There is a game played by CEOs with the corporate issuance of lottery tickets. Otherwise known as stock. Stock can be issued in any number of ways, shapes or forms. Warrants, options, restricted or unrestricted stock. No matter what you call it, every CEO hired, is asking for equity knowing that their only goal is to hit the jackpot and create a pool of wealth that puts them in the "fuck you" wealth category. Thats enough money to buy or rent just about anything you can think of and put you in position to never have to work again. You just live off the cash in the bank.
Put another way, every hired CEO is looking to be in a position to look in the mirror , smile and tell themselves they have made it. They are living the American dream. The only way to do that is to grab as much equity equivalents as you can and do everything you can to get that stock price up as high as you can while periodically liquidating the stock and stuffing the cash in your bank account.
There is absolutely nothing wrong with doing so. Any CEO who doesnt take advantage of this golden ticket opportunity is an idiot. In fact, although I don't have actual numbers, I would hazard a guess that more than 95pct of CEOs hired to run companies with a billion dollar plus public market caps probably do get themselves to the position of having more than 10mm dollars in equity very quickly. While those who manage to hold on to their jobs a while and not screw up too bad, can relatively quickly get past the 25mm dollar in equity mark and reach the 50mm dollar mark with in 10 years. Its actually pretty tough to screw up and not get there if you have any brains at all.
Why ?
Because you have the entire Mutual Fund, Hedge Fun and Brokerage industry doing everything they can to get you there. Think about it.
You can't turn on CNBC or Fox Business without them cheerleading the market to go up. Every man, woman, child, fund, index or interested party who buys the stock is doing everything they can to get the stock of the company to go higher. They don't really care how you run the company and they care less about the results of the company than they do about the performance of the stock. Heck, even if they did care, shareholders dont really own anything and have zero say in the company. If you really dig into it, its the ultimate in social networking. Everyone who owns the stock belongs to the fan page or group for the stock and they are telling everyone they can how wonderful the company is and why the stock will go up, all while praying it does so.
Its the American way and it works ! Hundreds of millions of dollars are spent every year by brokerages telling every American that the stock market over time will go up 7pct per year. All you have to do is diversify and hold onto your stock long enough. For better or worse, everyone believes it.
With all of that social networking power, call it stocksourcing behind stocks, how can CEOs not get rich ?
The problem with all of this is that there is a huge disconnect between the CEO and shareholders doing well and those who work for the company doing well
Yes, its true, particularly in markets like we are experiencing now, stocks can hit 52 week, or even multi-year lows.(although more often than not, in spite of low stock prices, market caps have increased).
Yes, its true that CEOs see the value of their holdings shrink. However, unlike lottery tickets whose value goes to zero when you dont hit the number, the CEO equity positions retain their upside and history has shown us that if they go far enough underwater, they will get repriced and /or reissued. All in the name of keeping the CEO happy. So while CEOs may get "less rich" for awhile, the game is stacked so that a downturn gets them happy real fast when the upturn comes.
The disconnect is that there is a big difference between not making Wall Street happy and not making money.
The pressure from Wall Street is to grow earnings forever. Not matter what it takes. This isnt a problem when a company is doing well. EVeryone is happy. But when the economy hits a bump like it has now, when the market is hitting a bump and stock prices are declining, like it is now, the pressure comes. Everyone owning the stock reacts and whats to know what the CEO will do to get the price back up. This, as they say "is where the CEO earns their pay" Unfortunately, what this really means is that everyone who works for that company is at risk. At risk of losing their jobs, benefits, raises, you name it. Its at risk.
All of which is a long winded way of saying that employees live in the corporate cash zone, CEOs and the top few in management live in the equity/lottery ticket zone.
Those in the cash zone always take the first hit. People,places and things that consume cash are the first things to go because cash expenses immediately reduce earnings. If you or anyone like you consumes cash, unless someone upstairs thinks you generate a straight to the bottom line return on the cash expenditure, you are about to become a corporate ghost. Your person, place and thing will be memorialized as a cut to increase earnings mentioned in a press release that wall street will cheer and use to push up the stock price.
