Posted by Marc Hodak on July 23, 2013 under Governance, History, Invisible trade-offs | 
The birth of a new British heir once again causes us governance geeks to scratch our heads at the succession mechanism formally known as primogeniture, the winner-take-all system whereby the first-born (generally male, but not always) becomes heir to substantially all of the parents’ titles and property. In the context of a monarchy, has anyone ever believed that such a mechanism would consistently yield good leaders?
The answer, of course, is “No,” but the question assumes the wrong purpose. In fact, primogeniture did not evolve as a way to select a certain quality of leader; it evolved as a way to enable society to accumulate capital.
For most of history, it was extremely difficult to preserve and grow capital from one generation to the next. Before the 19th Century, the lives of ordinary people–how they labored and what they had in their homes–were virtually indistinguishable from that of their grandparents. Things were hardly better among the aristocracy. For them, accumulated property was basically an invitation to plunder. Consequently, from the Fall of Rome to the Industrial Revolution, the vast majority of capital created by the upper classes was in the form of weaponry, and most of that was consumed in battle. It was in this neo-Hobbesian war of all against all that primogeniture evolved as a way to select kings.
The customary transfer of allegiance of powerful nobles from their king to a royal heir greatly reduced the odds of a civil war. Societies that tended to avoid civil war tended to accumulate far more capital. More capital made them more powerful, economically and militarily, creating a dynamic that eventually led to the institution of monarchical succession via primogeniture spreading throughout most of the world.
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Posted by Marc Hodak on July 10, 2013 under Governance |
This week we celebrate the 65th anniversary of the Roswell crash landing, a watershed event for conspiracy theorists everywhere. I sympathize with the hapless Air Force officers looking at the wreckage of their high-altitude weather balloon, the glass, rubber, and metal strewn around, probably including a reflective saucer-shaped instrument shell, and having to explain within the bounds of military secrecy what happened that night, only to be met with the suspicion of people wearing tin-foil hats. The chagrin of those officers must have turned to alarm as the fallen balloon was figuratively resurrected, and the flying saucer took off as one of the enduring stories of our time: A crash landing by stray aliens being covered up by the U.S. government for its own nefarious, if unspecified, purposes.
The reason I can easily sympathize with the government on this is because I have seen an even bigger conspiracy theory that I personally know to be equally ludicrous—the conspiracy of corporate leaders to control the U.S. political and economic machinery to their personal benefit. A whole phalanx of academics, journalists, and elected officials has benefited from the public’s credulous acceptance of this theory, especially with regards to executive pay.
Lest I be accused of creating my own anti-“corporate conspiracy” conspiracy theory, let me quickly add that each of these parties has participated in their part of the anti-corporate crusade according to their own particular incentives, i.e., to publish in select journals, sell newspapers or airtime, or win higher elected office. No coordination was necessary to blow this balloon beyond what reality could contain.
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Posted by Marc Hodak on July 1, 2013 under Governance, History |
As we celebrate the birth of our country this week, I think it’s worth reflecting on the United States as history’s most daring experiment in governance.
Most of us were taught the Constitution in middle or high school as a series of clauses defining the various workings of our federal government. Some concepts such as “checks and balances” managed to penetrate our pubescent fog because the idea of constraints on authority is innately appealing to young people. But few of us were left with a sense of how bold an innovation our Constitution was at the time of its adoption, or how fragile was the republic that it created. Understanding those things greatly enhances one’s appreciation of the American civilization that would emerge from that experiment.
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Posted by Marc Hodak on June 20, 2013 under Governance |
Lynn Stout published the The Shareholder Value Myth late last year, and it has created some stir. In the book, she blames meltdowns like Enron and disasters like BP’s Macondo on “shareholder value thinking,” and suggests that managers and directors loosen up on this obsession. I’m always surprised when people use Enron and BP–companies that miserably failed their shareholders–as examples of shareholder value thinking run amok. But Stout is a respected legal scholar, and her arguments deserve a more thorough appraisal.
Posted by Marc Hodak on May 22, 2013 under Executive compensation, Governance, Reporting on pay |
In yesterday’s WSJ, an article reported rising criticism of directors’ pay from institutional investors. Many of the quotes came from one such investor, T. Rowe Price.
Current pay structures don’t give directors enough of a stake in making sure the company does well, and boards need to be more creative about tying their compensation to performance, said John Wakeman, a vice president and portfolio manager at mutual-fund giant T. Rowe Price Group Inc.
