Posts Tagged ‘Executive Compensation’
Friday, February 26th, 2010
Over the past year, we have discussed everything from the housing industry to Starbucks coffee, thanks to insights from our expert faculty at Smeal. Thank you for your support and readership. We look forward to the year ahead and hope we continue facilitating discussion and producing content of interest to you.
Below is a recap of some of our most viewed posts, addressing several key issues that made the past year a challenging one for business.
Several car companies took a hard hit as the economy tanked and stock prices dropped, forcing them to close plants, layoff workers, and turn to the government for support. In early June, President Obama announced that General Motors filed for bankruptcy and gave Washington a 60 percent stake in the company. Smeal’s Terrence Guay provided a detailed analysis of GM’s history, highlighting the many places they went wrong, in his post, “What Happened to GM?”
The housing industry is slowly on its way to recovery after a volatile year. An unstable mortgage market and a suffering real estate market brought about decreased lending and mortgage defaults. In September, Smeal’s Brent Ambrose addressed the transformation of Fannie Mae and Freddie Mac in his post, “Breaking Up Fannie Mae and Freddie Mac.” In addition, Smeal’s Austin Jaffe outlined ten principles to help navigate the new real estate economy in his October post.
With the Obama administration came the appointment of various czars. One that made headlines was Kenneth Feinberg, the pay czar, proving that executive compensation was a hot topic in 2009 and Smeal’s Don Hambrick, Ed Ketz, and Tim Pollock had much to say about it. In May, Hambrick noted that an increase in CEO’s stock offerings could potentially lead to more risk-taking by the CEO. In his study, he suggests a better way to compensate CEOs. In addition, Ketz recommends giving shareholders more influence over corporate boards in his July post. Pollock goes as far as to say that it is going to take a cultural shift, not a pay czar, to rein in executive compensation.
Retailers had to adjust their strategies given the decrease in consumer confidence and lack of spending. In July, handbag retailer Coach, Inc. aimed to lower prices, while maintaining its luxury image. Smeal’s Lisa Bolton offered various strategies for marketers to position their luxury brands in a weakening economy. Starbucks went through the same dilemma as they adjusted pricing to portray the image of being both an affordable and premium brand. Smeal’s Jennifer Chang Coupland thought this might be a rather risky approach and outlined the reasons why in her August post.
Tags: Ambrose, Coach, Coupland, Executive Compensation, GM, Guay, Hambrick, Housing, Jaffe, Ketz, L. Bolton, Management, Marketing, Pay Czar, Pollock, Real Estate, Smeal, Starbucks
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Wednesday, November 4th, 2009
Pay czar Kenneth Feinberg acknowledged concerns on Monday that his mandated executive compensation cuts at bailed out firms may cause some talent to leave these firms for those not facing pay restrictions.
I find it amusing to hear the arguments of bank managers and directors. Their major complaint is that the administration’s cap on executive salaries will drive talent away. That is such a self-centered argument! If they cannot live comfortably on $500,000 per year, then I really feel sorry for them.
But wait—aren’t these the same guys who misunderstood the nature of the derivative instruments that their firms were dealing in? And didn’t these managers make faulty decisions with respect to the housing market and counter-party risk? In short, didn’t these executives bring their own firms to the brink of destruction? Given the foolish and reckless behaviors of these managers, one has to ask what talent they are talking about. If this is talent, let’s give some untalented people the chance the run these companies. They couldn’t do worse.
Besides, where would these executives go? Before these talented people leave their firms, they would desire other positions with salaries greater than $500,000. I doubt that there are enough open positions that pay that much for so many executives. The labor market is slim for this end of the pay spectrum.
And there are other people who could easily replace these businessmen and who could do a credible job. For example, competent university presidents must have great managerial skills. With a median salary of $427,400, some of them might be willing to accept the new challenges of running a bank. And take a pay boost.
There are several legitimate concerns about Obama’s intervention into the pay of bank managers and others who accepted government bailouts. But, concern over the flight of talent is not one of them.
Wednesday, October 7th, 2009
The Wall Street Journal reports that “the Obama administration’s pay czar is planning to clamp down on compensation at firms receiving large sums of government aid by cutting annual cash salaries for many of the top employees under his authority.”
However, according to Smeal’s Tim Pollock, it’s going to take a cultural shift, not a government edict, to really rein in exorbitant CEO salaries:
The problems with executive compensation can’t be solved with regulation, or by a pay czar, because they are deeply embedded in the culture of Wall Street, in the case of financial services, and in the culture and belief systems of the executive suite and boardroom, more generally.
CEOs and senior executives, while always well compensated, were not always as lavishly compensated as they are today. What we see now largely began in the 80s when stock options began to be used more widely as a consequence of proscriptions derived from the logic of agency theory, which argues that executives will act in a risk averse and self-interested manner unless provided with incentives to behave otherwise.
The problems with stock options are that, unlike actual stock, which can go down in value as well as up, stock options can’t go below zero in value. And until recently they received favored accounting treatments that essentially made them a “free good”. As a consequence of the former problem, executives really face no downside risk from stock options. Thus, rather than take reasonable risks, they are more likely to take excessive risks because they bear no real costs from failure; they just might not (in theory) make any gains. However, even this rarely comes to pass, because boards swoop in to reprice the options, or to give the executives new grants at lower exercise prices, in order to keep them sufficiently “motivated.”
This problem was exacerbated by the Clinton administration’s well-meaning but disastrous attempt to limit executive pay by limiting its tax deductibility unless it was tied to firm performance, which meant more stock options. Further, the favored-accounting treatment options received made them a cheap form of compensation, so it was easy for boards to load CEOs up with huge option grants that turned into phenomenal amounts of compensation in the 1990s’ bull market, which, by the way, raised all boats, even those of marginal and incompetent CEOs. Because it was easier to ascertain the value of an executive’s compensation package due to the new reporting requirements implemented in 1993, CEO pay packages could be compared to each other, and the executive pay arms race was off and running.
