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When CEOs’ Equity Is About to Vest, They Cut Investment to Boost the Stock Price
- ChuckMcM 9y agoI think that is a clever way to tease out causality.
- gesman 9y agoInteresting way to play with stock options for public at large too.
- snarf21 9y agoLike most things, you get what you optimize for.
- ggg9990 9y agoThis is why the public ownership model is bound to fail, and already the most successful companies are avoiding it as long as possible or entirely.
- dpflan 9y agoDo you mean fail as in become socially and perhaps politically unacceptable ways of doing business?
- ggg9990 9y agoNo, I mean being outcompete by other businesses, in China and locally.
- lawnchair_larry 9y agoI think you have it backwards. CEOs can cook the books far easier if they are not a public company. Meanwhile, in China: https://www.reuters.com/article/us-china-anbang-regulation/china-seizes-control-of-anbang-insurance-as-chairman-prosecuted-idUSKCN1G7076 https://www.reuters.com/article/us-china-anbang-regulation/c... The reason that companies are not going public as quickly is because they aren’t making money, not because they are making too much money.
- imglorp 9y agoAlan Greenspan, on his way out, famously said > he had made a "mistake" in believing that banks in operating in their self-interest would be sufficient to protect their shareholders and the equity in their institutions. Greenspan said that he had found "a flaw in the model that I perceived is the critical functioning structure that defines how the world works." It's not a stretch to apply it to all C-levels at all public companies: they will absolutely manipulate the company to benefit themselves at the expense of the shareholder. https://www.cbsnews.com/news/greenspan-my-faith-in-banks-a-mistake/ https://www.cbsnews.com/news/greenspan-my-faith-in-banks-a-m...
- gowld 9y agoHe built his entire career, as a leader of USA financial policy, as a hardcore Randian Objectivist (he was a close friend of Ayn Rand herself, probably the most powerful Randian in the world), and then on the way out said "oops, I was wrong"?
- cromulent 9y agoYes, he did. "You found that your view of the world, your ideology, was not right, it was not working?" Greenspan agreed: "That's precisely the reason I was shocked because I'd been going for 40 years or so with considerable evidence that it was working exceptionally well."
- JoeAltmaier 9y agoThis is my sister's observation after 20 years in manufacturing. All her experiences at the executive level were of folks manipulating the company to get their bonuses regardless of the damage they did. They'd simply move on when a company failed. She got sick of it all after 20 years, and now runs a chocolate shop in semi-retirement.
- rbanffy 9y ago> They'd simply move on when a company failed. And often the failing company would even pay for the outplacement consultants.
- lev99 9y agoThe public ownership model is awesome at raising capital.
- rbanffy 9y agoSo are Ponzi schemes.
- harryh 9y agoMe: Looks back at the incredibly successful 400 year history of public companies. You: Notes a small amount of manipulation by CEOs and says public ownership is doomed. thinking face emoji
- fitblipper 9y agoDoing this would be foolish since they are taxed as income when they vest but capital gains after. If their aim was to unfairly take advantage they should wait until right after vesting not right before.
- Retric 9y agoThe article address this: "Only once this period is over can they sell — and they typically do, to diversify their personal investments." CEO's have a great deal of exposure to the upside of their company doing well, they want protection from the downside of it doing poorly.
- thisisit 9y agoOne of the interesting things which has egged on the current bull run has been the abundance of cash. I need to find the exact link but it seems lot of companies are buying back stocks which then masks the nonperformance under the garb of market beating EPS growth.
- sokoloff 9y agoWhat's the under or non-performance? If a company is generating enough cash to buyback its shares, that's every bit as much a real return to shareholders as a dividend would be. If a company retires 10% of its shares from a buyback, each investor now owns ~11% more of the company than they did before.
- adamlett 9y agoIt’s not so simple. In a perfect market, the market value of the company will go down when company buys back stock. Why? Because the value of the cash is now gone. So in your example, each stockholder just owns a slightly larger piece of a slightly smaller pie. Of course markets are not perfect, and nobody knows for sure if the market value of the company is fair or not. When a company engages in stock buybacks, it’s essentially saying that it believes its stock to be undervalued, which is why stock buybacks sometimes have the surprising effect of elevating the stock price, at least in the short run. After all, who has better information about the company and its prospects than itself? But as they say, the market is a voting machine in the short run, but a weighing machine in the long run. If it turns out that the market value of the company is higher than its intrinsic value, then stock buybacks are actually destroying shareholder value. The cash would have been better spent buying shares in an index fund.
