CEO Pay (Long)

Discussion in 'Politics, Religion, Social Issues' started by Desertrat, Feb 5, 2009.

  1. Desertrat macrumors newbie

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    #1
    This was in the morning email from Agora. Note the difference between "share price" and "shareholder value". And, note Fry's comments about what capitalism is and what it is not.

    'Rat

    "Demerit-Based Pay
    By Eric J. Fry

    Russia, according to Winston Churchill, was a "riddle wrapped inside an enigma." Wall Street's version of capitalism, according to us, is a fraud wrapped inside a delusion.

    The fraud is that merit-based pay is always meritorious; the delusion is that capitalist enterprises are always capitalistic.

    When you combine these two deceptions, you find lots and lots of people defending the right of incompetent corporate executives to receive multi-million-dollar paychecks…even after the companies that employ these executives receive multi-billion bailouts from the U.S. government.

    Sadly, mass deceptions tend to maintain their grip on the public imagination for destructively long periods of time. The executive compensation deception is no different. During the many years that stocks priced trudged from their 1982 lows to their 2007 highs, the merit-based pay deception advanced from benign heresy to malignant gospel.

    A series of warped deductions about cause and effect led America to embrace one of the greatest financial frauds of all time. Here's how the rationale for merit-based pay mutated over time:

    A CEO who increases shareholder value is a good CEO; and if a company's shareholder value is increasing, its share price will also increase over time. And if a company's share price increases over time, shareholder wealth increases. Therefore, to the extent that a company's share price is rising, the company's CEO is a good CEO who deserves hefty compensation.

    Unfortunately, dear investor, "rising share price" is not a synonym for "shareholder value"…and every merit-based CEO in America understands the difference. Indeed, some of America's worst CEOs deliberately and methodically erode shareholder value, solely for the sake of boosting their company's share price and – oh by the way – their own "merit-based pay."

    One of the most popular tactics is called the "option grant," whereby a company dispenses massive amounts of stock options to its executive team, in addition to traditional cash compensation. The stated rationale for these option grants (often stated by a grant recipient) is to incentive executives to focus their efforts on activities that will produce a rising share price. But of course, most executives exercise about as much influence over their companies' share prices as a starfish over a tsunami.

    By contrast, the option grant compensation mechanism itself CAN influence the share price. Back in the go-go days of the dot.com era, lots of tech companies doled out lots of stock options. And since these option grants did not show up in the income statements as a compensation expense, the companies that dispensed the grants were able to report much higher earnings than if they had paid equivalent amounts of compensation in cash. This practice provided no small benefit in the dot.com days, when "beating the estimate by a penny" could goose a stock by 30% or 40% in a single day.

    As long as share prices were rising, no one cared that the expense of option grants landed squarely on the backs of common shareholders as a reduction of "shareholder equity." But they should have. To satisfy the option grants, companies issued new shares. If the share count goes up without any underlying change to the balance sheet, each share of stock outstanding represents a smaller piece of the company and, therefore, is worth less than before.

    Favored tactic #2: The share buy-back. This tactic is a very simple, and effective, executive-enrichment tool, especially when used in concert with tactic #1, the option grant. The share buy-back is exactly that, buying shares of the company with cash from the corporate treasury.

    Not all buy-backs are bad, of course, but many are. A good buy-back uses corporate cash to buy the DEPRESSED shares of a company – e.g., buying one dollar of assets for fifty cents. A bad buyback does the opposite. But for some corporate insiders, nothing feels quite as good as a buyback that is bad…very, very bad.

    An option-laden executive loves the buyback for two reasons: 1) It contributes some marginal buying interest to the marketplace, thereby helping to boost the share price and; 2) It reduces the number of shares outstanding, which helps to produce a more flattering earnings per share result.

    Are you confused yet? You should be; Tactic #1 increases the share count. Tactic #2 DECREASES the share count.

    The sinister nature of coordinated option grants and share buybacks becomes painfully clear when you realize that many, many American companies simply churn the number of share outstanding without producing a net benefit for the common shareholder. The churning activity does, however, produce an enormous benefit for company insiders.

    Many, many other tactics – both legally fraudulent and overtly criminal – can combine to produce simultaneous wealth creation for management and wealth destruction for shareholders. Few played this game with greater audacity than the federally coddled GSEs, Fannie Mae and Freddie Mac.

    In July 2003, my former colleagues at Apogee Research, led by a brilliant forensic accountant named Robert Tracy, observed, "For the two years ended December 2002, Fannie [Mae] lost $11.8 billion of asset value that was never reflected in its GAAP [accounting] calculations, while simultaneously reporting GAAP earnings of $10.5 billion. Had the lost asset value been included in Fannie's GAAP net income, it would have booked losses for both years."

