It is most likely a character defect, but I must confess that I am one of those people who get attacked by that little green monster when I follow David Carte’s series on executive incomes. So with some effort, let me suppress personal pique and apply whatever journalist objectivity I can muster.
It is a much bigger issue than many think. It deserves serious national debate and far more scrutiny than a fob off as emotional rhetoric about envy. Although this too cannot be ignored in a society like South Africa faced with rampant expectations, huge welfare disparities and popular discontent. Rubbing people’s noses in ostentation is one thing; having a dubious source of that ostentation is another highly dangerous dimension.
Even the more enlightened will have difficulty in defending some of the mind boggling rewards that a few individuals can accrue in their positions in companies. Something must be very wrong. The unquestionable benefit of a values-driven free market is that it creates balance. Speculation is supposed to smooth the transition. When we have lived for nearly 40 years with growing imbalances, particularly in individual incomes then we have to face up to the fact that these markets are broken. I have argued before that this is so with both the upper end of the skills market, and the lower end.
Executive share options are the most contentious of all. The criteria for their allocation make little distinction between creators, builders and professional managers of companies. Remuneration committees are, according to Warren Buffett, packed with Chihuahuas and not Dobermans. A hypothetical sketch may help illustrate this.
Joe is passionate about developing a new innovative widget and spends many months in his garage perfecting it. He starts selling and soon recruits a few equally dedicated people to help. Years of development and sales, home mortgages and personal risk pay off and they go to the stock market to raise capital. A large proportion of the shares issued are allocated on merit between the founders. A few more years of rapid exponential growth and further rights issues give the founders mind boggling wealth. It culminates in their losing control to outside shareholders, some of whom may understand the widget and its potential. Many others are intent only on share value. Some are investors; many are simply traders or speculators. It is their demands that drive the selection of professional managers or executives, and to ensure common focus on creating maximum share value, they offer large share options to the incumbents.
The important distinction between the founders, internal builders of tangible value and the professional managers of share value is lost. The former two are arguably far more deserving than the latter. They are very special people and rarely “interchangeable” between transport, banking, law, mining and retail. You don’t “buy” these people. The belief that you can replicate a Joe or his dedicated followers through massive financial incentives is seldom true.
The point is simply that good executives should not kowtow to shareholder whims – like Richard Branson and many others have shown when they get fed up and de-list. Shareholders on the other hand would do well to follow the unsolicited and “un-incentivised” lead of good executives – like they did with Apple and Steve Jobs in 1997.
Recognition after the fact and cementing the relationship either through bonuses or share ownership is an entirely different matter. There is a huge difference between recognition and incentive. The former is not an expectation. The latter is, and creates behaviour that has ranged from outright fraud to inappropriate actions for the long term sustainability of a company. No number of King based regulations and sustainability reports can counter that. Share option benefits spread over 3 or even five years are still a long way off the Buffett norm of “forever”.
We are told that shareholders should think like owners, and executives should think like shareholders. This is blatant irony! At the very least it shows a severely broken link between the motives of owners, shareholders and executives.
I’m grateful to Moneyweb reader Joan, who brought to my attention an insightful book “Fixing the Game” published earlier this month and authored by Roger Martin. He draws a distinction between the “real” economy and “expectations” economy. It is similar to my distinction between “tangible wealth creation” and “speculative froth” which I spoke of in my article: “The Cappuccino economy”.
Martin argues that the shareholder-value theory and stock-based options In the U.S. focus executive attention on the “expectations” market because that is where the money is. Ultimately, he concludes, stock-based options force managers to focus on what they can control – managing the share price over the short term.
Stock exchanges world wide are driven largely by speculation. Speculation is obviously based on expectations of exponentially increasing returns and growth. This is rarely sustainable and to gain advantage of their share-option structures executives have to either keep expectations alive, cash in their options or leave before they implode.
Martin also contends that stock-based compensation has failed in maximising shareholder value. Total compound annual returns on the S&P 500 from 1933 to 1976 were 7.5%. From the beginning of the share-value era in 1977 to the end of 2010, they were 6.5%.
Executive share options hold a much greater threat to the economy than envy and some dubious executive behaviour. Martin warns that these theories underpin the regulatory fixes in the wake of bubbles and crashes and because they are based on the wrong premise, they will be ineffectual.
Coinciding with my argument for a return to tangible value creation rather than reliance on speculative froth, Martin says: “The difference in outcomes between a real-market focused world and an expectations-market dominated world is stark and critically important for the economy. When the real market is dominant, customers are the focus and the central task of companies is to find ever better ways of serving them.”
Clearly, executive share options are adding substantially to the froth and the speculative tail wagging the wealth creating dog!
Despite ever increasing regulation, share markets remain the arena for the biggest crimes in history. A superficial scanning of only some of Barry Sergeant’s articles will show how, even in this country, billions can be siphoned off into the pockets of a handful, sometimes with only a small dilution of share value. I’m not for one minute suggesting that this reflects the behaviour of most executives who have share options – far from it. But it certainly reflects the temptation and opportunities that are created for behaviour ranging from fraud to even the most modest inappropriateness. At an individual level the returns can be huge!
In this country too, we have compounded the issue with dubious B.E.E. deals creating instant individual, Porsche driving, sushi-eating-off-naked-bellies billionaires who certainly don’t have the same credentials as Joe the creator, or his fellow builders. Some even lack the basic skills of the professional managers. Unless, of course, we assume that being previously disadvantaged is a qualifying accreditation. It helps too, if the incumbent has political sway and some useful crony connections. A further handy attribute is an ability to turn one’s back on the surrounding squalor that one previously crusaded against, or ignore the plight of unpaid mineworkers.
This article is probably going to mean little more than tilting a lance – no a toothpick at a windmill. I accept that there are billions of rand in vested interests. These are often linked overtly, covertly and perhaps even corruptly through all institutions in our society, including government. But I firmly believe we underestimate the full ramifications at our peril, not only for investors, but for the country as a whole.
Yes, there is pique. But this should not detract from the fact that we have a real problem. If there is behaviour that can cause the throwing out of the free market baby with the greed contaminated bath water, then this is it.
We can start with the smallest of steps by replacing the Chihuahuas with Dobermans on the remuneration committees and their consultants.
No comments:
Post a Comment