“If bad people are going to be on these boards, we’ve got to stop it,” said Mr. Wakeman. “We owe it to our fund holders.”
“When you’ve gone to restricted-stock world, basically directors get paid more or less for showing up,” Mr. Wakeman said.
If Wakeman were referring to the portion of director fees paid in cash, then he would have a point about directors being paid for just “showing up,” but even that ignores the value of getting good directors to show up. Being a good director means working. In the world that Mr. Wakeman and I share, very few people beyond commissioned salespeople are expected to show up with zero guaranteed pay. Does he want directors compensated with purely variable pay?
But in alluding to “pay for showing up,” he is not referring to the fixed fees earned by directors, but to their restricted stock, which accounts for more than half of their total pay. Calling this “pay for showing up” is a curious accusation. To some extent, someone getting restricted stock compensation is almost certain of having something of value at the end of their tenure. But the value of restricted stock goes up and down with the share price. You don’t get any more performance-based than that. In other words, given both its retention and incentive characteristics, restricted stock may be the perfect compensation instrument for directors.
The point of bad people on a board is not how we pay them, but how do we prevent them or get rid of them. It may have been the writer instead of Mr. Wakeman who conflated these appointment versus compensation issues, but such a conflation does not help us determine the right way to either get good directors onto boards or to pay them.
The article also notes that some activist investors are experimenting with incentive pay programs for directors. The clear premise is that directors don’t have enough incentive in their current pay programs, which raises the question: what kind of pay package would be better than a program of fees plus restricted stock?
One can argue that the proportion of that pay mix ought to be more in favor of restricted stock than it is now, or that the stock restrictions should be more demanding, such as requiring that most of the stock be held to retirement. But as someone who has designed these things for many boards, and thinks deeply about compensation design every day, I would caution against too much experimentation. The three basic alternatives to restricted stock are:
1. A restricted stock-equivalent, such as a cash-settled stock appreciation plan that pays off exactly the way restricted stock would. I would favor such a plan only because it creates an income opportunity for those of us who design them. Otherwise, the shareholders get the same retention and alignment benefit as if they award restricted stock.
2. An alternative equity instrument, such as stock options. This would likely create an asymmetrical risk/reward profile for directors versus shareholders–the kind of thing that contributed to Wall Street’s troubles during the financial crisis.
3. A non-equity based incentive plan. This would be asking for trouble, as the Coke example in the article showed. The only body in a company than can certify achievement of performance results is the board of directors. Asking the board of directors to certify performance relating to their own pay creates an inherent conflict of interest. This is a fine recipe for either manipulation of corporate results, or the continual appearance of such manipulation. I would never institute a directors’ non-equity incentive plan for any company I advise (and have actually lost business for my refusal to do so).
The real story, here, is that pay is becoming the magic elixir for fixing all governance problems. We don’t have a significant problem with lack of alignment between directors and shareholders. We just have some companies that don’t perform well, and some of that lack of performance reasonably attributable to lax oversight by the board. Too much experimentation with director pay would only make the problems worse because it would be attacking the wrong problem.
Posted by Marc Hodak on March 21, 2013 under Executive compensation, Governance, Reporting on pay |
And that means a new flood of stories about CEO pay. In the past, the stories have almost uniformly been of the “can you believe…” variety. Can you believe that CEO whose company stock dropped 20 percent still earned $5 million? Can you believe that CEO who was canned got $20 million on the way out the door? So, I was surprised to finally see an example of intrepid journalism entitled “Pay for Performance’ No Longer a Punchline.” Apparently the relationship between pay and performance is improving.
The shift in how CEOs are paid highlights the growing role of investors in shaping executive compensation—and their push to align pay more closely with corporate results.
While a welcome the change in tone, I think that both the shift to improved alignment and the role of growing investor involvement are overstated. To see why, consider two items about CEO pay that are approximately true:
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Posted by Marc Hodak on July 13, 2012 under Governance, Politics |
Citizens United unleashed a firestorm of controversy and apocalyptic visions of corporations spending “unlimited” amounts of money on political campaigns. I was on a panel recently debating the governance issues related to corporate political spending. One of the arguments against it went like this:
- Such spending would invariably be proposed and executed by management. As such, it is likely to be guided by the personal preferences top management, especially the CEO.