    Obviously, the difference between a profit of $10.5 billion and a loss of more than $1 billion during the years 2001 and 2002 would have seemed material to some investors – material enough to have kicked Fannie's share price into cellar.

    The list of abuses committed in the name of merit-based pay does not end with option grants and buybacks. Indeed, many of the merit-based compensation schemes do not erode shareholder value methodically. Instead, they place shareholder capital in extreme peril, solely for the sake of a rising share price. Let's call this the "Wall Street Model."

    The main advantage of this tactic, from a CEO's standpoint, is that criminal intent is much harder to prove. A CEO who causes his company to leverage up the balance sheet 45-to-1 and uses the leverage to buy risky securities that no pawnbroker would buy at any price can say, "Hey, it seemed like a good idea. Everyone else was doing it. Besides, it wasn't even our fault. It was those damn short sellers that caused the problem!"

    And if you believe that, then you might also believe that nominally capitalist enterprises always behave capitalistically. But they don't. And neither does the American capitalistic system.

    The "capitalists" on Wall Street probably imagine that their DNA descends from the likes of Henry Ford, Sam Walton, Bill Gates or some other legendary entrepreneur. But under the microscope of honest examination, Wall Street's DNA appears almost identical to that of most DMV workers.

    Like their DMV counterparts, Wall Street's chieftains punch a clock each day, devise ways to work as little as possible, provide as little assistance to clients as possible, and periodically tabulate the value of their entitlements.

    Stated simply, CEOs are not entrepreneurs. They are stewards of the owners' capital. A good steward deserves a good reward…after the fact. A bad steward deserves a pink slip, and two weeks severance. A very bad steward deserves litigation.

    But American capitalism has strayed very far from these simple precepts of appropriate compensation. Miserable CEOs make spectacular amounts of money. And recent attempts to bring compensation back into line with actual merit must face an indignant chorus of apologists who complain that government-mandated pay is anti-capitalist and interferes with the free market.

    Really? Don't trillion-dollar bailouts interfere just a little bit with the free market?

    Wall Street's version of "capitalism" seems to distinguish between different parts of a corporate balance sheet. Assets and revenues belong to the "capitalists;" liabilities and expenses belong to the government. I've got a four-letter word for that: Balderdash.

    A capitalist takes responsibility for every part of the balance sheet and a truly free market treats assets and liabilities with ambivalence. A free market does not care if the assets belong to a sinner or a saint, or if the liabilities belong to high school dropout or a PhD in Economics. And a free market doesn't give a hoot if the victims of financial mismanagement belong to a country club or a bowling league.

    So if the truly free markets don't care about these considerations, why should anyone else?

    To conclude, we would like to issue both a word of caution and an apology. First, the word of caution: The fact that obscenely large executive compensation packages can still claim legions of defenders and apologists suggests that the financial crisis has not yet run its course. When merit-based compensation features more prison bracelets than option grants, the crisis may be drawing to a close…but not until then.

    And now for our apology: We admit that comparing a Wall Street CEO to a DMV employee is neither exactly fair, nor exactly kind. We apologize, therefore, to all employees of the DMV."
     
  2. Ugg macrumors 68000

    Ugg

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    #2
    There needs to be a serious overhaul of corporate governance laws. Shareholders should have input on executive compensation.
     
  3. kavika411 macrumors 6502a

    kavika411

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    #3
    Thanks for posting the article. It's an interesting read. Here's one part I don't understand:

    Like everyone else here, I'm well-acquainted with the pro and con arguments regarding whether CEOs should be paid as much as they do, but I have not seen "lots and lots of people" who defend payments to "incompetent corporate executives" who are paricipating in the bailout. While I may have missed some, I haven't seen even one person say that the CEO of a company that elects to take a portion of bailout money should maintain his "multi-million-dollary paycheck." I take that back, I guess I read about one CEO who said he/she should get it, but that hardly counts.

    Thanks again for posting.
     
  4. iAthena macrumors regular

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    #4
    They do when they vote their shares for the members of the board of directors and also any topics that are put to the vote. Some are binding and some are just advisory, but shareholders have representation by voting their shares. It's at least as good as the system where we elect our government representatives.

    I do support a system where what's good for the goose is good for the gander though. I think that the CEO should negotiate a package that applies to all employees proportional to their salary. Whatever incentivizes the CEO should incentivize everyone else.
     
