My recent series of posts concerning CEO and board compensation, and corporate governance, has led me to a heretofore unrealized question. Is "corporate governance" a viable or relevant concept in our modern financial markets?
Generally, when I have read pieces on corporate governance, going back at least a decade, they typically assume, it seems, some long-term, faceless group of ever-present shareholders. Or, worse, a "stakeholder" group, only some of which are assumed to be shareholders. Thus, the perspective of these writings is usually more political in nature. By that I mean, they deal with corporate policy within the context of our socio-economic and governmental environments in the US.
However, it occurs to me that the existence of deep, liquid financial markets in the US, available at very low prices, changes this perspective radically.
What is the relevance of long-term "corporate governance," and the debates about how to affect it, when any disappointed shareholder can become a non-shareholder in a matter of seconds, for about $9/trade, at retail. For institutional investors, the cost is pennies per share.
Why does there need to be any debate over CEO compensation, board compensation, etc? If you, as an investor, don't like a company's policies, but its performance is superior, do you really care? If a company is a paragon of corporate governance excellence, but can't outperform the S&P500, are you still going to hold its shares?
It seems to me that an overlooked aspect of the corporate governance debate, and the debate over CEO compensation, is that the exit cost for even a small shareholder is de minimus. It's far easier to fix the problem by selling the shares than it is to attempt corporate "reform."
As I have noted elsewhere, it seems to me that some investors have an inability to accept their limits as investors in, rather than as employees or majority owners of a firm. To me, liquidity is a Godsend. If the companies whose stocks I own do not perform up to expectations, selling them is a trivial matter. What could be a better remedy than this?
To follow this logic, if many investors felt similarly, the stock of the company in question would fall. If this would not galvanize a board into action, what would?
As with many aspects of our relatively free-market economy, I suspect that, in the matter of excessive and inappropriate CEO compensation, and other board-originated problems, too, price signals are much more effective than any regulatory or political "solutions."
Thursday, April 13, 2006
Coca Cola’s New Board Compensation Changes
In a feat of truly incredible timing, I wrote yesterday of some changes in corporate board requirements and management that I feel would have positive effects for shareholders. Incidentally, I believe such changes as I suggested may help curb the current epidemic of overpaid, underperforming CEOs. It was my intention to write next about how a company might transition from current common CEO and board compensation practices to those which I suggested. However, the recent Coca Cola announcement is too good to pass up as a topic for this piece.
Coca Cola has just announced, as reported in this morning’s Wall Street Journal, new board compensation policies aimed at placing directors in nearly the same position as the shareholders whom they are elected to represent. Henceforth, most of a Coke board member’s compensation will be dependent upon the fundamental operating performance of the company over several years.
This is a good start, but still woefully inadequate. Coke should have tied the directors’ compensation to total returns of the company’s stock, relative to that of the S&P500 for the same, multi-year time period.
For example, in a recent article in Business Week, entitled, “Blue Chip Blues,” the author alleges that
“…What exasperates the leaders of these corporations is that it seems there's little they can do about (it)…….delivering the earnings growth, but investors aren't responding. At work are forces largely beyond their control.”
If this is true, then Coke is targeting the wrong performance measure. However, regarding the BW article’s contention, I beg to disagree. A sizable portion of the valuation response of investors is, in fact, very much within the control of a CEO.
My proprietary research has shown, conclusively, that investors respond to long-term revenue growth more than simply to earnings growth alone. It’s up to the incredibly-well-compensated CEO to know this, and to figure out what performance will move his firm’s stock price. Then deliver that performance.
It is my contention that CEOs and board members should be compensated only for total return performance above that which investors could experience in an S&P500 Index fund.
Having discussed why total return performance is the relevant measure for shareholders to use for CEO and board member performance, rather than a fundamental target such as earnings growth, I wish to next return to the issue of whether “corporate governance”, per se, should be of concern to shareholders.
Coca Cola has just announced, as reported in this morning’s Wall Street Journal, new board compensation policies aimed at placing directors in nearly the same position as the shareholders whom they are elected to represent. Henceforth, most of a Coke board member’s compensation will be dependent upon the fundamental operating performance of the company over several years.
