Lets Talk Executive Pay - 4 / 3 / 2009

How do you put an end to this crazy argument about executive pay? Here's a novel idea, align executive pay with the owners of the businesses they work for. And remeber the owners are shareholders. Ever since I have been in the Merger and Acquisition and restructuring business, I have found the executive pay issue to be one of the largest sticking points. And now, as we see more and more outrage on the issue of bonuses when shareholders have lost 20%, 50%, even 80% of their value the knee jerk reaction to executive pay is understandable, but completely misguided and counter productive.

I am the first to speak out against executive pay. But I speak out against executive pay, that is disproportionate to the operational performance of the businesss. And 10 million dollar share issuances in any market condition is silly. Or is it? The truth is, there are healthy, aligned situations in which Executives should receive these types of bonuses.

But let's take a step back. First, let's stop treating shareholders as captive, no rights, holders of paper. Shareholders can sell their shares at any time. They are not beholden to any investment in any public company. So any argument that suggests that shareholders should be outraged by big executive pay when their stock has plummeted is really very foolish. Why did they hold the shares? So let's stop with the "How can CEO's take huge pay when shareholders have lost so much?"

Second, there is a total disconnect that has occured between shareholders and their perceived rights. And to understand why, we need to look back to the Internet Bubble. These were the times when companies could not pay cash bonuses because they were not profitable. So the thinking was, give them their bonus equivalent in shares. Sounds neat and tidy. One would think that if Executives were earning the bulk of their compensation in stock, then their decisions in operating their corporations would lean heavily toward increasing the value of the stock and ultimately that is what the shareholders want.

Here's what we found. When Executive officers are receiving the bulk of their compensation in common shares of their company, they manage their revenues, profits, balance sheet and cash to sustain and propel their share price based upon Wall Street's valuation methods for the industry they compete in.

This is entirely backwards and over the course of any 3 year period is counter productive to the value of shares. One need only look at stocks of 3 great or once great companies for the proof in this. In these examples, Management became so concerned with the growth of stock prices that they risked their company's economic futures to satisfy shareholders needs (and their needs) in the short term. Further to this, does it surprise anyone that theses CEO's considered the greatest by their shareholders over the last 10 years retired at the height or near height of their share price values - AIG's Maurice Greenburg, GE's Jack Welch, Citibank's Sandy Weil - each man was a master at operating their business for maximum shareholder value, each was a huge shareholder, and each knew when times were changing..and left.

So here's the solution. Pay the CEO's bonuses through their portion of company profits, or dividends. Pay dividends quarterly, annually, semi-annually. And pay all the other shareholders too. This simple process aligns shareholders with executives and places each shareholder on an equal footing with management. This dividend policy needs to have a permenant distribution ration. Let's use 50% of earnings for my example, but it really can be any percentage.

Now let's apply that to GE in 2000. In 2000, GE earned 10.7 billion dollars. 50% of that number is 5.35 Billion. There were 3.2 billion shares outstanding. Each shareholder would therefor receive $1.67 in annual dividends per share. If Jack Welch was holding 10,000,000 shares ( less than 0.5 % of the total outstanding) he earns a bonus of 16.7 million in cash. That comes on top of his salary. And, If you held 100 shares, you as a shareholder could take the cash ($167.00) or buy more shares. Either way you have the decision that an owner of a business would have, do I reinvest in the business? Or do I take the cash due me as a an owner of the business.

This is alignment.

There is another point which I will touch on here only, and pursue in a later posting. When an executive team focuses on increasing earnings through proper expansion and the pursuit of operational efficiencies then the value of the business goes up. But this does not mean that the stock market will respond to the increased value created by this team. Eventually share prices will align with earnings, but that does not mean that increased profits means increased share price, and executives should not be held responsible for both...and wouldn't be if they paid out a real percentage of the earnings the business created to its owners, the shareholders.

Build Value Everyday

Brad van Siclen