  5. freeny macrumors 68020

    freeny

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    #5
    The only ones I hear defending CEO compensations are other CEO's
     
  6. Iscariot macrumors 68030

    Iscariot

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    #6
    I have had it with your sea creature badmouthery and sass, mister! Even as we speak our dark undersea machinations — fish-like though they may be — have begun their slow march towards your shores. The most tentacled of the tentacled and the most cuttled of our fish have begun their dark work, suckers and sinew lashed together like so many coral reefs of doom. Each day your pollution raises the sea level is an inch closer to our eventual rise, and your untimely demise. Despair! Ours is a constitutional sharkocracy that spares none the rod and spoils not the child.

    PRAY TO YOUR GODS, HUMAN, THE SEA IS COMING
     
  7. kavika411 macrumors 6502a

    kavika411

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    #7
    Exactly. I guess the writer meant to say "lots and lots of strawmen."
     
  8. Desertrat thread starter macrumors newbie

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    #8
    Seems to me that Fry did a great job in pulling all sorts of bits and pieces together into a cohesive whole. I knew some of it, but hadn't really put it together into a meaningful package.

    I dunno. One thing, the change in our economy from being big on industry to big on "financials" meant that instead of making things to sell, we began to feed upon ourselves. Moving money around to make money. I've read that some one-half of all corporate profits in the (approximately) 1990-2005 period were in the financials.

    Boom times have always led to some form of corruption, whether political or corporate. And, Lordy, Lordy, we've had us some El Gigantico boom times, these last twenty-some years!

    'Rat
     
  9. mactastic macrumors 68040

    mactastic

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    #9
    One other side effect of these massive bonuses is that they predispose CEOs to take extreme risks.
    It's not solely for the sake of a rising share price, it's also for the sake of a gigantic bonus. IOW, the bonus is an *incentive* to take these massive risks with OPM. And we've trained these folks that if they take these risks, and they backfire badly, they'll get a golden parachute and the company will receive an infusion of taxpayer money.

    Just another among many reasons to keep bonuses reasonable.
     
  10. Desertrat thread starter macrumors newbie

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    #10
    To give an idea of the incredible changes, in 1961 a guy named Donner was CEO of GM. At that time, GM had 400,000 employees and 53% of the US car market. His pay and options totalled $862,000.

    Same year, whichever Ford was CEO of FoMoCo got a total of $714,000--noted as 17¢ per Ford sold. The Rolling Stones U.S. tour, six weeks, garnered some $15 million.

    (When I went to work for the Chevy Test Lab in mid-1962, I asked how far I could rise. I was told that if I had administrative talent, I could go far. The world is full of engineers, but administrative talent is hard come by. "If you and your wife put in eighteen hours a day for twenty or so years, you could become GM of Chevrolet. 20 to 22 hours a day and you could have Donner's job." Some things you never forget. And since I valued my personal freedom far more than Ed Cole's or Donner's jobs, I didn't chase that brass ring.)

    Given the levels of responsibility and stress, CEOs deserve high pay and bonuses based on performance. But there are certainly rational limits, and the financials went way beyond reality.

    'Rat
     
  11. DiamondMac macrumors 68040

    DiamondMac

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    #11
    If this were an across-the-board pay cut to companies NOT involved with the bailouts, I would agree it isn't warranted

    But, these companies want BILLIONS? Then people need to take pay cuts. Spare me the $500k isn't a lot of money. Tough, deal with it. Without the bailout, YOU WOULDN'T BE WORKING WHERE YOU ARE NOW.
     
  12. Counterfit macrumors G3

    Counterfit

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    #12
    You just won a billion shares of the internet.
    And Rudy Giulliani.
     
  13. Peterkro macrumors 68020

    Peterkro

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    #13
    It's somewhat unclear whether you mean the Stones tour was in '61 or not but for info it was in fact June '64 they first toured the US and as it wasn't very successful I would think the $15 million refers to the autumn '61 tour.

    (the autumn '64 tour is what I meant to type)
     
  14. Desertrat thread starter macrumors newbie

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    #14
    I'm unsure about the date of the Stone's tour. There was an article sometime in the early/mid '60s about comparative incomes. Executives, entertainers, sports figures. Heck, later on, the world went berzerk over Elway's $13 million signing package with the Broncos.

    To me, what's notable is that the rate of pay for CEOs has risen far faster than the rate of inflation, and far higher than seems justified by ROI to stockholders.

    I guess that it's less a measure of our own perceptions of "worth" or "value" than it is the ideas of the promoters/owners/Boards of Directors as to the profitability potential of the "Star".

    All of which is separate from the concept of bonuses to people whose decisions led to the companies' values going toward zero and needing bailouts.

    Sorta like the U.S. government, for that matter.

    'Rat
     

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