The Big Lie – CEOs and Shareholder interests are aligned

There seems to be “prevailing wisdom”, or we could call it a school of thought, that ifthe CEO of a public company owns stock, that their interests are aligned with shareholders.

The underlying logic is that all shareholders want the price of the stock they own to go up. So if management owns stock, and they work to get the price up, then management and shareholders have achieved a meeting of the minds and everyone is happy. Right ? Wrong.

There is one primary disconnect that makes this completely untrue and at its heart, the reason why executive pay has gotten so out of line and why individual shareholders are being taken advantage of every single day.

Lets start with shareholders and their interests.

There is a survey published by the Securities Industry Associationthat provides some fascinating data about who owns stock in the US, how much and how they hold it.

Here is the link to the survey, entitled Equity Ownership in America 2005.

For the sake of this argument, the highlights of the survey are that nearly 90 pct of equity owners hold some or all of their equity assets in tax deferred accounts,90 pct of all equity holders dont have any sell transations in any given year and 96 pct of investors agree with the statement, “I view my equity investments as savings for the long term”

My “analysis” of this data is that if corporate management wants to be in alignment with shareholders, they better understand the shareholder credo, which is:

“Ive invested in your company for my future and the future of my family. Dont screw it up !”

I understand that at this point some may suggest that the first disconnect is between individuals and the people who run the mutual funds they invest in. As I have written about before, I agree. But for the sake of discussion, lets move past that. The numbers and perspective mentioned above hold with those people who own stocks directly in companies

Now lets look at the perspective of the corporate insider, in particular the CEO.

There are two types of CEOs, those who are the founders or co-foundersof their companies, and those who were hired to do the job. The difference is important because those involved with the founding of their companies not only have a different personal connection with the company and its employees, but more importantly, since they founded the company, they most likely already own a lot of stock. The motivation of a founding CEO will be money, but there will be other considerations. Sometimes.

Then there are those hired to be CEOs. What are the goals of hired CEOs ?. Plain and simple, its to get paid. To make as big a chunk of money as they possibly can in the shortest amount of time. No one in their right mind is going to take on a job with the amount of pressure, stress and away from familytime that comes with being the CEO of a public companywithout getting paid incredible sums of money.

There is an interesting kinship between hired CEOs and professional athletes. Both realize that there are limited opportunities to make the big financial score, and if they dont make it this time through, they may never get the opportunity again.

There isnt a CEO in America with the opportunityto take the helm of a public corporation that didnt run the numbers in their head and play “what if”. What if the stock went to this price ? What if the stock went to that price? Then based on the total number they needed to get to the networth they always dreamed of, and using the CEO pay totals of men or women who had already done the same thing to get their current jobs as comps, they negotiated their deal from there. Any CEO in this position who tells you otherwise is lying.

Which is why the concept of CEO and shareholders interest being in alignment because they both own stock is a big lie. The CEO wants to hit the homerun of their career when they take the job, the shareholder just doesnt want to strike out with their life savings.

Stay tuned for Part2 for some ideas.

79 thoughts on “The Big Lie – CEOs and Shareholder interests are aligned

  1. Aside from fraud I don’t see how long term and short term interests diverge. The price of the stock is determined by the estimated net present value of future cash flows. In other words people will value the stock higher when they feel that the future (the future!) earnings of the company will rise. Both short termers and long termers will be trying to convince the market of this reality.

    Comment by runescape money -

  2. As a result, the highly desirable spread of shareholding and options among business managers perversely created incentives to artificially inflate reported earnings in order to keep stock prices high and rising.

    Comment by wow powerleveling -

  3. CEO and codes of conduct:

    I sent this one to Mr. Cramer at the Street.

    Mavericks please read and let me know if this makes any sense to you. Half of the CEOS need to be in the Fed Pen.

    RE: ST JOE COMPANY

    Dear Mr. Cramer,

    I’m a shareholder for many many years.

    After reading corporate codes of conduct on the St. Joe Site ; I
    have a few questions regarding the ‘codes’.

    St. Joe Codes:

    ” You may not have any significant direct or indirect financial interest in, or any significant business relationship with, a person or entity that does or seeks to do business with the Company or is a competitor of the Company.”

    “You also should not use corporate property, information or position for personal gain. ”

    “In addition, any outside work must not involve any actual or potential conflict of interest with your duties at the Company.”

    Mr. Cramer, if I recall correctly Mr.Rummell, a nobody who came from Disney, and his associates were borrowing against this publicly traded company to buy shares. Isn’t this direct competition to the shareholders ?

    No one at St. Joe ever offered to loan me anything. I have to go to bank and pay interest.

    Any ideas on how we shareholders (other owners)can recover some our company money Mr. Rummell and his assoicates have taken from the company we also equally own ?

    Or do we equally own shares ?

    It appears Mr. Rummell’s intent; when he borrowed against the company was as a shareholder , not an employee.

    Mr. Rummell is also on the board of directors of Progress Energy. Of course,Progress is a government regulated industry and this appears to be a conflict of interest to me.

    After Mr.Rummell steals enough money from the company, maybe President Bush will appointment him to be secretary of the US Treasury.

    I hope someone can do some about this grave situation. Any ideas. Please feel free to forward my email or mailing address to anyone else with similar concerns regarding the ‘ gutting of St. Joe’.

    Yours very truly I am,

    Nancy J. Edwards ( Native Floridian)
    6491 62nd Street
    Pinellas Park, FL 33781
    USA (family pre 1776)

    Comment by Nancy J. Edwards -

  4. MARK….WHATS UP WITH THE PURCHASE OF IMMEDIATEK BY RADICAL HOLDINGS…DO YOU HAVE ANY PLANS FOR THE PURCHASE OF IMMEDIATEK…AS A SHAREHOLDER HAVEN’T HEARD ANYTHING SINCE YOU HAVE PURCHASED IMMEDIATEK…LET US KNOW…

    Comment by scott delcoco -

  5. Hi

    I am a young investor and I agree. Off topic: I’ve owned mutual funds for over 5 years with a crappy rate of return despite their 4 star rating. If the experts can’t get it right, how is the average Joe/Jane saving for retirement supposed to get that 10% annual rate of return and that exponential growth curve the 401K planners always display? I still don’t understand how the stock price affects the company’s bottom line in the end. If anyone cares to explain it to me, please email me at oxdivaxo at hotmail.com

    Comment by photos tatouages -

  6. I mean I could EASILY make the exact opposite argument that Mark makes.

    Comment by whales -

  7. << 68. Posted Mar 25, 2006, 5:35 PM ET by nate
    << http://finance.google.com/finance?q=uaua
    << Consider clicking on “Take-Off from Bath Tub”
    << at site above (see bottom-right corner). Any
    << input on bankruptcy process at United?