- JumpCrisscross 9y ago> In a perfect market, the market value of the company will go down when company buys back stock Consider a company worth $100 with ten shares of stock with $10 of cash on their balance sheet. Each share is worth $10. They company uses the $10 to buy back one share of stock. The company is now worth $90 and has 9 shares outstanding. Each share is still worth $10.
- chibg10 9y agoHas anyone read the paper? What is the effect size? I'm assuming the author means "statistically significant", which is worthless from any decisionmaking perspective (e.g. policy).
- notahacker 9y agoEffect size is ~0.2% of annualised net investment in R&D ($2m for median firm size) per standard deviation in vesting equity (unvested equity and remaining vested stock have minimal effect on equation as specified). So not huge but not trivial. Paper is pretty thorough, including looking at changes in actual measures of firm efficiency, forecasts by friendly analysts vs actual earnings growth and an attempt to defeat the reasonable alternate hypothesis that boards time vesting decisions according to when they think massive investment is no longer needed and earnings growth will kick in. It does however focus on [estimated per quarter based on annual info] vesting schedules and not actual share sale decisions. Actual share sales are found not to be statistically significantly related to investment drops (likely due to a variety of other reasons for offloading and reluctance to offload if the investment drop is due to short term dips)
- dv_dt 9y agoI think this is one of many bits of data that I add to support my personal hypothesis that public equity markets are increasingly failing at their job of being an efficient way for our economy to allocate capital.
- JumpCrisscross 9y agoWhat's your proposed alternative?
- da_chicken 9y agoThe first step in correcting a problem isn't proposing an alternative. It's identifying the problem. Given that the powers that be clearly have no consensus on the existence of the problem (nevermind that they may have a vested interest in not identifying the problem), and that identifying a problem, while non-trivial, is typically orders of magnitude easier than identifying a solution, it's a little disingenuous to dismiss the point by asking for a solution. Just because the solution is unknown doesn't mean we can't discuss the existence of the problem.
- aidenn0 9y agoThe promise of public markets isn't perfection though, it's just "better than the alternatives." Austrian economics doesn't claim that short-term inefficiencies do not exist in markets, but rather that they are less harmful than attempts to fix them. [edit] The sibling comment that asks if the markets are failing more than in the past is more productive because if they are that means that something is different; I personally am disturbed by the degree to which "a rising tide lifts all boats" is no longer true. I wonder if it's because the wealthy and powerful have gotten better at cornering the market on gains (which would beg for some check on their power), but I also worry that it's actually because material growth has actually stalled, and the market gains are mostly illusion (which would require some other correction).
- da_chicken 9y ago
- StriverGuy 9y agoRelevant to the impact of stock based compensation in real terms for CEO's: https://www.bloomberg.com/graphics/2018-blackstone-schwarzman-pay/ https://www.bloomberg.com/graphics/2018-blackstone-schwarzma...
- markhall 9y agoSomewhat relevant topic into how many of these CEOs got to where they were: "New Study Reveals How Many CEOs Fast-Tracked Their Way To The Corner Office" https://goo.gl/Bz8fP5 https://goo.gl/Bz8fP5
- ScottBurson 9y agoActual URL: https://www.forbes.com/sites/markhall/2018/03/01/new-study-reveals-how-many-ceos-fast-tracked-their-way-to-the-corner-office/ https://www.forbes.com/sites/markhall/2018/03/01/new-study-r... I think URL shorteners are frowned on here.
- mlinksva 9y agoNot to mention, Forbes "articles" are frowned on. It's a rewrite of https://hbr.org/2018/01/the-fastest-path-to-the-ceo-job-according-to-a-10-year-study https://hbr.org/2018/01/the-fastest-path-to-the-ceo-job-acco...
- ucaetano 9y agoIn other news, people are found to act in their own self interests and game whatever rules and systems are in place for their own personal advantage. Further research reached the surprising conclusion that CEOs are people too, and game the system just like any other person. [Edit: adding color, as my comment lacked substance to abide by HN's guidelines] Snark aside, this is a great example on how we need to design robust incentive systems that minimize the chance of gaming them. People are amazing optimizers, and will find any loopholes or gaps that allow them to use any system to their advantage. CEOs delaying investments, CFOs colluding with industry analysts, rushing product launches, technical debt, etc. are all examples of the same symptom. "Detecting Earnings Management", by Richard Sloan (a former professor of mine) is a great article that shows the same behavior as this article: managers will anticipate or delay earnings and investments in a way that maximises whatever metric they are evaluated on. This is further exacerbated by the non-linearity of the market response to earnings surprises. Unsurprisingly, the distribution of earnings surprises over time are not symmetrical to the average market return.