What makes me sad about all of this is that I really think that in this country if there truly was a connection between shareholders and management, that if given a choice by profitable companies, most of us would choose to hold on to our shares and accept an expanded PE for some period of time in exchange for people keeping their jobs.
I would love to receive an email from a company I own saying something to the effect of:
Dear Shareholder,
We are facing a very difficult decision that we would like your feedback on . Our earnings per share last quarter were 20 cents, and for the entire last year, 80 cents. Because of a downturn in business caused by XYZ factors, we face the choice of making 10 pct less, or cutting headcount and related expenses in order to maintain our earnings and possibly even grow our earnings a couple cents this year.
As a shareholder, we would like to ask you whether you would consider allowing us to retain these valued employees. We recognize that it would require you accepting a PE multiple 10 pct higher than the current market. We hope you would be willing to make this concession. We think that the jobs this will save will return far greater value to shareholders over the long run.
We look forward to your vote.
Personally, Im willing to give a higher multiple in exchange for saving people's jobs. At least once.
Unfortunately, this of course is a fantasy that can't happen in this country.
Which brings us back to CEO Pay.
As long as CEOs live in the equity/lottery ticket zone and employees in the cash zone, CEO pay is going to be outrageous relative to everyone else.
The only possible way to change this is to put CEOs in the cash zone. Make companies generate 100pct of their compensation in cash that is 100pct expensable in the quarter paid. Thats not to say they cant own stock. Hell yes they can own stock. But make them buy it either on the open market, or as part of the programs that make stock available to every company employee, on the same terms. They are getting paid enough in cash and if they believe in their ability to run the company, they can put their money where their mouth is. Eliminate all the free lottery tickets. Make them buy stock, options, warrants, whatever, on the same terms as everyone else can.
Shareholders tend to ignore how much stock is given to management, they don't ignore cash. Companies will always be a lot more stringent with their cash, whether its paid to the CEO or anyone else. CEO cash compensation will go way up, but total compensation will come way down. More importantly , CEOs getting paid huge sums in cash will stand out like a sore thumb when things arent going so well. They will be treated like everyone else in the cash zone and held far more accountable for their work.
Of course this is all just my opinion, but to me its a good thing for all involved. The rich can still get richer, but everyone shares in the risk.
My 2 Cents on CEO Pay
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Reader Comments
(Page 2)22. The shareholders that drive these companies are rarely you and me - it's the Carl Icahns, the hedge funds, etc. - groups that are rarely in the stock for long term profits or for encouraging companies to be productive employers but are in it to make short term gains. Getting the stock price up is the name of the game - and the way "the street" keeps score. You will almost never see CEOs selling stock (maybe cashing in some options as they expire) because they get crucified for doing so. It's easy to throw stones at those guys - and sometime they need it - but it's not easy being "the big guy".
Posted at 2:09PM on Apr 15th 2008 by Ann Y.
23. I think CEOs should have a cap on the amount of stock they can receive as part of their compensation, say 50% of their cash salary. So if a CEO makes 2 million, the total market value of the stock given to him can't exceed 1 million dollars.
Most of my career, I have worked for small family businesses or non-profits, so I have been pretty immune to big business stock prices. Our company is actually doing well right now due to the increase of Canadian and foreign tourism in our area. I laugh all the time about how well the business could be doing if the owners actually knew what they were doing though.
Posted at 3:39PM on Apr 15th 2008 by Mike
24. I think you hit the ball out of the park on this one. It’s obvious the problem with American companies is the "short-sighted" approach we have towards maximizing earnings in the near-term. It seems most CEOs plan for the quick and easy jolts that things like layoffs, or a complete lack of diversification.
Unfortunately layoffs and a non-diversified approach bring higher risk to the entity. If their core-competency is challenged, or market forces diverge from their niche the company is now in a weakened position to defend itself.
Looking at Ford, WAMU, Chrysler, Bear Sterns , Countrywide, or many other companies we can see the disasterous impact this management style offers.
Most disheartening of all though is the fact that these people do not operate in a vacuum and as such have now threatened the very fabric of our Economy.