    I don’t pay much attention to big bankruptcy cases anymore. But I am curious about the “bath tub” article. I didn’t find the article at the link. (If you can find it, I might comment…)

    One thing is for sure: once a BK is filed by a public company, the shareholders lose. In fact, truth be told, the only (real) winners are the bankruptcy attorneys.

    Pran

    Comment by Prantha Trivedi -

  8. on short:

    http://www.nber.org/papers/w10434

    on CEOs:

    BARRON’S COVER Week of March 27
    View From the Top by Andrew Bary

    Comment by nate -

  9. Alex, be careful with stocks with high short interest. I would not own them. They often end up badly. Don’t bet against short sellers hoping for a squeeze. Shorts expose themselves to higher risk (stock could go to infinity) and because of that are usually better informed. That was borne out in a Harvard study done several years ago.

    Comment by Steve W -

  10. Mark,
    You are right that often CEO and shareholding interest isnt aligned. In fact that may be one of the few things that your close friend Patrick over at Overstock has going for him. As im sure you know he doesnt take a salary (as refused compensation) and owns 1/3 of the stock. He does this to keep his interested exactly inline with shareholders.

    And btw, while the stock has been a trainwreck, I hope you covered recently. Alsin over at Realmoney.com as some compelling articles that are bringing back the bulls. Could be a major short squeeze.

    Comment by Alex -

  11. http://finance.google.com/finance?q=uaua

    Consider clicking on “Take-Off from Bath Tub” at site above (see bottom-right corner). Any input on bankruptcy process at United?

    Comment by nate -

  12. Good piece Mark. I wish more in your position would speak out like that. The one factor that seems to be overlooked in this discussion is the fact mutual funds have become the investment of choice among American investors. When the interests of so many become spread thin over so many funds, no one is accountable to anyone. Most fund investors have no idea where their money is. They assume someone, better able, is taking care of it. Little do they know that they are likely more capable than the fund manager. The fund manager will take more risk since he is not using his own money. Most people don’t understand the risk that they are exposed to by owning equities through mutual funds (especially growth funds). Fund managers are not pressing for good governance, fair executive compensation, or honest accounting (GAAP). They are content to invest in companies that have never earned one thin dime, use pro-forma (EBITDA) reporting (to hide the truth), steal from shareholders by disgracefully large stock based compensation plans (without expensing them), and incestuous relationships among directors (executive compensation committees). Many of these companies are marginally profitable but their insiders are enriching themselves, not by honest profits in the enterprise but by selling their stock to the public. Brokers and investment banks aid in the scheme to distribute worthless stock to the unsuspecting public through mutual funds who siphon off the top through fees. Fund managers don’t care one whit about how a company is run, whether it’s profitable or its insiders are making themselves rich and neither does Mr. and Mrs. American Investor since they don’t know they own companies like that. If the momentum is running in that direction, they’ll be there and when it’s not, you lose.

    Comment by Steve W -

  13. Enough said.

    http://moneycentral.msn.com/content/P145685.asp

    Comment by Jon -

  14. FINALLY…Someone with money who has been there telling it like it really is. I just have to shake my head when someone tries to convince me top management has the same interest as me–“well, we’re all shareholders.” Yes but I paid full price for mine. Thanks Mark for being honest.

    Comment by mike -

  15. By the way, is Google sexist and racist? The 10-K seems to say so.

    http://mrwavetheory.blogspot.com/2006/03/google-why-are-you-so-sexist-and.html

    Also, more info on how Google may be running out of steam – slow down in revenue per query

    http://mrwavetheory.blogspot.com/2006/03/key-metric-at-google-revenue-per-query.html

    Comment by Mr Wavetheory -

  16. When CEO’s start dumping stock because they know their company is about to tank while putting out positive press releases…I would say that their interestes are not aligned with shareholders.

    Comment by gadget boy -

  17. http://www.theonion.com/content/node/46231

    “Report: Many Jobs Lack Benefits to Cut”
    March 13, 2006
    The Onion

    excerpt:

    …employers are reporting difficulty finding job benefits to eliminate…

    Comment by anon -

  18. This entry is featured on the blog associated with the NY Times– http://dealbook.blogs.nytimes.com/?p=842 (“Mark Cuban, CEO’s and the Big Lie,” 3/17/06)

    Comment by JohnD -

  19. Its interesting how Mark says his argument is against “prevailing wisdom” and yet I am the ONLY commenter here that is against him.

    About becoming an “experienced” investor by going to Law school, I have little to say. I went to a top 15 MBA school and am still “mom and pop”.

    I am open minded. But, unfortunately nobody has given EVEN ONE EXAMPLE to demonstrate Mark’s theory. Really, without examples we are just left with a “People Magazine” level of analysis.

    An aside here. Mark does not talk about stock options. He talks about CEOs owning stock. NOT THE SAME THING. The risk/reward curve for options is very different than for stock ownership. Options holders are much more likely to have a “hit a homerun” mentality as basehits could be of little or no value. For example 1 million options at $51 have no value at a stock price of $50 and have the SAME value to the CEO at $10. If he could just get it to $75… but wouldn’t the shareholders be pissed!!! (lol)

    Comment by Scott -

  20. Mark,

    An well understood point by experienced investors; sadly, not a well understood point by “mom and pop” investors.

    In law school, we gave a presentation to our professor (a very experienced investor) about options and how they incent management to meet a target for their stock price. The incentive does not align the interests of management with long term investors. Management is incented to barely beat numbers they provide to analysts so they can get a “pop” in the stock price.

