The S&P 500 crashed another 7.5 percent today, bringing U.S. stocks, adjusted for inflation, back to where they were in mid-1996. Investors are apparently not sold on the idea that managers of U.S. corporations are going to pay them a healthy share of profits. What would it take to restore investor confidence in the U.S. market? How about governance reform?
Right now the shareholders of a public company are at the mercy of management. Without an expensive proxy fight, the shareholders cannot nominate or vote for their own representatives on the Board of Directors. The CEO nominates a slate of golfing buddies to serve on the Board, while he or she will in turn serve on their boards. Lately it seems that the typical CEO’s golfing buddies have decided on very generous compensation for the CEO, often amount to a substantial share of the company’s profits. The golfing buddies have also decided that the public shareholders should be diluted by stock options granted to top executives and that the price on those options should be reset every time the company’s stock takes a dive (probably there is a lot of option price resetting going on right now! Wouldn’t want your CEO to lose incentive).
If current trends continue, the CEO and the rest of the executive team will eventually have salaries that consume 100 percent of a public company’s profits and they will collect half ownership of the company via stock options every few years. Who would want to invest in that? Not sophisticated investors, it turns out. Big universities such as Harvard and Yale have reduced their exposure to U.S. public companies down to about 15 percent. Instead of buying a forestry company and watching the managers steal the trees, they’ve chosen to own forests directly. Given the laziness of university administrators, it should have been a wake-up call to the SEC that something needed to change when Harvard preferred to run its own forests.
Corporations are supposed to operate for the benefit of shareholders. The only way that this can happen is if a majority of Directors are nominated by and selected by shareholders. It may have been the case that social mores in the 1950s constrained CEO-nominated Boards from paying their friend $50 million per year, but those mores are apparently gone and the present structure in which management regulates itself serves only to facilitate large-scale looting by management.
Spot on Phil. Corporate governance reform is well overdue – but aside from you r comment, I haven’t heard anyone else raising this issue. From my place in Australia this seems very odd – the $700 billion may be just good money chasing bad without governance reform, and yet there seems a resounding silence on this obvious requirement. I think $700 billion plus governance reform would have been a much better deal for US citizens.
regards, Greg
Carl Icahn had an analogy of a Fraternity house which he applied to this. The president of any Frat was the amiable guy always hanging out at the bar, doing little, but always there to talk out your problems of the day. When election time came around for house officers he got elected- “nice guy” “seems genuinely concerned about us”. His first act as chief would invariably have people not quite as smart, or as well liked, elected to be his second in commands. Who would want someone smarter and more capable in a lower post? Someone would invariably notice and recommend a change in command. Better to be surrounded by idiots and preserve your dominance of stupidity.
I can not agree more, what count is accountability. Currently everything else but this can be seen. I heard US managers are held responsible with their properties. I can not remember having seen that in action. So what about it. And the managers not being owners have been proved an absolute catastrophic failure. I guess among them are a few “well-doers”. But on the whole they never ever seem to be bothered with accountability.
So to get back some normality. It would be a good idea make those accountable which have done this harm. I’m afraid your Mr Insanity would have to suffer an impeachement.
Regards
Friedrich
Problem is that most stockholders, certainly smaller stockholders, have zero interest in actually taking the time require to pick directors or evaluate their choices of CEO.
They work another way. If they like what the company is doing, they buy, and if they don’t like, they sell. Normally we all feel we certainly don’t have enough stock to make a difference in a board election. Certainly not enough of a difference to make it worth the time to really learn what’s up.
So I don’t think your proposal can work. You could have a rule that aside from the usual election, directors are automatically replaced if a stock underperforms the market. But replaced with whom?
It’s a problem of scale. Few individual or small groups of stock holders have a big enough share to control the company. Most of the shares will be controlled by Institutional Investors, Mutual Funds, etc. As the long as the money is rolling in, the CEOs and managers of these organizations have little interest in cutting the salaries of other CEOs and managers.
Philip – Your last paragraph make a point that I’ve been thinking about a lot over the past few years. There wasn’t much that would have prevented the CEOs of major corporations from convincing their boards to pay them outrageous salaries back in the 1950s. The unions were powerful back in those days, but they were mostly concerned about what their members were getting paid. So there must have been something in the culture that made everybody think that there was a certain limit to what was reasonable. The idea applied to other highly paid people. For example, doctors made house calls in those days. hey would actually drive out to visit their sick people in their homes, even though they probably lost on that appointment.
