Roger Martin, Rotman, asks whether executives "gamed the game" because of their stock options?

With the US Government’s Pay Czar taking unprecedented action in cutting bankers’ salaries and bonuses, the go-go years seem a faded memory. Executive compensation is now a hot topic. What is fair pay and how should talent be rewarded? What went right and what went so badly awry? SpencerStuart, Canada’s top recruitment company, held a fascinating panel with heavy hitters Roger Martin, David O’Brian and Tim Hockey dissecting the past thirty years of corporate performance and how this will affect executive compensation in the years to come. Roger Martin shifted my thinking on compensation and since I am designing pay for a top CFO and COO in a public company right now, even changed the compensation plan. Here are some random takeaways from Roger Martin:

Roger Martin: The evidence is damning that the stakeholders doing very well from the Standard & Poor top 360 companies listed in the New York stock exchange are not the shareholders but the managers. Roger Martin, Dean of Rotman Business School, ran the statistics of management compensation and discovered that between 1980 to 1990, CEO compensation doubled for each dollar of income produced. In other words, CEOs did unbelievably well.

No big deal, you may say, but how about shareholders? How did they fare in the same time period? The shocking picture that emerges is that, no, shareholders did not do as well. The performance of companies worsened and the returns were worse than the previous period. What happened in this time period was that there was an article written in 1976 by Michael C. Jensen and William H. Meckling, discussing the merits of stock options. This philosophy of aligning executive interests with shareholders caught fire and within years, every Standard & Poor CEO wanted stock options as part of their compensation package.

Why? Don’t stock options make sense?

On the surface, stock options seemed like a great idea but as with many well meaning programs, they had unintended consequences. Jensen and Meckling said that it was good to get employees’ interests aligned with the shareholder interests and that seems to make good sense. However, the CEOs realized that one way to get share price up (improving stock options), was to boost shareholder expectations by raising the dreams of future performance. After all, what is a stock? It is a collective expectation of future performance. This hyping of the stock soon became the top way to raise the price, not through hard work and actual growth. Smart CEOs figured this out.They learned to game the game.

Roger Martin says that this thinking clouded CEOs’ behaviour. A CEO would do a flurry of activities. Do acquisitions that never pay off. Do aggressive accounting to change the value on the balance sheet. Expectations raced ahead of value. The CEOs knew they could not beat the expectations and needed to run up the stock, cash out and get out quickly. Consequently, Roger Martin believes that stock based compensation further diverges interests of shareholders and CEOs, and should be removed as a tool from a CEO compensation. Unless the stocks can only be recouped years after retirement, stocks should not be used as a reward.

Chrystia Freeland, US Managing Editor of Financial Times, thanked Roger Martin and commented that Facebook is a stock that is priced on future expectation. The Facebook CEO says not think of it as a business but as a service, but it has yet to make a profit. I think Rotman will pull ahead to be the leader in the MBA pack because we are fortunate to have erudite and involved Dean like Roger Martin who gets out into the real world and debates with the big hitters in industry. I like Roger's gutsy style and I recommend you buy his books to get more of his views. I changed my actions and so will you.

1 comment:

Anonymous said...

This is very interesting and I will go and read this article mentioned by Martin. Thanks.