    They are also incented to create volatility in the stock price (which increases the value of options) by playing games with their numbers. Experienced investors know that accounting is more art than science; management also knows this and uses this fact, legally and sometimes illegally, to their advantage. (Our professor had problems with our analysis, thinking that options were good, but I still stand by our analysis.)

    The emphasis on diversification and long term investments (although both good things in the abstract) exacerbate the problem. Since each holding is only a small part of your portfolio, the agency problem becomes bigger.

    Sadly, I don’t see an end to this problem. The only solution is more active management which brings its own greedy set of problems. (See, e.g. Warren Buffet’s latest letter to shareholders at berkshirehathaway.com.) As public markets become more public, the agency problem grows and management will continue to enrich itself at the expense of shareholders.

    Experienced investors can only help themselves; they cannot help everyone else. I wish there was a better solution to this problem, but until investors are smart enough to solve this problem for themselves they will suffer the consequences of their mis- or non-information.

    By the way, I loved your reality TV show. It was much better than any of the ones still running. In particular, the “you’re fired”, everyone selfish, B.S. show. Thanks for trying to inform people about what it takes to be successful.

    Comment by Brian Long -

  21. Hey Pran,

    Nice post, and very cool experience to bring to the blog. It would be interesting to get an example (nothing so specific as to give away any confidentiality) as to the decisions that the CEO made that were against shareholder interests.

    Also, bankruptcy is an interesting area as shareholder value is usually heading to zero. Under those circumstances I could see other parts of the CEOs compensation package outweighing his interest in the stock. So, I could see how you would be right that the interests could diverge at very low or negligent market capitalizations (most bankruptcies).

    I also agree with your assessment of the dapper CEOs.

    However I still think I am right under circumstances where the both CEO and shareholder own stock and that stock has value.

    Comment by Scott -

  22. A fundamental conflict of interest between corporate managements and shareholders is that passive minority investors (the majority of shareowners) can just sit back and let the stock appreciate. It’s management that has to do all the work to make this happen. So on the face of it, it seems reasonable to create a pooling of interests by having management be directly incentivized by an appreciating stock price.

    For whatever reason, this maxim hasn’t held true in the American stock market. Is the European “phone booth” model of investment preferable to the American “Rose bowl” model? You can stuff the controlling shareholders of European companies into a phone booth, a controlling interest in American companies can only fit into the Rose bowl. The European shareholders can meet in a smoke filled room to quickly decide on the fate of their CEO. American investors get mailed proxy forms with management recommendations.

    Things have changed in the US with the rise of the hedge fund activist, however their results have been hit and miss. In truth, their methods are fairly clumsy given the current state of technology (holding a shareholder meeting somewhere in Manhattan).

    The other fine way to coerce management is to grouse on stock chat boards and blogs. Glass-Lewis and ISS have no interest in organizing the thoughts of individuals, or even communicating with them.

    Another inherent problem of agency is that if the stock holder doesn’t like how management behaves, they can take their money elsewhere. A few stocks with high integrity managements get boosted to high valuations, and many inefficient companies languish with few interested in unlocking value, save a few activist hedge funds or private equity firms.

    Is there any way that the power of individual shareowners could be harnessed (their ownership is growing with the trend away from pensions toward 401-Ks/IRAs, and an S&P index fund will never take controling interest in a badly managed company)? Yahoo stock chat seems like an excuse for something useful.

    Comment by bronxite -

  23. “Its the visionary long-term CEOs that are a problem for conservative stock holders.”

    Disasters use this rational to justify their current disaster and mess.

    Comment by anon -

  24. I think for these reasons it is important for investors to attempt to diversify there portfolios by investing in different industries, securities, and markets instead of individual companies.

    Comment by Bushuowo -

  25. #52 says:
    >>However, I would have to say that Mark’s thesis — that stock owning CEOs and shareholder’s interests are not aligned — is CRAP.

    I think Mark is right. But I look at the situation with a rather jaundiced eye. I practiced corporate bankruptcy law for about 15 years. My experience was that CEOs cared much less about their shareholders than about making sure they secured their own piece of the corporate pie.

    Bankruptcy lawyers often find themselves in a sticky situation when representing a public company in bankruptcy. We actually SHOULD BE representing the shareholders, but we take our orders from the CEO. Quite often, the CEO wants to do things that are damaging to the shareholders’ interests. What do we (lawyers) do? To tell you the truth, we usually do what the CEO says. I often found the practice abhorrent. (After all, it is a conflict of interest.) I knew that I could not continue to do that work because these executives eventually made my stomach turn.

    I got a bleeding ulcer in one of my cases in the late 1980s and early 1990s. I represented a bunch of public REITS with a total (initial, pre-bankruptcy) value of $120 million. The CEO was a sleazeball of the lowest order (IMHO), but he carried himself well and looked so dapper in his $3,000 suits and $500 Italian leather loafers. (Look out for those “dapper-dudes!” In my experience, they are the worst. If a CEO looks a little frumpy, he is generally better at his job. I think this is because he is not spending valuable time getting his “Saint Tropez tan” and shopping on Rodeo Drive.)

    I received calls from “moms and pops” and grandmothers who invested their life savings in one of the REITs, and I had to tell them that their money was almost all gone. Meanwhile, this guy ate at the finest restaurants, lived in a mansion in Beverly Hills, and drove a Rolls. Whenever I think of him, I get a queasy feeling in the pit of my stomach.

    Pran

    Comment by Prantha Trivedi -

  26. I am a young investor and I agree. Off topic: I’ve owned mutual funds for over 5 years with a crappy rate of return despite their 4 star rating. If the experts can’t get it right, how is the average Joe/Jane saving for retirement supposed to get that 10% annual rate of return and that exponential growth curve the 401K planners always display? I still don’t understand how the stock price affects the company’s bottom line in the end. If anyone cares to explain it to me, please email me at oxdivaxo at hotmail.com

    Comment by Jenn -

  27. Hmmmm. I am reading some good stuff on this blog, but its not really about the issue of aligning of interests between shareholders and CEOs. Some CEOs may be better than other CEOs. Some CEOs may be overpaid, maybe even wildly overpaid.

    However, I would have to say that Mark’s thesis — that stock owning CEOs and shareholder’s interests are not aligned — is CRAP.