Posted at 3:42PM on Apr 15th 2008 by Nick Brackney
25. I don't think the problem is so much that CEO's are getting the bulk of their compensation via stock options but the fact that the boards typically set the strike price so low that any uptick at all leads to a reward for the CEO that has no relation to how well the company actually did. Not to mention those sweet golden parachutes that are awarded to even the screwups like Bob Nardelli.
Stock options should be awarded based on how well a company does in relation to it's peers in several areas (not just stock price), instead of the broader market. That will minimize the "rising tide lifts all boats" effect that rewards CEO's for things they didn't do and avoid the temptation to use cheap tricks like a round of layoffs to artifically, and temporarily, boost the stock so they can cash in.
Posted at 3:43PM on Apr 15th 2008 by Jason
26. For a lot of companies, the CEO you want would be qualified to start his or her own company and end up with a lot more equity as a founder than he or she would get as a hired CEO of an existing company. Why are founders better at thinking long-term?
If you made your compensation for a hired CEO similar to the stock ownership patterns of company founders, would you get more founder-like decisions?
27. I wonder if really no company has ever send out a message to their shareholders like this.
On the otherside, I think the problem is not firing the people when things go bad. I think a lot of companies acquire a lot of "fat", when things are going great. (That is they are afraid to fire people who are not doing great.)
If they would fire the bad apples when things are goog good, they would really be great instead of good
Posted at 3:49PM on Apr 15th 2008 by YvesHanoulle
28. Mark, I enjoyed your thoughts.
It was my understanding that the principle behind reporting equity compensation as an expense was designed to put more transparency and cash equivalency into stock-based compensation and its reporting.
I recognize the importance of cash but larger companies are managed through the P&L. And jobs are at risk when expenses become too out of balance in relation to revenues – if the expense is properly flowing through the P&L, one would expect a similar result to be attained – or perhaps I missed something.
I couldn’t agree with you more on the option reset/repricing issue. Boards should not allow this. I have never seen an employees cash bond reset in the way stock is repriced.
Posted at 4:53PM on Apr 15th 2008 by Scott
30. Mark, what do you think of a company going through rounds of small layoffs, no more than 2% of their domestic workforce, and electing not to publicize the cuts, even within the company, as a way to boost the bottom line without the reverberations of lost confidence?
31. The way that stock options are awarded to top company executives is, and has always been, a complete sham. 80%, or more, of the appreciation in stock price that occurs under most CEOs watch is due to 1. a good economy and 2. a good industry, neither of which they have any control over. The way that these options SHOULD be granted is to be awarded not based on the appreciation of the stock but on HOW MUCH THE STOCK OUTPERFORMED ITS INDUSTRY PEERS...period. CEOs and top company executives should not be rewarded by stock appreciation that occurs just because they happened to be lucky enough to be "present" when good things happened that they had absolutely NOTHING to do with.
Peter Lynch said it best years ago when he advised people to only buy stocks that were in markets that were so good that they became so easy to manage that even a monkey could manage them...because, he said, one day a monkey really would. The problem, though, with the way stock options policy is applied today, is that it makes the monkeys rich for, well, being monkeys...and often not even very bright or efficient monkeys.
Posted at 5:44PM on Apr 15th 2008 by Joseph
32. This sounds incredibly dangerous to long term shareholder interests. The value of a share of stock is supposed to represent the net present value of all future earnings. The market is inefficient enough at estimating that, but I think you'd agree with this: it is possible to take actions which greatly boost short term earnings but damage long term value. For example, burning bridges with customers you have a near lock-in with by soaking them can drive up earnings in the short term, but drive them to your competitors long term. Cutting R&D could boost short term and kill long term.
The net result could be a few incredible 99th-percentile quarters of performance, followed by disaster. Then the CEO is replaced, but he already has his cash.
Even without the extreme examples, there could be a distinct reluctance to make long-term decisions that impact 3, 5, 10+ years down the road.
What would make more sense would be to tie CEO performance to options with deferred exercise dates. So, for example, you start vesting shares immediately - and not initially priced underwater - but your exercise (or at least sale) of those shares must be deferred in a large part for many years. So for example, you may vest an initial grant over 5 years, but your first year's vesting will not be salable until the 11th year of your tenure, or what would have been the 11th year. If your shares have improved over that time, great.