- dang 9y agoSure, but your comment breaks the HN guidelines, which ask: Please don't post shallow dismissals, especially of other people's work. A good critical comment teaches us something. It also breaks this guideline, since you've ignored the substantive core of the article: Please respond to the strongest plausible interpretation of what someone says, not a weaker one that's easier to criticize. We all know how easy and satisfying it can be to fire off a bit of snark into the internet, but it makes for poor discussion, and actually causes harder systemic problems than outright personal attacks and the like. So please don't post like this to Hacker News. https://news.ycombinator.com/newsguidelines.html https://news.ycombinator.com/newsguidelines.html
- ucaetano 9y agoI added some content making it more useful, thanks for the feedback :)
- 9y ago
- zombieprocesses 9y agoCan you blame them? People act in their selfish self-interest. It's the same thing with cops and firefighters. Their pensions are calculated based on the earnings of the last few years of employment. So that save vacation days the last few years to inflate their earnings the last few years. If there is one thing you can count on, it's human greed. And I'm not pretending I'm above it myself. The problem is that the system is set up to be exploited by the CEOs/etc.
- rhizome 9y agoCan you blame them? People act in their selfish self-interest. Hoo boy, but if a CEO has self-interests that involve steering the company in a socially responsible direction (or maybe just being less extractive), cries of fiduciary duty to shareholders ring out.
- aje403 9y agoWhat you're describing is a selflessness, almost the exact opposite, which doesn't get you promoted to that position in the first place
- drharby 9y agoYou ignored the core concept
- aje403 9y agoI'm really not sure what that is...that some are forced to be that way but secretly want to act ethically? The people who get promoted to this spot tend to fall into the culture of the industry and company, and they've been extensively socially vetted by the people with say beforehand. Companies who tear down rain forests and pollute rivers aren't going to hire someone who wants to change that. This is the reality of how the big corporate world works in America.
- jjoonathan 9y agoCan I blame them? Yes, the same way that I can blame a thief for stealing a car even though society "gave him an incentive to steal it." One of these is an ongoing source of considerable societal damage. The other is illegal.
- batterseapower 9y agoInterestingly, it's well known that the stock of firms with high levels of investment does worse than the stock of firms that do not invest as much -- see https://www.sciencedirect.com/science/article/pii/S0304405X14002323 https://www.sciencedirect.com/science/article/pii/S0304405X1.... One possible reason for this is that managers may channel investment funds into unproductive empire building.
- fullshark 9y agoThis is cross-sectional returns over a month so it basically confirms the OP, don't invest money if you want the stock to up in the next month (or quarterly report).
- valine 9y ago>> Could the investment cuts actually be efficient? Perhaps stock price concerns are motivating, because they induce the CEO to make tough decisions, such as cutting wasteful investment. If so, we would expect the CEO to improve efficiency in other ways as well, such as increasing sales growth or cutting other expenses. And we find no evidence of that. I imagine looking for ways to increase sales growth and cut costs is something a good CEO does on a regular basis, so maybe there's not much low hanging fruit in that respect. I honestly don't see an issue with the explanation that CEOs are simply more motivated to cut wasteful investment prior to their equity vesting.
- purplezooey 9y agoThis is well known. Mostly what (public) companies spend money on these days is share buybacks. Especially for retail, they'd be better off in the long term paying benefits for their hourly employees.
- jimrandomh 9y agoNeat fact: the publishing of this article has caused its headline to stop being true. Since CEO equity vesting schedules are public, all it takes is a few algorithmic traders acting on this to make the strategy stop working.
- wqnt 9y agoAlgorithmic traders focus on short-term market movements. The investment decisions described in the study are about long-term foundamental of companies. As long as enough investors prefer cash flow to capital reinvestment on the earning report, the strategy will continue to work. Cutting costs and investments can easily dress up short-term financial performance at the cost of long-term productivity. But it will look good for investors who don't understand the underlying matter and rely on simplistic metrics to make investment decisions.
- Spooky23 9y agoI hate to break it to you, but this isn't exactly a revelation.
- spaceflunky 9y agoIs that really true though? How do you know?
- LorenPechtel 9y agoThey missed the real fix for the problem--change how vesting works. They are talking about changing vesting from 3 years to 5. Instead, how about take that pile of options and split it into 5 piles. Pile 1 vests in 3 years. Pile 2 vests in 4 years and so on. The point is to spread it out over time--they'll do better with a long term approach.