This is a good start, but still woefully inadequate. Coke should have tied the directors’ compensation to total returns of the company’s stock, relative to that of the S&P500 for the same, multi-year time period.
For example, in a recent article in Business Week, entitled, “Blue Chip Blues,” the author alleges that
“…What exasperates the leaders of these corporations is that it seems there's little they can do about (it)…….delivering the earnings growth, but investors aren't responding. At work are forces largely beyond their control.”
If this is true, then Coke is targeting the wrong performance measure. However, regarding the BW article’s contention, I beg to disagree. A sizable portion of the valuation response of investors is, in fact, very much within the control of a CEO.
My proprietary research has shown, conclusively, that investors respond to long-term revenue growth more than simply to earnings growth alone. It’s up to the incredibly-well-compensated CEO to know this, and to figure out what performance will move his firm’s stock price. Then deliver that performance.
It is my contention that CEOs and board members should be compensated only for total return performance above that which investors could experience in an S&P500 Index fund.
Having discussed why total return performance is the relevant measure for shareholders to use for CEO and board member performance, rather than a fundamental target such as earnings growth, I wish to next return to the issue of whether “corporate governance”, per se, should be of concern to shareholders.
Wednesday, April 12, 2006
The "Real" CEO Compensation Issue: Boards of Directors
As I reread my post on CEO compensation of the other day, it occurred to me that I am guilty of leaving you, the reader, hanging on an important aspect of this issue.
I attributed the mess to board members, particularly those on the compensation committees, but failed to suggest solutions for their actions. If it was not for their dereliction, on behalf of shareholders, more underperforming CEOs would be shown the exits, and shareholders would be better served. At least they would theoretically pay less for the underperformance they receive from a poorly-performing CEO.
So the question we should ask is, how do shareholders affect the recruitment, retention and behavior of board members, so that the boards behave effectively and responsibly in their oversight of the company and its CEO?
I doubt I'm going to solve this rather momentous question in one post on this blog. However, I intend to begin, as Einstein would call them, "thought experiments" on the subject. Chances are, musings about various solutions may uncover key attributes of what the solution should contain and "look like."
The overwhelmingly attractive alternative in my mind is to truly align the board members' interests with the shareholders, i.e., not stopping with doing so for the CEO, but extending this concept to his/her overseers. I would propose, and feel better about companies which, required board members to own and retain voting control of, some minimum number of shares or value of shares of the company. Today, it's a rare board member who is not already a retired CEO or a sitting senior executive or CEO of another firm. So, requiring someone to have a lot of money to be a director is really not such a major departure from current practices. About the only people it would weed out would be token appointments of unqualified, but politically acceptable directors, for public relations reasons.
This alternative makes being a board member into a rather interesting, and potentially lucrative, job. Someone could, in theory, borrow money to buy shares and run for a corporate board, intending to exercise effective oversight, in order to profit from the company's presumed increased total return.
It seems very clear to me, as I write this, that the major problem with today's corporate board structure is that it fails to require the board members to share the most important interest of the shareholders- personal financial gain or loss of a significant nature, based upon the firm's performance. In this regard, Ed Lampert's role in Sears and K Mart are a good example of expecting to make money by buying your way onto a board. In his case, he didn't stop with only "another" board seat, but became CEO.
If you think about it, the modern corporate form began in an era when most other company CEOs had contributed a significant amount to their own firm's success. Thus, filling a board with other CEOs usually meant recruiting active, successful talent on whom you could rely to know how to get superior performance from a company and its CEO.
Nowadays, though, with so much ineffectual overcompensation of underperforming CEOs, I suspect most boards are comprised of members who both have not actually demonstrated the success they are meant to foster on the board on which they serve, and who do not have a truly material interest in the success of the company in the first place. And the result is self-propagating. We see learned behavior of rewarding incompetence spread from company to company.
If a company actively publicized that its board was filled with people who met my qualifications, perhaps they would become a more attractive company to own, simply because the overseers of the CEO had the shareholders' interests as their own. And would, in time, cause better returns, which would reward shareholders appropriately.
So, at this point in my thinking, I believe that CEO compensation is simply an outgrowth of a deeper problem- incompetent, insensitive corporate boards. If board members had to own substantial amounts of a company's stock to serve, and, thus, profit, as a board member, I think the CEO compensation issue would resolve itself in short order.
