Do We Need Greedy Pigs?
My good friend Peter Ryan at the ABC has just penned an excellent piece on the recent findings of a research report into CEO bonuses.
In my book Value.able I wrote of the many motivations that can drive CEO behaviour. Even isolating the behaviours to Mergers & Acquisitions we can find the following:
- The desire to be bigger – the yardstick by which salaries are measured
- Pressure from institutions to grow revenues
- The desire to increase the share price quickly
- Pressure from advisers to take advantage of low prices and/or low interest rates
- Pressure to take advantage of high prices for share-based takeovers
- Suggestions to borrow more because the balance sheet is lazy
- The desire to justify a higher salary
- The belief the buyer can do a better job than the target
Peter Ryan’s coverage of research by Dr Peter Cebon from the Melbourne Business School at the University of Melbourne and Dr Benjamin Hermalin from the University of California, Berkeley, reveals that excessive CEO pay and performance bonuses – especially when a company’s bottom line is under pressure – is out of kilter with the best interests of shareholders.
“Rather than encouraging bosses to make a company more profitable in the long term, the research says the lure of a fat bonus can often tempt a CEO to pursue poor strategies.”
This should come as no surprise to followers of this blog. At the most basic level you cannot truly align the interests of owners and a caretaker.
CEO pay around the world has grown out of control because of this natural imbalance. When CEO’s say that low exercise options or unvested shares ‘align’ their interests with shareholders, they fail to point out that their interests are only aligned on the upside. The losses of shareholders are not born by the holder of unexercised and/or unvested options or shares.
More over it is our observation that CEO salaries are set by a compensation committee – often made up of unquestioning yes men – that meet once per year for 30 minutes.
And like toddlers in the playground, if a CEO sees another CEO receive a large bonus, he throws a tantrum demanding he deserves one too.
Here’s an extract from Peter’s article:
“Uncapped bonuses create ‘an economy full of traitors’
The research, published in the Review of Financial Studies, suggested that, although bonuses should not be banned, there could be a regulated cap on the level of bonuses.
“If you want to live in an economy full of traitors, then there’s nothing wrong with having uncapped bonuses,” Dr Cebon said.
“If you want to live in an economy full of companies that create long term capability in their organisations, then a regulated cap on bonuses would appear to be what you want.”
Dr Ceton cited performance bonuses for the chief executives of Australia’s big four banks and suspects they would do the same job with or without massive incentives.”
You can read the full article here.
Roger Montgomery is the founder and Chief Investment Officer of Montgomery Investment Management. To invest with Montgomery, find out more.
Roger Montgomery is the Founder and Chairman of Montgomery Investment Management. Roger has over three decades of experience in funds management and related activities, including equities analysis, equity and derivatives strategy, trading and stockbroking. Prior to establishing Montgomery, Roger held positions at Ord Minnett Jardine Fleming, BT (Australia) Limited and Merrill Lynch.
This post was contributed by a representative of Montgomery Investment Management Pty Limited (AFSL No. 354564). The principal purpose of this post is to provide factual information and not provide financial product advice. Additionally, the information provided is not intended to provide any recommendation or opinion about any financial product. Any commentary and statements of opinion however may contain general advice only that is prepared without taking into account your personal objectives, financial circumstances or needs. Because of this, before acting on any of the information provided, you should always consider its appropriateness in light of your personal objectives, financial circumstances and needs and should consider seeking independent advice from a financial advisor if necessary before making any decisions. This post specifically excludes personal advice.
Jules W
:
Perhaps greed is pervasive.
If many shareholders are only concerned with rising shares, not the value of underlying business or it’s long term future, they may be happy to employ a caretaker (oxymoron?) holding similar views.
Roger Montgomery
:
Care-taker. Oxymoron or factually correct?
Sammy Giunta
:
Excellent article, Roger
I’m interested in your thoughts on companies run by their founders, in some cases still the majority shareholder in the company.
I own shares in Nick Scali and My Net Fone. In the past, I’ve owned shares in Objective Corp and Academies Australasia. Not only have these been sound business, but the fact that you know that management owns such a large stake in the business makes them attractive to me.
Any thoughts would be appreciated, including any drawbacks you see with such business types.
Roger Montgomery
:
I agree that it is a big tick. Keep in mind though that the dollar value of the stake needs to also material to the total wealth of the individual too.
Yavuz Atasoy
:
Hi Roger,
Has there been any case where you decided not to proceed with investment in a company because of a high CEO salary, options, bonuses, etc…? That means the company in question meets all your investment criteria, but you found the CEO salary( incl. options bonuses, et…) too high?
Roger Montgomery
:
Yes. It was because of management options and it was in a mobile home manufacturer.
Andrew Legget
:
You once again Roger have posted an article about something that I have recently been spending some energy thinking about.
Another example was a recent post on this blog where a company linked its bonus to ROE>WACC.
A poorly structured remuneration program can create big problems for the investor as it shifts the focus/bias of the management team that are hoping to cash in.
The ROE scenario above would quite probably see debt increase significantly. Low or zero exercise price options might might see overly risky behaviour occurring.
It is an art form and one that I don’t think has been perfected yet and the unfortunate thing is that I don’t think there is necessarily an incentive for company management to perfect t as it makes their jobs harder and less profitable as the shareholders are not the one setting the terms and most will likely just get fed up and sell rather than fight.
The one thing I do believe is that social media has reduced the cost of activism and enhanced the ability for shareholders of all sizes to get together and promote change when it happens as it is easier for them to find like minded investors and pool their proxy votes even though instituitions will likely still be he main players. It will be interesting to see if data in the future shows this happening.
Roger Montgomery
:
Thanks for sharing those thoughts Andrew.