At some point, though, these highly paid people came to believe that no amount of income was sufficient. No matter how much they get paid, they always want more. From what I’ve read, it appears that the change happened in the early 1970s. What’s interesting is that that was just a few years after the turmoil of the 1960s, when there was a lot of concern about the poor, women and minorities, the environment, etc. In what seems like just a few years, the whole culture was consumed by an insatiable desire to get rich. The rich never had enough. Of course, most people were not able to get able to get rich, so they started using credit cards to buy their little piece of the good life.
I think that this whole phenomenon would make a great book, if a historian were to go an document the change that took place in the early 1970s and try to figure out what caused it.
What should be happening is investors avoid companies that overcompensate managers, and thus never become shareholders at all. Let the market dictate the punishment for mismanaging the company.
Only…in a bull market like the one that just abruptly stopped, is there any difference? Does the market shakeout eventually separate the companies that choose golfing buddies vs. companies that outperform?
The book “Good to Great” made what seem like good points about corporate management, and how it was almost always a deciding factor in the long-term success or failure of the company. Unfortunately, doing a quick survey of “great” companies revealed many of them aren’t public companies any more. Looks like many were acquired (Gillette, for example) during the recent years of cheap money.
The move towards index funds exacerbates this, because index funds can’t even vote with their feet, at least not until a company like Kodak is mismanaged so long it is booted off an index like the DJIA.
The main problem is that every public company has its own byzantine bylaws drafted by lawyers paid by the CEO and board to insulate them from accountability to shareholders.
The solution is to abolish all public companies’ by-laws and replace them with a standardized set of statutory bylaws. For starters, CEOs should be barred from the boardroom – the CEO is an employee of the company, not a principal. You don’t invite the butler to preside over family councils.
Hi Phil, I know that you have an investing page floating around here. Do you still invest in index equity funds? Or have you found a kind of investment that yields the same risk-adjusted gains? Your take on fixing corporate governance looks like the kinds of things that John Bogle or Warren Buffett would say: split the chairman and the CEO; fix manager incentives to respect the shareholder; worry more about growth in intrinsic value than in the share price. Unfortunately, when the government will try to fix corporate governance, it will screw up the regulations because the government and corporate America are bedfellows.
Jeff: I didn’t find anything more clever to do than Vanguard funds. I have some international and REIT (figured that the managers of real estate are less likely to attribute profits to their own genius and loot everything). Some of my rich friends have various forms of active money management working for them. They all seem to have lost about 20 percent in the last few weeks… same as the indices.
I have always found it odd that government is the bitch of the CEOs. Supposedly the government represents rich people. Rich people are primarily stock owners, not managers at big companies. Why then wouldn’t the government act for the shareholders?
Rich people are primarily stock owners, but there are fewer CEOs. So the squeaky wheel gets the grease as it were. And with a little subterfuge, companies can hire lobbying groups to make it seem like an issue is important to the general public.
comment to comment 10.
Well if you rely on “active money management” you still have to be aware on the interests of conflict. Usually, the managers get a certain yearly fee and share the probably wins, I’ve not heard of anyone sharing the losses BTW. If they are not invested they, do not “win,” if they are invested and loose, well that’s bad luck or whatever they name it.
So of course they will be invested. Be it for good or worse. That’s a really bad thing currently.
If they would come up with some other payment scheme, let’s say taking at least as much from the losses then they got for the wins, then they may get out of the market if need be.
Another point worth discussion. Why havn’t they invested in Puts? This would be a quite cheap insurance, but that was not done either obviously. So how about asking those managers of some compensation?
I have deinvested all my money starting August 2007, so currently I’ve not loses, and because if the situation I’ve bought a few puts. That was a low risk investement under current circumstances.
And I can not see any change. Those having been responsible are nearly untouched. Paulson still is you secretary of finance, and has got 700 Mrd money for playing. What will be the outcome if that won’t work (which is forseeable)? Who will take the responsibility than?
I doubt very much his/her name starts with B or P and ends in ush an aulson…..
Everything they do currently is backing the guilty and pursuit the innocent.
I can not see how that will rebuild trust…..
Regards
Friedrich