- There is a good chance that the political preferences of management may not coincide with the best interests of the company (i.e., an agency problem).
- Furthermore, such spending is guaranteed to offend the sensibilities of significant portion of not only a diverse shareholder base, but of employees and customers as well, and that can’t be good for the company.
- Therefore, corporate political spending–although allowed as a matter of law–should still be discouraged, if not banned, by boards and investors as a matter of good governance, if not public decency.
This point was raised by both my fellow panelists and members of the audience. The audience was largely anti-corporate, and frankly willing to accept any excuse to prevent corporations from exercising any influence on the political arena. That is probably why my retort seemed to cause nothing but a hush in the crowd. That retort was:
- Agency is inherent in all organizations.
- For example, the non-partisan Center for Responsive Politics says that about 92 percent of union contributions go to Democratic candidates. Yet, about 38 percent of union members vote for Republican candidates.
- AARP, Sierra Club, and all kinds of broad-membership non-profits have similar agency issues.
I don’t point this out to suggest that unions or anyone else should be prevented from spending on politics, but to suggest that the existence of agency is not per se a reason to prevent one kind of organization from indulging in such spending when all other kinds of organizations, suffering from the same agency issues, are considered OK for such spending.
For the record, I believe that union leaders are probably as conscientious in allocating their political pelf in a manner that supports their organizational interests as corporate leaders are be about allocating theirs. The main difference between union and corporate spending is how lopsidedly different they are in their support for parties and candidates. Unions are remarkably monolithic in their support or “liberal” or “progressive” causes. Corporations, in contrast, ironically follow the Obama prescription, and spread the wealth around, giving about equally to both parties.
Posted by Marc Hodak on June 20, 2012 under Executive compensation, Governance |
That is one of the main arguments being put forth in the continuing assault on corporations in the form of new proposals for binding Say on Pay.
The short answer is “No.” Shareholders are not “owners” like Ma and Pa who own their store and have decision rights with respect to its management. Shareholders have no legal say in the operations of their company unless one changes the law to give them that say. Shareholders can’t set prices for the products their companies sell. They can’t sign off on what the companies pay for supplies, including their supply of labor. Who would give them such power, unless they wanted to destroy the corporation as we know it? The question answers itself.
People making the argument that CEO pay is different from other kinds of costs invariably avoid the implication of that argument. What they mean is that CEO pay “seems” too high (against all kinds of irrelevant standards that no one would really argue in an honest debate about the best interests of shareholders). What they leave out is the possibility that paying a lesser amount can, at least in some situations, have an impact on the company far more costly than the reduction in pay they presumably desire. In other words, the decisions by boards of what to pay their executives are strategically significant, with a profound impact on shareholder value. The Say on Pay mob ignores the existence of that impact, and makes no allowance for even well-functioning boards doing a job that can’t possibly be done as well by outside “owners.” (Please spare us the idiotic response of CEOs not possibly being worth what they are paid by their “owners.” You try to buy a $5 million home for $1 million, and see the response you’d get from the owners.)
There is no doubt some fat in the pay of some executives. But once you change the law to give shareholders an axe to wield at that kind of corporate fat, you can’t take it back just because there is a lot of blood when they try to use it.
Posted by Marc Hodak on June 22, 2011 under Governance, Scandal |
I’m not sure if that is what this union officer meant by this:
“We fight for our pensions and paychecks the same way C.E.O.’s fight for theirs,” said Scott Diederich, a lifeguard and president of the Laguna Beach Municipal Employees’ Association.
That is, the head of a lifeguard union whose head lifeguard just retired at age 57 with a pension of $113,000 per year.
Anyway, there are a couple of interpretations of Mr. Diederich’s statement. The most innocent interpretation is: “Everyone has a right to negotiate hard for what they want.” True enough, and the reason I believe that “greed” is a peculiarly weak accusation against people who end up with more by dint of their preparation and hard work.
However, there is another interpretation. Most unions characterize the negotiation between CEOs and boards as a form of self-dealing. They believe that directors are generally cronies of the CEO, belonging to the same country club, sitting on each others boards, or, worse, that CEOs have the power to boot dissident directors who might not “play ball.” Leaving aside the gulf between that out-of-date stereotype and my experience in dealing with modern boards, the implications of Mr. Diederich’s statement is that he is condoning a form of, “Everybody does it.” Not as noble a sentiment.