Upsides: aligns the long term interest of CEOs with shareholders. Probably helps retain GOOD CEOs; since any CEO will be putting their future net worth at risk.
Downsides: probably deters some talented CEOs from signing on if more competitive deals are offered.
One thing I can say that's great about your plan is the cash acknowledgment of the compensation, but I think shifting the focus to the short term isn't good for the long term competitiveness of the company or the value of the shares.
Posted at 6:08PM on Apr 15th 2008 by Matt Wallace
33. Company:We want to put our leadership on the same side as our employees, so our compensation is cash based. We also require management to take a equity position in the company to show they are serving the stockholders.
Prospect: Hmmm. Okay, to be on par with my colleagues, in similar sized companies...(mumble present value of... for 3 years)...I'd require a salary of $10 million a year.
Company: Whoa, that's pretty expensive! We want to keep management pay around 10 times our average pay, so employees still feel like their in the same reality as management.
Prospect: Well, how about paying me $500K a year, and the rest in stock? That way we'll meet both requirements.
Company: Hmmm. Buying that stock outright each year will cost us quite a bit...
Prospect: Well, I could take options instead. But they might go underwater due to economic situations beyond my control, plus I couldn't exercise them for a while. So...(mumbling...black-scholes...)...you'll have to give me around $20 million in stock options.
Company: Okay! We have a deal!
Posted at 6:26PM on Apr 15th 2008 by mikeh
34. You were once a CEO of a company. What did you do? Business can cause bruises, don't be a whimp Mark and don't forget where you came from.
Posted at 12:37AM on Apr 16th 2008 by jeff
35. The incentives to acquire stock as an incentive vs. pay are a great advantage to the stock holders to force CEO's to drive profits. The problems arise with shady book keeping and dishonest CEO’s. Large cooperation’s need a more checks and balances to get the current system to work. I know when I make money online the reinvestment portion goes into retirement and stocks. I am my own CEO.
Posted at 3:40AM on Apr 16th 2008 by Make Money online with HomebizSEO.com
36. Wicked article Mark, incentive management is key when reforming expected outcomes!
Posted at 4:16AM on Apr 16th 2008 by The Business Student
37. I'm 50 pages into Free Lunch: How the Wealthiest Americans Enrich Themselves at Government Expense (and Stick You with the Bill), by David Cay Johnston. One of the interesting points is that the US, along w/ Russia, Brazil, and Mexico, have very similar ratios of the percentage of all the country's wealth owned by a small percentage of the population. In Asian and European countries, the wealth is spread around the entire population much more evenly.
Enjoyed the post and look forward to more like it, Mr. Cuban!
Posted at 8:11AM on Apr 16th 2008 by David
38. If you are in an industry that is going through a contraction and you don't cut costs (like laying off employees) you will most likely go out of business. The P/E tolerance of shareholders won't make any difference.
Posted at 12:13PM on Apr 16th 2008 by Jon
39. I'm all for a CEO getting the big bucks when they have earned it, not just because they know the world of finance and can play a numbers game. I have been in large and small VC funded companies and in the end the numbers get cooked to show a different story to the rest of the world.
The problem is nobody wants to tell it like it is because too much is riding on telling the truth, The system is built around playing games.
I agree with your thoughts let them take it all on cash basis, very few are worth the money.
Posted at 6:15PM on Apr 16th 2008 by Martin
40. posts like this are what I love to read the most from you, Mark! muahahahahahahaha
Posted at 8:30AM on Apr 17th 2008 by eddie
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21. Great analysis, and terrific suggestion. Just one problem:
With the same fox in charge of the same hen-house, wouldn't we end up seeing the same tricks, but with cash accounting? I guess it's marginally harder to hide how much the company is spending with stock options.
And another thing. I love it that some company reports make it so hard to figure out how much the CEO is getting paid, exactly. It's a useful signal to me about how much that management cares about its shareholders.
Posted at 2:01PM on Apr 15th 2008 by Michael Martin