CEOs Are Paid Fortunes Just to Be Average
Verizon’s purchase of Yahoo! for $4.83 billion, while an interesting exercise in combining content, networks and mobile services, highlights the broken norms for paying executives of U.S. corporations.
The short version is that issuing and repricing of stock options compensates executives for bull markets rather than their own performance is absurd.
When the deal is complete, Yahoo Chief Executive Officer Marissa Mayer will walk away with more than $200 million for doing little more than keeping the seat warm for the past four years. Or consider the billion dollars Jack Welch was paid for being brilliant enough to start as General Electric’s CEO when the bull market began in 1982, and then leaving in 2000 when the bull market ended. It didn’t hurt either that he cashed in his stock options just before a huge earnings scandal blew up, revealing how the numbers had been massaged for years. The accounting fraud led to a Securities and Exchange Commission settlement related to hedge accounting and revenue recognition and other disclosures.
Research has shown that external influences account for the majority of a given company’s share price. A rule of thumb is that the company itself is only responsible for about a third of its price movement. The market gets credit for about 40 percent, while the performance of the company’s industry drives another 30 percent.
There are of course exceptions. Apple’s incredible share run-up on the iPod, iPhone and iPad is hard to match. But most companies’ share price gains and losses largely reflect things beyond the control of the company or its executives.
Do you have doubts about this thesis? Ask yourself: How the best-run companies’ share prices did from January 2008 to March 2009? How have the worst-run corporations done from March 2009 to present? Consider industries such as home builders in 2005, mortgage underwriters in 2006, and investment banks in 2007; no matter how well managed they were, shares of those companies all got shellacked.
Many factors go into how well a company’s stock performs:
- State of the economy
- Company’s internal rate of return on capital investment
- Inflation and interest rates
- Management team
- Industry trends
- Global events
- Company revenue and profit
- Secular bull and bear markets
- Intellectual property
- Federal Reserve policy
This is hardly an exhaustive list.
The key point is that many things can and will affect the price of any one company’s stock.
The counterargument is that you want a steady hand on the tiller when a storm strikes. I don’t disagree, but I am suggesting that paying that steady hand for achieving a market-based performance is foolishness plain and simple.
What makes more sense? If shareholders are compensating CEOs and the rest of the management team for how well they are managing the company, then there should be some metrics that are easy to agree upon on advance. All of them can be readily identified and tracked versus peers. Consider these five things on a relative basis to the business’s competitors:
- Changes in revenue and earnings
- Return on invested capital
- Development of long-term strategy
- Execution of current strategy
- Innovation and intellectual-property development
Share price isn’t a very precise way of compensating for value delivered. Indeed, share price may be one of the worst ways to judge an executive’s performance. It rewards executives for positive events beyond their control, and doesn’t do an effective job of measuring the impact of management on a company’s overall performance. It transfers money from shareholders, the actual owners of a company, and gives it to management regardless.
In recent years, and especially after the financial crisis, many analysts and investors have recognized that most money managers deliver returns that are no better than -- and often worse than -- the market averages. The result has been the growing popularity of funds that minimize management costs while aiming to achieve returns that simply match the market.
There should be a similar reform in corporate pay policies; executives who deliver returns that match the market or industry should be compensated like low-cost service providers. It’s long past due that this happens.
This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.
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Barry Ritholtz at firstname.lastname@example.org
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