My next piece on this topic will probably address how a company makes the transition from one with an ineffectual board, to the type of firm I am envisioning in this post. Perhaps a good case would be to imagine how one would transform GE from what it is now, to a truly well-run company. One which compensated its CEO appropriately for his performance, rather than rewarding him for consistent underperformance, as it now does?
I attributed the mess to board members, particularly those on the compensation committees, but failed to suggest solutions for their actions. If it was not for their dereliction, on behalf of shareholders, more underperforming CEOs would be shown the exits, and shareholders would be better served. At least they would theoretically pay less for the underperformance they receive from a poorly-performing CEO.
So the question we should ask is, how do shareholders affect the recruitment, retention and behavior of board members, so that the boards behave effectively and responsibly in their oversight of the company and its CEO?
I doubt I'm going to solve this rather momentous question in one post on this blog. However, I intend to begin, as Einstein would call them, "thought experiments" on the subject. Chances are, musings about various solutions may uncover key attributes of what the solution should contain and "look like."
The overwhelmingly attractive alternative in my mind is to truly align the board members' interests with the shareholders, i.e., not stopping with doing so for the CEO, but extending this concept to his/her overseers. I would propose, and feel better about companies which, required board members to own and retain voting control of, some minimum number of shares or value of shares of the company. Today, it's a rare board member who is not already a retired CEO or a sitting senior executive or CEO of another firm. So, requiring someone to have a lot of money to be a director is really not such a major departure from current practices. About the only people it would weed out would be token appointments of unqualified, but politically acceptable directors, for public relations reasons.
This alternative makes being a board member into a rather interesting, and potentially lucrative, job. Someone could, in theory, borrow money to buy shares and run for a corporate board, intending to exercise effective oversight, in order to profit from the company's presumed increased total return.
It seems very clear to me, as I write this, that the major problem with today's corporate board structure is that it fails to require the board members to share the most important interest of the shareholders- personal financial gain or loss of a significant nature, based upon the firm's performance. In this regard, Ed Lampert's role in Sears and K Mart are a good example of expecting to make money by buying your way onto a board. In his case, he didn't stop with only "another" board seat, but became CEO.
If you think about it, the modern corporate form began in an era when most other company CEOs had contributed a significant amount to their own firm's success. Thus, filling a board with other CEOs usually meant recruiting active, successful talent on whom you could rely to know how to get superior performance from a company and its CEO.
Nowadays, though, with so much ineffectual overcompensation of underperforming CEOs, I suspect most boards are comprised of members who both have not actually demonstrated the success they are meant to foster on the board on which they serve, and who do not have a truly material interest in the success of the company in the first place. And the result is self-propagating. We see learned behavior of rewarding incompetence spread from company to company.
If a company actively publicized that its board was filled with people who met my qualifications, perhaps they would become a more attractive company to own, simply because the overseers of the CEO had the shareholders' interests as their own. And would, in time, cause better returns, which would reward shareholders appropriately.
So, at this point in my thinking, I believe that CEO compensation is simply an outgrowth of a deeper problem- incompetent, insensitive corporate boards. If board members had to own substantial amounts of a company's stock to serve, and, thus, profit, as a board member, I think the CEO compensation issue would resolve itself in short order.
My next piece on this topic will probably address how a company makes the transition from one with an ineffectual board, to the type of firm I am envisioning in this post. Perhaps a good case would be to imagine how one would transform GE from what it is now, to a truly well-run company. One which compensated its CEO appropriately for his performance, rather than rewarding him for consistent underperformance, as it now does?
Tuesday, April 11, 2006
If Only It Were That Easy: CNBC Advises GM
CNBC has been running a special series this week, featuring their automotive sector reporter, Phil Lebeau. He has been providing the answers on how GM should build better cars "and" a better car company.
If this weren't so hysterically ridiculous, it would be merely good comedy.
I'm guessing at least half a dozen of the country's larger consulting firms- McKinsey, Bain, Accenture, Booz Allen, BCG, AT Kearny - are calling on Rick Wagoner to pitch their solutions. While I may not believe they can cure what ails GM, I'm pretty sure doing so involves more of what they will do than what Phil Lebeau is doing.
