6 ms·

No value: Investing, CEO pay and the economy

132 points by known 12y ago

fennecfoxen 12y 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.
- Zigurd 12y ago
  "Eyes on the scoreboard, not on the ball." It's not hard to see where problems could come from. Quarter-driven management, etc.
- Retric 12y 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.
  - pflats 12y 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.
    - Arubis 12y ago
      Doing exactly that would select specifically for people that care enough about future generations and those to follow to make personal sacrifices: "you won't end up filthy rich, but your children can escape the bonds of debt." Obviously not universally appealing, but I would go out of my way to work with someone like that, and would attach a level of personal trust to an organization under their guidance. 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.
      - gohrt 12y ago
        Why should the offspring of a person get the person's salary?
      - tormeh 12y ago
        10 or even 5 years would be long enough. That's far longer than most CEO's stay in the job.
        wpietri 12y ago
        That's not the correct yardstick. CEOs are supposed to be making strategic decisions with decades of impact. If they are compensated based on short-term results, then they will have a strong incentive to make short-term decisions.
        tormeh 12y ago
        I think this is an unsolvable problem. I don't understand how anyone could accept such a delay in payment. Remember most companies aren't alive for 30 years. IBM, GE, etc. are exceptions to the rule. 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.
        wpietri 12y ago
        I think you have it backwards. Perhaps the reason most companies no longer last is that the people running them have no financial interest in their long-term survival. 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.
        pflats 12y ago
        >90% of Jeff Bezos's wealth is still in Amazon stock despite being there 20 years. 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.
    - Retric 12y ago
      They still receive some stock on year 1 they just also get the same amount of stock on year 10 and year 30. Anyway the whole point is to get a CEO to optimize for the long term if there not willing to get deferred compensation you probably don't want them as your CEO. Sure, there are tax implications but company's can generally just pay those taxes. The point is getting upper managment to align with invested plenty of investors care about there returns over longer periods than 30 years.
  - wpietri 12y 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 12y 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.
- bobcostas55 12y 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.
  - glesica 12y 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).
    - bobcostas55 12y ago
      >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. 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.
      - glesica 12y ago
        It's true that they are different, though I disagree that the next-best option is always going to be "vary close"). However, in this case the "shareholder value" problem is systemic, meaning that there really isn't anywhere else for shareholders to put their money. This potentially helps explain some of the asset bubbles we've seen, as well as the startup bubble (if one exists). Regardless of how the analysis falls out for the shareholder, then, the situation is almost certainly sub-optimal for the economy as a whole.
- NPMaxwell 12y 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.
iwwr 12y 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://en.wikipedia.org/wiki/Shareholder_rights_plan http://www.investopedia.com/terms/s/sharkrepellent.asp http://www.investopedia.com/terms/s/sharkrepellent.asp
- Zigurd 12y 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 12y 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.
    - wpietri 12y ago
      I don't think I agree. 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.
michaelochurch 12y 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.
- tormeh 12y ago
  This applies to governments as well.
  - toolz 12y 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?
    - tormeh 12y ago
      It's a positive feedback mechanism, but I think it can be kept under control. When it really goes to shit is when people are brought up with believing that being a total shit is just how bureaucracy/business/finance is done, then they get into those positions and they behave in the asshole way they believe is natural. Later it's on Fox News and the same kind of people there go "that's not wrong, wouldn't you do the same if you were in their place?". I think not being upset when politicians are corrupt is unacceptable behavior. I think it's both symptom and cause, basically.
      - deleted 12y ago
        [deleted]
- 12y ago
pcurve 12y 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 12y 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 12y ago
  I have been think about that too. Then investing would also be less of a gamble on the stock market.
simon_ 12y 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...

132 points by known 12y 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.

Zigurd 12y ago
"Eyes on the scoreboard, not on the ball." It's not hard to see where problems could come from. Quarter-driven management, etc.
Retric 12y 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.
- pflats 12y 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.
  - Arubis 12y ago
    Doing exactly that would select specifically for people that care enough about future generations and those to follow to make personal sacrifices: "you won't end up filthy rich, but your children can escape the bonds of debt." Obviously not universally appealing, but I would go out of my way to work with someone like that, and would attach a level of personal trust to an organization under their guidance. 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.
    - gohrt 12y ago
      Why should the offspring of a person get the person's salary?
    - tormeh 12y ago
      10 or even 5 years would be long enough. That's far longer than most CEO's stay in the job.
      - wpietri 12y ago
        That's not the correct yardstick. CEOs are supposed to be making strategic decisions with decades of impact. If they are compensated based on short-term results, then they will have a strong incentive to make short-term decisions.
        tormeh 12y ago
        I think this is an unsolvable problem. I don't understand how anyone could accept such a delay in payment. Remember most companies aren't alive for 30 years. IBM, GE, etc. are exceptions to the rule. 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.
        wpietri 12y ago
        I think you have it backwards. Perhaps the reason most companies no longer last is that the people running them have no financial interest in their long-term survival. 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.
        pflats 12y ago
        >90% of Jeff Bezos's wealth is still in Amazon stock despite being there 20 years. 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.
  - Retric 12y ago
    They still receive some stock on year 1 they just also get the same amount of stock on year 10 and year 30. Anyway the whole point is to get a CEO to optimize for the long term if there not willing to get deferred compensation you probably don't want them as your CEO. Sure, there are tax implications but company's can generally just pay those taxes. The point is getting upper managment to align with invested plenty of investors care about there returns over longer periods than 30 years.
- wpietri 12y 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 12y 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.
bobcostas55 12y 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.
- glesica 12y 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).
  - bobcostas55 12y ago
    >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. 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.
    - glesica 12y ago
      It's true that they are different, though I disagree that the next-best option is always going to be "vary close"). However, in this case the "shareholder value" problem is systemic, meaning that there really isn't anywhere else for shareholders to put their money. This potentially helps explain some of the asset bubbles we've seen, as well as the startup bubble (if one exists). Regardless of how the analysis falls out for the shareholder, then, the situation is almost certainly sub-optimal for the economy as a whole.
NPMaxwell 12y 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.

iwwr 12y 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://en.wikipedia.org/wiki/Shareholder_rights_plan http://www.investopedia.com/terms/s/sharkrepellent.asp http://www.investopedia.com/terms/s/sharkrepellent.asp

Zigurd 12y 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 12y 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.
  - wpietri 12y ago
    I don't think I agree. 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.

michaelochurch 12y 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.

tormeh 12y ago
This applies to governments as well.
- toolz 12y 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?
  - tormeh 12y ago
    It's a positive feedback mechanism, but I think it can be kept under control. When it really goes to shit is when people are brought up with believing that being a total shit is just how bureaucracy/business/finance is done, then they get into those positions and they behave in the asshole way they believe is natural. Later it's on Fox News and the same kind of people there go "that's not wrong, wouldn't you do the same if you were in their place?". I think not being upset when politicians are corrupt is unacceptable behavior. I think it's both symptom and cause, basically.
    - deleted 12y ago
      [deleted]
12y ago

pcurve 12y 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 12y 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 12y ago
I have been think about that too. Then investing would also be less of a gamble on the stock market.

simon_ 12y 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...