did well enough even though median CEO compensation (cash, stock, and options) was around $1m annually in real terms. So it's reasonable to think that we'll still be able to attract decent talent for the merely 2x that CEOs are getting in cash. The long-term stock would be an incentive for long-term behavior.
Caring about future generations on one hand, and making sure that one's own children will be very well off financially (as opposed to merely debt-free) on the other hand, are very different things. I don't think that effectively giving shares to a CEO's children incentivizes that CEO to make decisions that benefit future generations as a whole. It might, however, drive her/him towards a long-term thinking.
If she/he has children, that is.
You don't need CEO money to escape the bonds of debt. I went to prep school, where most of the parents were stock brokers, lawyers, doctors, or sub-C-level executives. Annual salaries in the hundreds of thousands, but not millions. Between merit scholarships (which are easier to get when you're well-off) and family money, every student there that I still talk to graduated college with little or no debt whatsoever.
CEOs get the big bucks because, supposedly, they are making wise strategic decisions that have an impact for decades. They are, in theory, building to last. I'm generally suspicious of incentive pay, but we're going to use it the time scales should match the results we are trying to incentivize.
(Of course, I think the pay system we have exists because CEOs get paid the big bucks for entirely different reasons. If a system consistently produces a given result, then whatever the nominal purpose, the result generally reflects the actual purpose.)
Even if it were, it's still not a good argument: even if shareholder value necessarily imposes (opportunity) costs in terms of profitable projects not taken (what's the difference between the lost returns and the second-best choice, anyway? probably negligible), you have to compare this to the costs of alternatives. Countries with "stakeholder" involvement in the governance system tend to have marginal q < 1, i.e. they undertake negative NPV projects, destroying capital.
It might even be the case that shareholders today aren't really any better than other "stakeholders" in terms of alignment of incentives. If I'm just arbitraging a stock, do I really care how the company actually performs in real life? Probably not. I care about the popular perception of the company in the market at the point at which I want to sell (or buy, I suppose, depending whether I'm long or short, but whatever, same difference).
The crucial difference is that, according to the article at least, the short-termism leads to them not taking +NPV projects, instead returning money to shareholders. This money can be redeployed productively, so even if it's not earning the NPV of that theoretical project, it's earning something very close to it. The opportunity cost is very small.
Stakeholders undertaking -NPV projects is a whole other ballpark. Just consider the growth implications when this happens economy-wide.
But this is what I would do if I were in charge.
- Eliminate options grant because if share price declines, execs are not exposed to downside. Yet when share price goes up, it can be a complete boon.
- Cap ratio of base salary to incentives so that bonus is no more than 100% of your base. When much of your total compensation derives from your bonus, you are not incentivized to make 'right' decisions.
- If you want to participate in equity sharing, execs need to make conscious decision to spend part of their after-tax paycheck. This is having true skin in the game.
The economics experiment on how rural Indian farmers respond to financial incentives is interesting, but... is it really applicable here? How solid is the unstated assumption that elite CEOs have similar ability to perform under pressure as random subsistence farmers? Doesn't sound that solid to me...
Make dividends tax deductible for companies (effectively treat them as big LLCs), eliminate the capital gains tax advantage, and watch sanity return to c-suite comp.
When people are trusted, most will keep the self-dealing to a minimum in order to continually earn that trust. But once they sense that their organizations or managers don't trust them, it's just natural to conclude, "I don't care for them either" and maximize for short-term personal yield. At scale, this leads to macroscopic underperformance and everyone loses.
I think it's both symptom and cause, basically.
The vastly increased level of racial and ethnic heterogeneity in America can not be ignored as a potential cause, either. Diversity may hinder social cohesion and a sense of community. [http://www.hks.harvard.edu/news-events/publications/insight/...] [https://www.msu.edu/~zpneal/publications/neal-diversitysoc.p...]
Every event of large-scale deception -- or even incompetence that gives the appearance of deception -- has a huge negative effect on the overall level of trust in a society. It's sort of like the "bad neighborhood effect." If you experience one mugging, that location is forever a "bad neighborhood" even if 99.9% of its inhabitants are perfectly peaceful law abiding citizens. It takes one act of official misconduct to undo the goodwill of thousands of noble and responsible acts.
I think the term is "elite deviancy" -- the condition in a society when that society's elite no longer believe the rules apply to them and no longer have any sense of shared pride or loyalty to the society at large.
But these things have a way of being recursive-- it's possible that this elite deviancy is a response to growing alienation. This condition could also arise if our elite think they're on a sinking ship. I wonder sometimes about things like the Limits to Growth and what effect that had on the belief systems of those at the top. The timing matches pretty well-- it seems as if everything went to short-term hell shortly after 1970. "Get as much as you can and get out" is a rational strategy in a civilization one believes is dying.
I wonder... did you make a throwaway because of the ethnic/race part of your response? I don't think you're wrong. People do tend to cooperate far more readily with people who look like them and have the same cultural values. It's something I find deeply depressing though... what are we, social insects? Can we only cooperate in homogeneous hives?
well, I kinda feel that too but... consider, for example, eBay. I was certain it would fail because you have to trust that some random person far away will take your money and send you what they said they would. And it works!
Also I download all sorts of code and run it without checking every (or even many, or any) lines of source (though I won't do 'curl blahblah | sudo sh' !)
I don't know if it's symptom or cause, but what I have found striking is the pronounced shift to a more punitive or retributive world view.
For example prisons are to make sure people are punished like children rather than rehabilitated (though some are still called "correctional institutions" -- but are there still "penitentiaries?"). "Three strikes laws" are still popular. And everything is always somebody's "fault". It's a really sad, zero sum view of the world.
Consider what that says. I don't think my attitude is atypical.