I can just imagine the producer(s) at CNBC huddling with the staff to discuss how to capitalize on GM's troubles....."and let's have Phil do some pieces on how they should get out of this mess. After all, he's our auto guy....."
If only it were that simple. Lebeau basically stands in Toyota factories and solemnly intones that GM should "be more like Toyota, which is doing GREAT!" He must know that what he is saying sounds superficial and silly. How can one lightweight, on air sector reporter really suggest that he can deliver the solution for GM in a few 3-minute blurbs?
Suffice to say, some consulting firms will be booking millions in fees before GM bites the dust, or staggers into some semblance of life as a much-shrunken vehicle assembler. It's not going to be because Rick Wagoner was watching CNBC this week.
I think it's pretty embarrassing for CNBC. It suggests that they aim so low in order to reach their audience's level of comprehension. Or, they simply are filling up air time because they have nothing better to offer. The truth is probably somewhere in between.
Either way, I think GM needs more than a news reporter telling them to make better cars with more cool features and fewer defects.
If this weren't so hysterically ridiculous, it would be merely good comedy.
I'm guessing at least half a dozen of the country's larger consulting firms- McKinsey, Bain, Accenture, Booz Allen, BCG, AT Kearny - are calling on Rick Wagoner to pitch their solutions. While I may not believe they can cure what ails GM, I'm pretty sure doing so involves more of what they will do than what Phil Lebeau is doing.
I can just imagine the producer(s) at CNBC huddling with the staff to discuss how to capitalize on GM's troubles....."and let's have Phil do some pieces on how they should get out of this mess. After all, he's our auto guy....."
If only it were that simple. Lebeau basically stands in Toyota factories and solemnly intones that GM should "be more like Toyota, which is doing GREAT!" He must know that what he is saying sounds superficial and silly. How can one lightweight, on air sector reporter really suggest that he can deliver the solution for GM in a few 3-minute blurbs?
Suffice to say, some consulting firms will be booking millions in fees before GM bites the dust, or staggers into some semblance of life as a much-shrunken vehicle assembler. It's not going to be because Rick Wagoner was watching CNBC this week.
I think it's pretty embarrassing for CNBC. It suggests that they aim so low in order to reach their audience's level of comprehension. Or, they simply are filling up air time because they have nothing better to offer. The truth is probably somewhere in between.
Either way, I think GM needs more than a news reporter telling them to make better cars with more cool features and fewer defects.
Sunday, April 09, 2006
Overpaid CEOs: Does It Really Matter?
Once again, the issue of CEO compensation is in the headlines. I wrote a piece on this topic here a few months ago. My feelings and thoughts have not changed. However, they have gotten a little more nuanced.
Rather than rewrite what you can read by following the link in the first paragraph, let me address a few aspects of the public outcry over this topic.
First, I do not think it is an appropriate matter for any type of legislative or governmental interference. These are publicly-held companies, with boards of directors and bylaws governing their behavior. The companies in question have stock listed on exchanges where a shareholder may easily dispose of his stake in the firm, if he dislikes the way the firm is managed or directed.
Second, I think this issues is moot for any firm whose total return performance has consistently exceeded or is exceeding the S&P500 index return for a period of five years. When a CEO delivers the goods, who cares how much he was paid? This type of performance is so rare that, if a CEO actually enriches his shareholders, continually, at an above-market rate, those shareholders should be thrilled to pay that CEO very handsomely.
Third, the "issue," as it exists, exists only for those companies whose total returns are either consistently below the index for 5 years or so, or inconsistenly not much different than the index. Simply put, why should anyone pay excessive amounts of compensation for the right to hold a single stock, with its attendant concentration risk, and earn no more than the market return?
But, even here, the culprits are not the CEO. No, the culprits are the board members- particularly the compensation committe members. These snoozing guardians of the corporate treasuries abet the "excessive CEO compensation crisis" by failing to set realistic and appropriate corporate total return requirements for the CEO to achieve in order to enrich himself. For more details, see my post on Jeff Immelt, the overpaid, underperforming CEO of GE.