    Yes, one party would prefer a high price on date X and the other party on date Y. BUT HOW DOES THAT TRANSLATE INTO THE DECISIONS THEY MAKE? Answer: it doesn’t.

    I mean I could EASILY make the exact opposite argument that Mark makes. I could argue that the more short sited a CEO is, the more his interests align with conservative (low risk, don’t lose all my money) shareholders. The more long-term a CEO thinks, the more radical and risky would be the path the company would take. By definition, the long term CEO wouldn’t care as much about present earnings and would be willing to bet more, possibly much more, on the future. The gamble may work, it may not. But, in Mark’s scenario, how interested are the “keep my life savings safe” shareholders in some visionary CEOs promise of a future based on today’s large gamble? Answer: not very.

    To sum it up, here is an argument that reverses the preference. Conservative shareholders SHOULD align with short-sited CEOs. Its the visionary long-term CEOs that are a problem for conservative stock holders.

    Sorry Mark, I think you are wrong on this one.

    (However, I think you are doing a GREAT job with the Mavs! BTW are they being managed for short term selling price or the long term? I, obviously, cannot tell.)

    Comment by Scott -

  28. Looks like Google just filed their 10-K. Mr WaveTheory posted his analysis of the trends cited in the 10k in this posting … Google filed their 10-K. Very insightful.

    http://mrwavetheory.blogspot.com/2006/03/googles-10-k-is-out-today.html

    Comment by Mr Wavetheory -

  29. An interesting blog, to say the least. Mark is right on target with what he is saying about the two types of CEOs. There is more depth to it, however, and I look forward to reading his additional thoughts.

    I fit into the “founder CEO” category. There are those of us who are founders – those who have ideas or concepts, grow the companies from tiny miniscule entities (sometimes even one-man shops), learning every step of the way, and putting every breath of passion and energy into it, and hoping one day to actually have a payday to secure our futures. Most of the time this takes years – it is never an “overnight success” unless the business was not real to begin with, in which case it would crater anyway.

    Then there are the CEOs who are hired, and who want the big paycheck because of their reputation or experience. This overall attitude, not necessarily a bad thing depending upon the situation, rolls downhill into other experienced executives as well – not just CEOs, but all “seasoned” professionals. They will stick around as long as there is a paycheck. The “hired guns.” Once the check is gone, so is the executive. I’ve seen it happen over an over.

    The primary difference between the two types of executives, however, is that the founders who are also CEOs also happen to have “been there and done that” and bring far more valuable experience to the table in terms of their products and their market space, and they will be the absolute last guy to jump ship in the case a company actually doesn’t make it.

    They often put their families and loved ones in peril, just so shareholders have a chance to survive and make a return, and will go weeks if not months without paychecks just for the greater good. But that is also part of the responsibility of being a founding CEO. It is also the mark of an entrepreneur and not someone only in it for their own net worth. Typically, hired gun executives will not display such dedication.

    For those types of CEOs – the founders, they are driven by motivation, determination, belief, and unparalled pasion, not greed. In fact, greed is usually the furthest thing from their minds.

    It is important that these individuals are surrounded by people who buy into the passion, embrace the vision, and rally to support it and to recognize that experience is brought to the table that can be had only by being in that individual’s shoes. Examples of such CEOs would be people like Steve Jobs. When he left Apple, the company virtually fell to pieces when the company had hired guns. When he came back, he has since transformed Apple, with the support of his followers, into one of the most respected success stories of the new millennium.

    In order for a visionary, founder CEO to be successful, and for his or her company to be successful, it is imperative that they be surrounded by those people who will augment that person’s built-in talents. Often, founding CEOs are “50,000” foot people – those who see the big picture, but need really good executioners to help get the job done. In the growth stage of any company, there is a period of time when the company can’t afford to have the type of talent necessary to bring the “hired guns” in. Remember – these guys want a paycheck, and sometimes those paychecks are too fat for a small company. Therefore the challenge exists to protect the value of the shareholders and sacrifice long enough to build the company to the point of being able to hire that talent.

    So with this type of CEO, you can rest assured that the passion and love of the business supercedes individual needs and wants in almost all cases. Our views are very much aligned with the shareholders of our companies. Without our shareholders – particularly those who took chances on us in the early days, and the mom and pop investors who took the risk – we would not be here. Therefore every decision that is made is done so with the shareholders in mind. If a CEO – ANY CEO, founder or otherwise, makes decisions to protect his shareholders, then that in itself also protects us individually.

    Of course, as a founder, we sometimes think it would be nice to have that payday after all the hard work and sacrifice. That’s not greed, it’s just finally getting some hard-earned payback.

    Unlike large, well-funded companies, typically founding CEOs are not liquid, and live life on the edge just to keep the company alive and moving forward, particularly when the company is at that in-between stage where the proof of concept is proven, and growth is burgeoning, but the company is not making the big bucks yet.

    And indeed, the majority of founding CEOs have worked many hard years and sacrificed countless relationships, opportunities and years we will never get back, and we have indeed already brought value to the shareholders and I probably couldn’t count the number of shareholders who have made a substantial amount of money from our company because of our determination and sacrifice. Does that mean we are greedy? Absolutely not.

    So what DO founding CEOs share with their hired gun brethren? The need to make it happen, to happen big, and to make their company successful. Why? Because unlike a hired gun with “once chance” and a resume, a true entrepreneur CEO knows that it might TRULY be his or her only chance, not just to “make it,” but to “make a difference.” We are talking life’s dream here, not another job at a faceless corporate giant. It’s a high-stakes game, one that any founder knows that they can’t afford to lose.

    Sure, there are probably some founders who will go out and start something else, and never look back. But if you want to have the home run, you have to play the game like it is the only one you will ever have. Give the home run to your shareholders: focus on building the business (i.e. doing what you would do anyway), and the success will follow. Even if it doesn’t, put your head and your heart in the right place (which is NOT the ol’ wallet).

    In the end, if I can make my shareholders winners, that means I’ll be a winner too.