It’s a subtle difference. On the one hand, someone is taking advantage of their leverage in a fair game–we’re not all born or made equal with regards to what is needed to win at a particular game. (Luck plays a role, too–my parents were obviously way wrong in denigrating my ambition to become a Cali lifeguard.) On the other hand, someone is taking advantage of their ability to alter the rules of the game to favor themselves. People have trouble with that.
When we complain about CEOs extracting money from pliant boards, the proper focus is on the system of governance that allows such a thing to happen. That focus has led to immense changes in corporate governance over the last 20 years. Now, attention is turning to the influence of public sector unions over the bosses they help elect, teeing up that system for changes. I expect unions to fight those changes every bit as much as the good ole’ boys resisted changes to our board culture. But when you give up the moral high ground with an “everyone else does it” explanation for a scandalous outcome, your power to prevent change measurably drops.
Posted by Marc Hodak on May 6, 2011 under Executive compensation, Governance |
Well, not a rabbi, really, but the CEO of a Jewish organization, along with the others “will be there to press Goldman Sachs Group Inc. to evaluate whether it’s paying executives too much.”
“When we see CEOs earning over 300 times more than the typical worker, it raises serious questions for shareholders on whether they are really (that) valuable,” says Sister Nash, who has been a nun for 50 years.
I personally have no doubt that Goldman’s executives are paid way too much. I have somehow found a way to be reasonably happy and secure with my relatively paltry income, so why do they need so much? I can only imagine how it must look to nuns, who have taken a vow of poverty.
But that, of course is my personal, not my professional, opinion. I can’t render a professional opinion on Goldman’s pay because I don’t know what information the board had about:
a) Agreements, explicit or implicit, that had been reached between these executives and their (quite independent) compensation committee
b) The likelihood of losing key executives to hedge funds, where they could each make multiples of what the top five made together
c) The impact on the company’s returns if one or more of these people left
The latter gets to the heart of how valuable these executives are relative to the “typical” worker.
Goldman has a market cap of about $82 billion. Its shareholders understand that the firm recently survived a financial tsunami, is now dealing with the radioactive Frank-Dodd aftermath in the midst of market and regulatory shifts that are transforming the global financial industry. The “typical worker” is not going to have much impact on how Goldman Sachs strategically and organizationally responds and adapts to these changes for the benefit of the shareholders. So, the relevant question is this: Is it possible that the difference in outcomes between what this management might achieve versus the next best management team that the board might lure could be something in the range of $69 million?
If the Sisters of Saint Francis asked God, “would losing your dear, unconverted son, Lloyd, in favor of his next best make a two hundredth of one percent difference in the GS stock price?” and the Lord replied, “Yea, my children, losing Lloyd would make 10 times, nay 15 times, that difference,” would they then go back to the board and insist that they increase management’s pay? Would they do that for the sake of the shareholders?
Stout’s disparagement of “shareholder value” begins with the disconnect between a corporate board’s legal requirement versus its economic imperative. Contrary to popular belief, boards have no legal obligation to maximize shareholder value. The evolution of fiduciary duties plus the business judgment rule sets the legal bar far below “maximization,” which leaves directors plenty of leeway to take risks without fear of being dragged into court every time an investment fails. Stout believes, and I agree, that this legal order has served shareholders and our overall economy very well. But the reason this low legal bar works is because the board’s economic imperative is far less forgiving.
If you aren’t aiming to maximize returns to your shareholders, then you’re doing something else. There is nothing wrong with pursuing other social goals that coincide with shareholder value, but if your “success” comes at the expense of your shareholders, you will lose them. The competition for capital is fierce. It crosses industry lines and national borders. It never ebbs or wanes. There is little room for slacking off in the pursuit of shareholder value.
Stout does not so much disagree with this characterization of the shareholder value imperative as she defines it away. She asserts that “shareholder value thinking” leads to short-term behaviors and illusory results that don’t actually lead to long-term value creation. But what Stout is describing is not a goal problem; it’s a knowledge problem. The market cannot distinguish what managers claim to be a focus on shareholder value versus the reality of their behavior. If it could make that distinction, it would immediately discount sub-optimal decisions and actions into the stock price. In other words, Stout rejects management claims that their behavior actually enhances shareholder value, yet accepts their labeling of their bad behavior as “shareholder value thinking.”
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