Realistically, pragmatically, what is the average shareholder to do? Or even, for that matter, the average institutional fund manager to do? As I wrote on a related topic recently, it baffles me why any investor honestly thinks s/he can affect the behavior of a large corporation in which s/he owns shares. Or why s/he should even try. Does it not make more sense to simply sell shares of a poorly-run company, and buy shares of one whose performance, or prospective performance, you prefer?
Thus, my "final" answer is, I think the spotlight being shone on these overpaid loser CEOs is great. The Wall Street Journal's "CEO Compensation" section in yesterday's issue is about as good as it gets. Provide sunshine, full information, and let shareholders make their choice with their investment dollars.
After all, we want free, liquid, fully-informed markets and investors, right? Why should anyone be doing anything but applying the "disinfectant" of fully-disclosed performance and compensation information for the benefit of investors?
Followed to its logical conclusion, I suppose, in a perfect world, a company like, say, GE, which consistently overpays its CEO for poor performance, would see investors head for the exits, and its stock price and total return plunge. Then, ideally, that CEO would be dismissed, a la my prior post guidelines. And if the new CEO got things back on track, s/he would be amply rewarded, and investors would return to hold a consistently-superior performing stock.
So I stand by my earlier recommendations: handsomely reward performers, and fire the already-wealthy underperformers. Pay all the CEOs with less cash and more stock. Make them wealthy by leading a company to consistently-superior total return performance, and nothing less.
Rather than rewrite what you can read by following the link in the first paragraph, let me address a few aspects of the public outcry over this topic.
First, I do not think it is an appropriate matter for any type of legislative or governmental interference. These are publicly-held companies, with boards of directors and bylaws governing their behavior. The companies in question have stock listed on exchanges where a shareholder may easily dispose of his stake in the firm, if he dislikes the way the firm is managed or directed.
Second, I think this issues is moot for any firm whose total return performance has consistently exceeded or is exceeding the S&P500 index return for a period of five years. When a CEO delivers the goods, who cares how much he was paid? This type of performance is so rare that, if a CEO actually enriches his shareholders, continually, at an above-market rate, those shareholders should be thrilled to pay that CEO very handsomely.
Third, the "issue," as it exists, exists only for those companies whose total returns are either consistently below the index for 5 years or so, or inconsistenly not much different than the index. Simply put, why should anyone pay excessive amounts of compensation for the right to hold a single stock, with its attendant concentration risk, and earn no more than the market return?
But, even here, the culprits are not the CEO. No, the culprits are the board members- particularly the compensation committe members. These snoozing guardians of the corporate treasuries abet the "excessive CEO compensation crisis" by failing to set realistic and appropriate corporate total return requirements for the CEO to achieve in order to enrich himself. For more details, see my post on Jeff Immelt, the overpaid, underperforming CEO of GE.
Realistically, pragmatically, what is the average shareholder to do? Or even, for that matter, the average institutional fund manager to do? As I wrote on a related topic recently, it baffles me why any investor honestly thinks s/he can affect the behavior of a large corporation in which s/he owns shares. Or why s/he should even try. Does it not make more sense to simply sell shares of a poorly-run company, and buy shares of one whose performance, or prospective performance, you prefer?
Thus, my "final" answer is, I think the spotlight being shone on these overpaid loser CEOs is great. The Wall Street Journal's "CEO Compensation" section in yesterday's issue is about as good as it gets. Provide sunshine, full information, and let shareholders make their choice with their investment dollars.
After all, we want free, liquid, fully-informed markets and investors, right? Why should anyone be doing anything but applying the "disinfectant" of fully-disclosed performance and compensation information for the benefit of investors?
Followed to its logical conclusion, I suppose, in a perfect world, a company like, say, GE, which consistently overpays its CEO for poor performance, would see investors head for the exits, and its stock price and total return plunge. Then, ideally, that CEO would be dismissed, a la my prior post guidelines. And if the new CEO got things back on track, s/he would be amply rewarded, and investors would return to hold a consistently-superior performing stock.
So I stand by my earlier recommendations: handsomely reward performers, and fire the already-wealthy underperformers. Pay all the CEOs with less cash and more stock. Make them wealthy by leading a company to consistently-superior total return performance, and nothing less.
Subscribe to:
Posts (Atom)