    Comment by Devon -

  30. I guess I don’t see how selling the company is against shareholder interests, long or short. Also, outright purchases like the Albertsons purchase need to be approved by these same shareholders that, according to Mark, don’t share the same interests as the CEO from Albertsons. (Actually this example seems to suggest that CEO and shareholder (long and short) did agree…

    Also, on a side note from an entreprenuer… I wouldn’t consider selling my company for a lot of $$$ as “flushing” my life’s work. I doubt Mark cries about selling broadcast.com…

    Comment by Scott -

  31. The trends with young people and equities were interesting. See page 10 in the report that Cuban highlighted in this blog posting (Equity Ownership in America – 2005). Anyone know why trends with young people are changing?

    Comment by nate -

  32. What’s your thoughts concerning CEOs that are often paid 400 times to 1,000 times the pay of ordinary workers ?

    Related article:
    http://faculty.pnc.edu/arw/gbg344/For%20Richer.htm

    Comment by nolan -

  33. Similar thoughts on WorldCom era corporate governance from Alan Greenspan– http://www.federalreserve.gov/boarddocs/hh/2002/july/testimony.htm

    The former Fed Chair and onetime Ayn Rand acolyte said: […Why did corporate governance checks and balances that served us reasonably well in the past break down? At root was the rapid enlargement of stock market capitalizations in the latter part of the 1990s that arguably engendered an outsized increase in opportunities for avarice. An infectious greed seemed to grip much of our business community. Our historical guardians of financial information were overwhelmed. Too many corporate executives sought ways to “harvest” some of those stock market gains. As a result, the highly desirable spread of shareholding and options among business managers perversely created incentives to artificially inflate reported earnings in order to keep stock prices high and rising. This outcome suggests that the options were poorly structured, and, consequently, they failed to properly align the long-term interests of shareholders and managers, the paradigm so essential for effective corporate governance. The incentives they created overcame the good judgment of too many corporate managers. It is not that humans have become any more greedy than in generations past. It is that the avenues to express greed had grown so enormously…]

    Comment by JohnD -

  34. Mark,

    So true about the founder vs. the hired CEO. Investigate the story of Albertsons (ALB) The hired CEO (recently named as one of the highest overpaid CEO’s when compared to company performance) in order to “increase shareholder value” sold the company to Supervalu & CVS and will walk away with $40 million. Instead of working hard to make the company profitable he hit his homerun by putting the company up for sale.

    Fortunately the founder of the company Joe Albertson isn’t alive to see his life’s work flushed.

    Comment by Rooster -

  35. Hmmmm, sounds a lot like the assholes who run the country….

    Their credo: Do whatever it takes to look good today. Fuck the future.

    Thus we’re making irresponsible tax cuts while the Federal deficit approaches the point of no return. You think your odds of collecting social security suck? Your grandkids are fucked in so many ways.

    Comment by Tim -

  36. I have a much bigger disconnect with corporate management in that I don’t understand why they want more money. I make $38,000/yr and only spend half of it. I can’t imagine anything that I’d want to buy with the rest of it, so I don’t. How can anyone with a million+ in the bank actually want to go and work for other people? Needing more than that to do the things that make you happy is, to me, inconceivable. Knowing that their motivation is money makes them completely alien to me.

    Comment by Keith -

  37. very goooooood!!!

    Comment by story -

  38. very goooooood!!!

    Comment by story -

  39. very goooooood!!!

    Comment by story -

  40. very good!

    Comment by aaabbb -

  41. Mark, Interesting situation about a company offering last September 2005…Private equity player GTCR (6.5MM shares) and management of company(1MM shares) sold shares at $23.25 raising $181MM…most of proceeds were paid out to existing private equity holders…shortly after the deal the company missed EPS and stock cratered trading to recent lows of $15+…now same sr. management team comes and offers premium bid of $22 to take company private…harkens one back to the old Drexel Burnham days (highly confident letters and cheap debt capital)

    Comment by S St.Clair -

  42. very good!

    Comment by 11nong -

  43. FOLLOW UP for (Cuban) on post # 32 = more proof

    of what’s wrong on wallstreet with all their lackeys and bootlickers

    THE elitists GOLDMAN SUX flexed it’s CENSORSHIP muscle i see.

    again refer to post #32

    “TOKYO, March 3 ( Reuters ) – The Tokyo Commodity
    Exchange hopes to attract more foreigners and a wider
    range of investors, including institutions, with plans
    to bolster players’ anonymity and list new products, a
    senior exchange official said on Friday. TOCOM,
    Japan’s top commodity exchange, aims to discontinue
    its practice of disclosing daily outstanding positions
    for each member starting early in the next business
    year, which begins in April.”

    Comment by Ron D -

  44. Great post Mark. Esp this part:

    “There are two types of CEOs, those who are the founders or co-founders of their companies, and those who were hired to do the job.”

    I never thought about this as an issue but after reading it here it really opened up my eyes.

    Thank You,
    Toby

    Comment by Toby Pizur -

  45. its what has become a reality. its sad but true. the back bone of what was considered the path to financial freedom in this country for so many years is being turned more and more on its head. unless you have the means to go in and stir a ceo’s pot and get him crawling around then for me atleast there isnt much of a reason for spending my time or money.

    Comment by Ryan -

  46. http://www.informationweek.com/story/showArticle.jhtml?articleID=166401929

    http://finance.yahoo.com/q/bc?s=HPQ&t=2y&l=on&z=m&q=l&c=

    http://www.thestreet.com/tech/hardware/10233050.html

    I’d be interested to know what you (Cuban) think of Hurd’s moves at HP, including elimination of the pension.

    Comment by anon -

  47. Mark ,Not bad… glad to see your off your pedestal and back to

    writing about real people =small (shareholders),, instead of how you’re superior to some other very wealthy people not to mention us plebes.

    So, I was wondering if you would next HELP US AN write about large investment houses being ruthless. Could you please

    use Goldman Sux for a example ,,since you’re on the “in” there. And why they are being sued by Blanchard an CO. and why they would go to a Japan exchange to short 47,000,000 oz’s of gold {{THAT”S FORTY SEVEN MILLION OUNCES for us LITTLE PEOPLE,, with the help of two other corporations they are short ONE HUNDRED AND FIFTY SIX MILLION OUNCES @ the TOCOM exchange today, butt I suppose their just doing the Federal Reserve a favoras usual.

