No value: Investing, CEO pay and the economy

http://www.economist.com/blogs/buttonwood/2014/12/investing-ceo-pay-and-economy

by known • 12 years ago

132 44 12 years ago

With plenty of respect to the conclusion (stock options to pay CEOs are wildly exploited) I'm not sure how that's supposed to be a failure of the idea that "companies exist merely to generate economic returns to their owners". It sounds more like a failure of a common mechanism used to seek that goal.

Zigurd2• 12 years ago

"Eyes on the scoreboard, not on the ball." It's not hard to see where problems could come from. Quarter-driven management, etc.

Retric2• 12 years ago

It's a critique of a movement not an idea.

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.

pflats3• 12 years ago

While I agree with your sentiment, 30 years seems unreasonably long to me. At that point, you might as well just require the stock be put in a trust for the CEO's heirs.

wpietri7• 12 years ago

I think that would be an excellent approach.

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.)

gerbal• 12 years ago

The nature of ownership has shifted from a long term shared investment in an enterprise, to a short-term investment expecting immediate returns in the next quarter.

bobcostas552• 12 years ago

Agreed, it's a very shallow take on the matter. It treats "shareholder value" and "short-term expectations tunnel vision" as synonymous, but I don't think that is the case.

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.

glesica2• 12 years ago

But I think you're making the same argument. A CEO is a "stakeholder". When the CEO makes decisions with an eye on the very short-term (to hit share price or EPS targets) he or she potentially destroys 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).

gohrt2• 12 years ago

Citation needed. It sounds like you are valuing quality of life at 0 and onky valuing the amount of money changing hands. In particular, ignoring externalities like pollution (hello China) and other health hazards.

NPMaxwell• 12 years ago

I gather that the idea is that stock prices a manipulated to follow a sawtooth pattern -- plummeting with the big bath of the new CEO and rising during the CEO's tenure. I haven't seen the evidence that this is so, but it would explain why CEO compensation exceeds returns on investment.

iwwr2• 12 years ago

There have been great legal barriers erected to protect management from shareholders. Without restrictions on hostile or silent(unannounced) takeovers, management would not be able to employ tactics like overloading with debt or emergency stock repurchase (effectively harming the company to prevent being taken over).

http://en.wikipedia.org/wiki/Shareholder_rights_plan

http://www.investopedia.com/terms/s/sharkrepellent.asp

Zigurd2• 12 years ago

That assumes that hostile takeovers are good, even relative to entrenched and entitled management. It could amount to one fox keeping another out of the hen house.

ddeck• 12 years ago

Whether "good" or "bad" (not sure what that means in this context), it should be the owners of the company that decide whether or not to accept a bid for their ownership, not the company's management. Management and shareholder incentives are not often aligned when it comes to a change of control.

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.

michaelochurch• 12 years ago

What this is really about, to me, is trust and its tendency toward self-fulfilling prophecy. This isn't about a major change in the philosophical concept of a business. It's about CEOs no longer being trusted to make long-term decisions (and the culture of moronic short-termism trickles down to programmers dealing with "scrum" and "sprints" and shit.)

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.

tormeh4• 12 years ago

This applies to governments as well.

toolz• 12 years ago

When you put it that way I agree, but it makes me question if distrust is the disease or merely a symptom. Is the origin of so many of our political problems simply based in distrust?

api3• 12 years ago

I feel like there's been a general collapse in trust in at least America in the past 40 years. Short-term behavior is a logical individual response to that. I smell game theory.

throwaway9931• 12 years ago

Your feeling is correct, and numerous polls and studies quantify it.[http://www.usatoday.com/story/news/nation/2013/11/30/poll-am...] [http://www.npr.org/2014/03/10/288712990/social-distrust-bloo...] Robert Putnam in Bowling Alone was just one of the people who explored this effect. Putative causes include potentially "de-socializing" technology like TV, increasing income inequality, emergence of suburban living, and fear-heavy media.

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...]

gumby• 12 years ago

I feel like there's been a general collapse in trust in at least America in the past 40 years.

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.

pcurve• 12 years ago

Long vesting schedule isn't a viable solution for many companies. I think 3 year is reasonable.

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.

carsongross• 12 years ago

If returns were in terms of dividends, with owners actually sharing in profits, rather than more easily manipulated and leverage level dependent capital gains, the problem would solve itself.

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.

maxxxxx• 12 years ago

I have been think about that too. Then investing would also be less of a gamble on the stock market.

simon_• 12 years ago

Without saying anything about the broader thrust of an argument, I'll highlight a pet peeve: the drawing of wildly overconfident conclusions from social science research.

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...

No value: Investing, CEO pay and the economy

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