Today, the use of stock options, and the phenomenal levels of pay that CEOs, investment bankers, and traders receive, have become taken-for-granted parts of the corporate landscape. Restricting or modifying the pay of a few executives and firms by the government will not lead to a sustained change in pay practices, and could lead to the poaching of the competent individuals left at the troubled firms by firms not bound by these restrictions. We’ve already seen that it’s business as usual again at most Wall Street firms.
Until executives feel real pressure from shareholders, and each other, to rein in pay, not much is going to change, I’m afraid. This isn’t going to happen as long as the mantra of “maximize shareholder value” (And what does this even mean? Over what time frame? In what way? If firms compete successfully in delivering the best products and services, won’t this happen anyway?) continues to drive decision making.
Friday, July 24th, 2009
“The U.S. Congress is moving forward on a measure to give public company shareholders a nonbinding annual vote on executive pay, a concept backed by President Barack Obama that has gained traction amid the recession and credit crisis,” Reuters reports. “Critics—including some investor rights proponents—argue that say on pay will not rein in U.S. business leader compensation or help spotlight companies where pay practices need a serious overhaul.”
Smeal’s Edward Ketz has another solution for excessive executive compensation: Give shareholders more influence over corporate boards.
“The executive compensation issue remains a hot-button item,” Ketz writes in a recent column. “I think the key institution in this matter is the board of directors. If empowered and if held accountable for their decisions, I think the board of directors could properly address the issue of executive compensation.”
More from Ketz:
The board of directors supposedly represents the shareholders, but often belies that point by assisting managers in their grab for power and wealth. The Congress could help by enacting legislation that would allow investors to sue directors when the directors abrogate their duties to the shareholders. (Recall that the Supreme Court greatly restricted the liability of directors in Central Bank of Denver v. First Interstate Bank of Denver.)
Of course, the impotence of most boards of directors is frequently the consequence of allowing managers to choose their buddies to be on the board. “Independent directors” is a joke; I doubt if very many of them are really independent. So another thing that should be done is to give shareholders the right to vote for the directors. And not with a manager-stacked deck of choices as if we lived in some communist country. Give the shareholders the opportunity to add candidates to the ballot. Again, they are the owners!
Tuesday, June 9th, 2009
“The Obama administration plans to require banks and corporations that have received two rounds of federal bailouts to submit any major executive pay changes for approval by a new federal official who will monitor compensation,” according to The New York Times. Kenneth Feinberg, supervisor over the payouts to the families of the victims of the September 11, 2001, terrorist attacks, will enforce these compensation restrictions as the government’s new pay czar.
Smeal’s Tim Pollock, who studies executive compensation, is skeptical of the plan, stating the new position will create more problems than solutions.
More from Pollock:
Executive pay is out of control and it can’t be fixed by government regulation. Whenever the government tries to regulate compensation, compensation consultants always find a way around the regulations. In the early ‘90s, the Clinton administration tried to rein in executive compensation by limiting the tax deductibility of executive compensation in excess of $1 million, unless it was tied to company performance. This led to the increased use of stock options and instead of limiting executive pay, their pay skyrocketed over the ensuing 15 years and led to some of the risk-taking we see today.
Another problem arises with the current regulations only applying to companies that have received funds from the Troubled Asset Relief Program (TARP). If they are limited in what they can pay and their competitors are not, it will create an uneven playing field, making it even more difficult for these firms to recover.
It is also important to keep in mind that when talking about the financial services industry, the compensation of the traders and other mid-level employees is just as great an issue. They are the ones making the trades and engaging in excessive risk-taking that hasn’t gotten the financial services industry into trouble.
Nothing is going to change as long as 1) traders and mid-level employees are rewarded for taking risks that pay off and don’t suffer any consequences for the risks that don’t, 2) their compensation and the compensation of executives are tied to short-term performance measures, 3) analysts, directors, and others continue to focus excessively on short-term performance metrics (quarterly earnings) and over react to hitting or missing their expected earnings, and 4) most of the players involved have little or no understanding of how the financial instruments they have created work.
There has to be a massive culture shift on Wall Street that takes a longer term perspective on rewarding performance and making the traders and decision-makers responsible for failures as well as successes. The well-being of the system as a whole must be taken into account and not just the narrow self-interest of the traders, executives, and their firms.
Wednesday, May 6th, 2009
Executive compensation is taking a big hit in the down economy. The Associated Press reports that “90 percent of the $1.2 billion in CEO stock options granted last year are ‘under water,’ meaning the current stock price is too low to yield a profit.” Some boards are responding by offering even more stock options to their CEOs.
Critics say this move could lead to CEOs taking on more risk, and research from Smeal’s Donald Hambrick supports this concern. In their 2007 report “Swinging for the Fences: The Effects of CEO Stock Options on Company Risk-Taking and Performance,” Hambrick and Gerard Sanders of Brigham Young University find that CEOs with stock option-heavy compensation packages do tend to take on more and bigger risks. These greater risks lead to more extreme corporate performance “more likely to be in the form of big losses than big gains.” In other words, these CEOs who swing for the fences, “strike out much more often than they hit home runs.”
A better way to compensate CEOs, according to the study, might be restricted stock—stock that can only be sold after a certain amount of time passes or a certain goal is achieved. “Stock ownership causes CEOs to be equally concerned about gains and losses,” Hambrick and Sanders write, “whereas stock options encourage CEOs to think primarily about upside potential and little about downside.”
More on their study is online here.