    I’ll bet that OVERSTOCK dot com guy is to small fry to do biz there. ;)

    YOU’ve censored/removed a bunch of my posts .. I expect it again.. ;)

    Comment by Ron D -

  48. Mark,
    I could not agree with you more. It is amazing how companies today focus so intently on short term earnings growth. It is even more disheartening that many CEO compensation packages are tied directly to short term earnings goals, which as you stated in your blog, is a complete abandonment from the interest of most individual shareholders.

    I think for these reasons it is important for investors to attempt to diversify there portfolios by investing in different industries, securities, and markets instead of individual companies. By investing in a broad portfolio of industries and securities, an investor is aligning his interest (saving for retirement) with what he invests in.

    For those of you who are curious, visit my website and find out more about this method of investing. http://www.storehousefinaicial.com Otherwise please read up on how to diversify your portfolio so that you can align your investments with your interests and not the interests of others.

    Comment by Stephen Stull -

  49. Warren Buffett had a similar discussion in his 2005 Chairman’S Letter – page 16 starting on the 3rd para.

    Comment by marc -

  50. “The CEO wants to hit the homerun of their career when they take the job”

    When you say “homerun”, do you mean a big appreciation the price of the stock? Or do you mean a gigantic overall compensation package, including golden parachutes for severance or change-in-control?

    I tend to think a lot of CEOs these days do not care all that much about the stock price. It is more about size of salary, bonus, other types of compensation and reimbursements, perks, and severance. A lot of CEOs seem to be somewhat resigned about the stock price these days, as the stock price and general market mood may be somewhat uncontrollable by a CEO. There are all kinds of resources consumed by a CEO, many which are not seen by the public. In some ways, a person may be set for life financially once achieving CEO status of a large organization – regardless of performance or even stock price moves. This may be more true in large, legacy-type corporations and less-true in small corporations. I am not sure. People who are CEOs of large-cap corporations may have such large severance options that it may be rational for some of the CEOs to perform poorly and parachute to safety. This may explain some of the current poor performance of some large-cap organizations.

    All of this is anecdotal observation and could be wrong. This would need to be studied empirically. It would be hard to know anything for sure because things change over time, and you can not always go back in time and gather more data.

    Comment by anon -

  51. two things to consider on this:

    1. The Battle for the Soul of Capitalism (a book by Jack Bogle)

    2. http://www.proxymatters.com

    Comment by nate -

  52. Nice exposition, but I thought this was obvious. Based on comments, guess I was wrong. CEOs are self-interested like everybody else. A corporation works because the collective self-interests of people are aligned within a framework. There are checks and balances within a co. just as there are within our government. Likewise, there are not always enough restraints–sometimes, not even agreements.

    Comment by James Vaughn -

  53. To add to what Ben was saying above:

    Warren Buffet wrote about executive compensation and CEO-Investor alignment of interests in Berkshire Hathaway’s latest Annual Report.

    “Too often, executive compensation in the U.S. is ridiculously out of line with performance. That won’t change, moreover, because the deck is stacked against investors when it comes to the CEO’s pay.

    The upshot is that a mediocre-or-worse CEO – aided by his handpicked VP of human relations and a consultant from the ever-accommodating firm of Ratchet, Ratchet and Bingo – all too often receives gobs of money from an ill-designed compensation arrangement.
    Take, for instance, ten year, fixed-price options (and who wouldn’t?). If Fred Futile, CEO of Stagnant, Inc., receives a bundle of these – let’s say enough to give him an option on 1% of the company – his self-interest is clear: He should skip dividends entirely and instead use all of the company’s earnings to
    repurchase stock.

    Let’s assume that under Fred’s leadership Stagnant lives up to its name. In each of the ten years after the option grant, it earns $1 billion on $10 billion of net worth, which initially comes to $10 per share on the 100 million shares then outstanding. Fred eschews dividends and regularly uses all earnings to
    repurchase shares. If the stock constantly sells at ten times earnings per share, it will have appreciated 158% by the end of the option period. That’s because repurchases would reduce the number of shares to 38.7 million by that time, and earnings per share would thereby increase to $25.80. Simply by withholding earnings from owners, Fred gets very rich, making a cool $158 million, despite the business itself improving not at all. Astonishingly, Fred could have made more than $100 million if Stagnant’s earnings had declined by 20% during the ten-year period.

    Fred can also get a splendid result for himself by paying no dividends and deploying the earnings he withholds from shareholders into a variety of disappointing projects and acquisitions. Even if these initiatives deliver a paltry 5% return, Fred will still make a bundle. Specifically – with Stagnant’s p/e ratio remaining unchanged at ten – Fred’s option will deliver him $63 million. Meanwhile, his shareholders will wonder what happened to the “alignment of interests” that was supposed to occur when Fred was issued options.”

    I think this scenario pretty much outlines what Mark can talk about in his next post on this subject.

    Comment by Aaron -

  54. Many of you clearly have limited investment knowledge. But I appreciate you greatly. I’m an FA and your ignorance has put inordinate amounts of money in my pocket. By the way, try reading posts before you rant the same old BS. Redundant fucks!

    Comment by Jason -

  55. So the question is are short term shareholder interests aligned with long term shareholder interests… It seems to me that the short termers would probably be more likely to commit fraud in order to fool the market into valueing the shares higher in the short term. Long termers would rightly perceive the likelyhood of keeping up the charade long term as too remote. I’m not sure whether the lessons from the recent corporate ethics scandals are: “Go for it! Only 1 in 100 will ever get caught.” or “Holy Crap I’m a C-level executive, I can lead a very comfortable life as it is, why risk it all over a few extra millions?”

    Aside from fraud I don’t see how long term and short term interests diverge. The price of the stock is determined by the estimated net present value of future cash flows. In other words people will value the stock higher when they feel that the future (the future!) earnings of the company will rise. Both short termers and long termers will be trying to convince the market of this reality.

    Now you could say “Well, the long termers will put more money into R&D, the short termers will just cut all expenses.” But would that be true? Would someone who says “this is my future nest egg, don’t blow it” take big risks by betting good company money on R&D? How would they know its going to pan out? And, if they did know it was going to pan out, why wouldn’t everybody else who values the stock also know, and therefore push the stock price up? Why wouldn’t it also become the tool of the short timer to push up the stock price?

