Stockholder rights and executive bonus

I know, I know, executive pay has been written about more in the past five years than most subjects. Posting on this subject certainly runs the risk of "flogging a dead horse." But in light of the frustrations expressed towards the government in the media on a daily basis from both the Tea Party and the new Occupy movement I thought it worth revisiting.

Personally I don’t have a problem with a hefty and deserving executive bonus being paid. I do have a problem with ridiculously, excessive bonuses that are consistently paid to those who don’t bring at least that same value to the company. Apparently I’m not alone:

Four out of six chief executives or company presidents polled by the NACD in July and August said the compensation of top executives was high relative to their performance. Only 2.2 per cent of the nearly 70 chief executives and presidents involved in the survey said compensation was too low, while a third deemed it “just right”. Their views were backed up by outside directors, with more than 80 per cent of them saying chief executives were overpaid.

While this survey was conducted a few years ago I think it is still relevant. I wouldn’t even have a problem with incredibly huge bonuses if the money funding those bonuses are designed to benefit the stockholders. Which begs the question of what are the rights of stockholders and what happens when the government is a substantial stockholder? In our current system it seems that the common stockholder has rights but little to no voting rights that he/she can actually exercise. Thus having no rights regarding choosing a new board member, ultimately the CEO and influencing their pay. Most shareholders are relegated to either move their money to another stock with the same rights, or hold and hope for the best.

We (my family and I) have been in the position of trying to keep control of a company from other shareholders--to put it mildly--it was incredibly frustrating. But when we were trying to retain control it was a private corporation, born of a poor choice of partners. If the company is public, who really owns it? I understand equity is primarily a means of financing, but it is also a means of ownership that happens to have no real rights unless you have a lot of it. You not only have to have a lot of it, you have to have a lot of money to vote contrary to what the board proposes. How many of you have the money and time to organize a separate ballet and send them out to all the shareholders in hopes of convincing them to vote for another board-member? Me neither. I suppose this is the price one pays for diversifying his/her portfolio; if you are fully diversified you can hypothetically get rid of unsystematic risk. At the same time you also dilute your say in any single company’s decisions and hand it over to the mutual fund managers instead.

So what is the best incentive for executives to properly manage public companies with a long-term perspective? Even a better question, how should public companies determine what the executives' incentives for bonuses should be, and what role should the board and common shareholders have? Too many rights given to the stockholder could create a short term perspective, akin to what we see with our current political pendulum. Although, if the barriers of stockholder's rights are not decreased than stock being any type of ownership will continue to be a mirage except to the super rich. These are very important questions to have answered and become heightened by the fact that we now have a precedence for the government (taxpayers) becoming large shareholders of "too big to fail companies."


Dr. Tufte said...

I'm really suspicious of evidence like this: 80% of outside directors thought executive compensation was too high.

Then why didn't they do anything about it. They're the people who .... approve executive compensation.

This is really a better post for a finance class (but in my FIN 6100 class, we didn't have time to cover executive compensation). The evidence is pretty strong in finance that executives are paid in proportion to performance and risk.

Personally, I get annoyed at this topic (no offense Joe): didn't your parents tell you not to pry into other folks income? Why do we stop listening to our parents when it is executives income?

Anyway, discussion of executive compensation always focuses on dollar amounts, not proportions. This tells me this is a framing problem: one psychologists think we get the wrong answer to because of the way it is asked.

What I'd like to know, from everyone who ever discusses this, is if the value of a company goes up by X, what portion of that should the executive get? I think a lot of discussion on this will stop dead in its tracks if we can pin people down on this.

Xavier said...

Here's an attempt at applying this post to some more of things we've learned from this class:

A company maximizes profits when marginal cost is equal to marginal revenue. Let's consider the case of a heavily compensated executive working for a company with a performance-based pay scale. In this example, marginal costs and revenue would be parallel lines on a graph, so there is never a point at which the executive should stop producing (to maximize profits for himself or herself). Thus, it would be in the best interest of the company to pay more since they will get more back.

Even though it may seem more equitable to have an executive paid only 10% more than the average worker, if the profits are doubled by paying the executive 300% more than average, it makes sense to pay the executive more since the shareholders would get more back with the higher executive compensation (from a strictly monetary standpoint).

Dr. Tufte said...

I think your conclusion is correct, but the economics in the middle paragraph is suspect - you're very unlikely to have revenue and marginal cost be parallel. That might happen with marginal revenue rather than revenue, but when it does it is only over a range of production quantities rather than the whole range.