    Its easy to be cynical. Its a lot tougher to come up with some concrete examples of decisions that short timers would take versus long timers AND how those decisions would fool everyone valuing the stock.

    Comment by Scott -

  56. Regarding quote: “90 pct of all equity holders dont have any sell transations in any given year and 96 pct of investors agree with the statement, “I view my equity investments as savings for the long term””

    Wow. Do they just sit there, while everything collapses? If you bought at the top of the last bubble, and just sat there while it collapsed, you boarded the down elevator on the Titanic. 2000 was a scary thing. Didn’t that scare them into getting involved?

    I think you have to be a pragmatist.

    Comment by Bland Response -

  57. Mark…

    I wrote about this issue today too…but my take is a bit different than yours. Most people don’t invest directly, they hold stock through institutions. I see executive compensation as primarily a third party payment problem, much like healthcare. With one big exception: the motivations of the institutional proxies are often not aligned with shareholders.

    Here’s what I posted on my blog this morning, (porterian.blogspot.com) —

    WHO PROFITS FROM OBSCENE EXECUTIVE COMPENSATION?

    “The top three executives at North Fork Bancorp…stand to receive $288 million from the large New York Regional Bank’s $14.6 billion acquisition by Capital One Financial.”
    — WSJ, March 14, 2006

    These payments to the executives of North Fork Bancorp are obscene.

    There are 475 million shares outstanding of North Fork Bancorp stock. So, each shareholder will give about $0.60 to the top three executives, just for selling the company. That’s more than half a year’s dividend!

    A small shareholder, say a 1,000 share round lot buyer, will give $60 directly to the top three executives – just for selling the company!

    These payments come mostly in the form of accelerated stock option vesting and cash payments to cover the tax burdens of such equity grants. The IRS requires people to pay taxes on all compensation. So, when ten years worth of stock options get vested all at once, there is a big tax bill. Covering these tax payments has become a regular executive benefit, although such payments are expected to occur over the life of the executives’ employment, not all at once. In any case, North Fork Bancorp’s CEO, John Kanas, will receive $111 million in cash, just to cover his tax bill, when the deal closes.

    Why should some employees have their taxes paid by the corporation? They justify it by explaining that if the CEO had to pay his own taxes, he’d have to sell half the shares he earns and that selling might negatively impact share price. But that, of course, is a retarded argument. It assumes that a temporarily depressed share price is a bad thing – it’s not. A weak share price for a week or ten days is a blessing for other shareholders, who could buy more at a better price.

    The real explanation for the obscene payments being made each year to executives is a corporate governance system that’s still completely broken – because it’s dominated by third party, institutional shareholders who have deeply conflicted interests.

    Board members have to approve executive compensation deals. Board members also have to approve mergers. Shareholders vote on who gets on the board. Therefore, board members check in with big shareholders, to make sure their interests are being represented.

    So, who are the large shareholders of North Fork Bancorp…? Whose interests are being rewarded by this merger…? And whose interests are served by paying the top three executives more than a quarter billion dollars…?

    In this case, it’s JP Morgan, which owns 4.42% of North Fork Bancorp (a little more than 21 million shares). JP Morgan is also the world’s largest derivatives trader and has a large, proprietary trading group. Is it possible that JP Morgan encouraged this deal in order to prop up its own trading account? JP Morgan’s share of the executive compensation bill for the top three North Fork Bancorp executives comes to nearly $13 million.

    Would JP Morgan agree to spend $13 million for nothing…?

    Comment by Porter Stansberry -

  58. When you think about it, that really is a terrible thing. Some of those hired CEOs out there could potentially do something drastic to raise the stock price up a buck or two (like cooking the books). It is unforunate that the people hurt by something like this is the average hard-working American.

    Comment by funny shirt guy -

  59. RESULTS BASED CEO’s . . . Convince stockholders that the job of finding a CEO will be exponentially harder, but that the only offering to the CEO will be based on company profit and stock value. NO CASH down! CEO’s who work on commission only, maybe plus expenses! This way, they can still net many millions, but it is all above board. I volunteer to be the first RESULTS BASED CEO. That’s my phrase Mark, so give me credit if you use it.

    Comment by rob thrasher -

  60. Mark – I appreciate and love your insight – I wonder if you had a million dollars (only a million!) and a family to provide for – and such deep concerns about mutual funds and CEO’s what would you do with it to make it grow and keep it safe. Its one thing to tell us what is not safe – it is another thing to help us find a better place for it. Thanks ERIC

    Comment by Eric Pinczower -

  61. Current inflation rate is 3.99%. How’s that 3.8% ING sound now? If you are putting more money into ING than into your 401K then…well, that’s probably not a great idea. A balance between high quality bonds (read about TIPS), solid common stock and index funds will do you better in the long run.

    Comment by Jon -

  62. DIVIDEND RIGHTS…

    As opposed to stock options. A claim on future company dividends over a finite but long time horizon (maybe 7 – 21 years, contract left to board). Dillution would be transparent and could be expensed (long story, ask an accountant). If the CEO pays himself a huge dividend, shareholder get it too. If he sells his rights in the open market, you’d get a real assesment of company value. It’s perfect. I could defend the theoretical tenants, but I’ll let this one marinate first.

    Comment by Jason -

  63. DIVIDEND RIGHTS…

    As opposed to stock options. A claim on future company dividends over a finite but long time horizon (maybe 7 – 21 years, contract left to board). Dillution would be transparent and could be expensed (long story, ask an accountant). If the CEO pays himself a huge dividend, shareholder get it too. If he sells his rights in the open market, you’d get a real assesment of company value. It’s perfect. I could defend the theoretical tenants, but I’ll let this one marinate first.

    Comment by Jason -

  64. “Posted Mar 14, 2006, 8:42 AM ET by Zach
    Who is John Gault?”

    I detest that phrase! It’s vulgar!

    (Just wanted you to know you’re not alone, Zach)

    Comment by Kurt -

  65. Mark,

    I would add that it should be a red flag for a CEO to also be Chairman of the Board. I think it is a conflict of interest to have the same person run the company and run the group that is supposed to oversee the management team. Yet you see it all the time.

    My company, which is public, has been hemorrhaging money for the past three years. This year in the annual report the management team discussed all of the risks associated with lack of investment in the company. They discussed how the lack of personnel, and the lack of investment in technology could negatively impact the business. Then a few paragraphs down, they disclosed their bonuses. They were pretty big. Since we have not made a profit in the past 3 years, they are taking money directly from the investors, shareholders, and employees and putting it in their pockets. They are getting paid really well for negative performance, and since the CEO is the Chairman of the Board, who is going to stop him?

    Comment by Chris -

  66. Mark,

    I would add that it should be a red flag for a CEO to also be Chairman of the Board. I think it is a conflict of interest to have the same person run the company and run the group that is supposed to oversee the management team. Yet you see it all the time.

    My company, which is public, has been hemorrhaging money for the past three years. This year in the annual report the management team discussed all of the risks associated with lack of investment in the company. They discussed how the lack of personnel, and the lack of investment in technology could negatively impact the business. Then a few paragraphs down, they disclosed their bonuses. They were pretty big. Since we have not made a profit in the past 3 years, they are taking money directly from the investors, shareholders, and employees and putting it in their pockets. They are getting paid really well for negative performance, and since the CEO is the Chairman of the Board, who is going to stop him?

    Comment by Chris -

  67. Who is John Gault?

    Comment by Zach -

  68. If only the Directors of more corporations did more than a half ass job of overseeing management… Don’t they, by the laws of virtually every state, have a fiduciary duty to act in the corporations best interest? Maybe I am naive, but many of the compensation packages they’ve awarded to top CEOs and executives in the last 15 years or so just don’t seem compatible. I am curious as to whether and how Sarbanes Oxley affects this conflict of interest.

    Comment by ForwardLooker -

  69. This year’s Berkshire Hathaway annual report also goes on at length at the problems posed by poorly designed executive compensation packages (among other issues related to the securities trade).

    Comment by ben -

  70. Thank you… I will use this information to my advantage for the rest of my life.

    Comment by branton -

  71. I totally agree
    The intention and purpose of CEOs does not necessarily compliment the intention and purpose of shareholders because each party aims has their own personal agenda. CEOs do it for professional purposes while shareholders control the money and when it comes to money taking a big risk is also a very big issue. In this case, I think that good communication between the two could be a very big help in bridging the gap.

    Comment by elaine -

  72. Post #4 references an article (“Why Rules Can’t Stop Executive Greed,” NY Times, 3/5/06) I meant to include in my prior post (#2) about a similar article in the WSJ. Here’s the link to the NY Times piece– http://www.nytimes.com/2006/03/05/business/yourmoney/05cont.html?ei=5090&en=5cb53fa552c3f087&ex=1299214800&adxnnl=1&partner=rssuserland&emc=rss&adxnnlx=1142301908-KoBJJlJPHn6efM2jvbB00w

    And a good sidenote to any conversation on this topic is Malcolm Gladwell’s popular “New Yorker” piece on “The Talent Myth” — http://www.gladwell.com/pdf/talent.pdf

    Comment by JohnD -

  73. Dirty Muffin —

    I’d focus on the 4% savings account right now. I’m dumping far more money into my ING savings account right now than I am my 401k. I only put enough into my 401k to get the full company match, just because it’s silly to pass up free money. The market is likely moving towards a readjustment soon (a polite way of saying a big drop), and the best thing to do is take Cuban’s advice and keep your savings in a safe interest earning account. Those of us getting 3-4% right now in savings accounts are beating the people in the stock market only making 2%, if that.

    The stock market right now is no different than the housing market, it’s all emotion and speculation and not a whole of actual numbers and logic.

    Comment by Larry Myers -

  74. Can’t wait to hear “Part 2″.

    But if I may, couldn’t one argue that your take is a tad cynical? It kinda reminds me of the “politicians only care about re-election” line.

    In both instances, don’t the shareholders/voters often deserve what they get as a result of their own lack of involvement and/or disniterest?

    Comment by Charles -

  75. The disconnect is certainly there with shareholders that want dividends, rather than (or as well as) share price growth.

    What do you think of Google shares ? There’s a really nice post at ‘Xooglers’ (a blog by ex google employees) that uses the analogy of buying shares in a car, with shares of a company.

    http://xooglers.blogspot.com/2006/03/speaking-of-trouble.html

    Comment by Heather -

  76. Yup, Daniel Akst pretty much sums it up when he touched on the agency problem in the NYT back on the 5th:

    “HISTORY teaches that there is no ultimate solution to the so-called agency problem, or the tendency of those who merely work in an enterprise to act in their own interest rather than that of the owners. Rules and incentives can help, of course, but they cannot take the place of an honest sense of obligation, duty and loyalty — values that ought to run in all directions in any decent corporate culture”.

    Comment by BIG SWINGING -

  77. I’m getting torn over here. I don’t know if I should listen to you, a billionaire who has nothing to loose by telling it like it is. Or every single person I know. Your view of the stock market is so cynical, which I am quick to agree with, because of my cynical nature. But I am a regular guy and I’m trying to be real and I need to know if I should be fiddling with mutual funds, or just keep my money in a 4 percent saving account. I know everyone is in it for themselves. I know Fidelity isn’t going to make all my dreams come true. But does the good out way the bad in the long run?

    Comment by Dirty Muffin -

  78. A few weeks ago the “Wall Street Journal” had a related story on how “an increasing number of corporate boards are imposing performance targets on the stock and stock options they include in their CEOs’ pay packages.” See http://www.bradenton.com/mld/bradenton/business/13956245.htm

    Comment by John -

  79. Mark,

    Great observation – it seems like this applies not only to CEO’s, but to pretty much everyone else in a company. We’re moving closer to a corporate culture where the average tenure at a company is less than a year. Everyone from C-level executives to directors and middle managers is looking for short term results in everything they do. Whether it be marketing campaigns, consumer loyalty programs, or new product development, it’s rare that ANYONE has the long-term interests of the company in mind. And you almost can’t blame them – if they don’t succeed today, they won’t be there tomorrow.

    This is clearly a problem for long term investors in the company. A problem that I don’t see a simple solution to. I’m interested to see what you have to say in part 2.

    Comment by SportsLizard -

Comments are closed.