31 August 2006
Fake Owners
On 27th August the Sunday Times included an excellent article by Nicholas Berry under the headline "Fake Owners are ruining capitalism". The article is available at http://www.timesonline.co.uk/article/0,,2095-2329967_1,00.html
The point that Nicholas Berry makes is that for many listed companies the major owners of shares are pension funds, investment trusts, hedge funds, unit trusts and the like. He calls these "fake owners" because the people making the investment decisions are not the people whose money is at risk. Fake investors make their money from selling their services as investment managers. Unlike real owners, they are often not concerned about whether a particular business investment will prove to be a success or failure in the long term. They are much more concerned about the short term performance of the share price and making themselves look good as investment managers.
This is a huge problem with capitalism as we experience today. There is great pressure on business managers to meet the short term needs of fake owners. This detracts from management's ability to focus on the long term growth in business value which is what ultimately matters to end investors and to society as a whole.
The proper incentives to manage executive pay also arise from a concern for long term value creation. Fake owners find it much easier to collude with a culture of high executive pay, because they themselves like high pay and because they are not personally damaged by the negative long term effects of overpaying executives.
All of us who hope to live off pensions or savings in the future are dependent on a healthy environment for business ownership and efficient capital allocation. Without a healthy investment environment the value of the investments that underwrite our savings and pensions will be seriously damaged in the long term. We therefore need to champion real ownership and try to minimize the influence of fake owners. Here are some suggestions for how this can be done:
1) Invest in simple financial products that select good businesses to invest in and invest in them for the long term.
2) Avoid investment products that pay high fees to the investment managers.
4) Only accept performance payments to an investment manager if the performance is measured over the long term. An investment that makes a good return four years out of five, but a serious loss in the fifth year should not get any performance payment.
5) Ensure that the fund manager can never receive commission payments directly for decisions about how your capital is invested. Hedge funds sometimes pay managers a proportion of the commission associated with stock leading. If the manager is influenced by this commission it means that the best interests of the investors is taking second place.
6) Encourage your pension fund trustees to follow these principles.
The point that Nicholas Berry makes is that for many listed companies the major owners of shares are pension funds, investment trusts, hedge funds, unit trusts and the like. He calls these "fake owners" because the people making the investment decisions are not the people whose money is at risk. Fake investors make their money from selling their services as investment managers. Unlike real owners, they are often not concerned about whether a particular business investment will prove to be a success or failure in the long term. They are much more concerned about the short term performance of the share price and making themselves look good as investment managers.
This is a huge problem with capitalism as we experience today. There is great pressure on business managers to meet the short term needs of fake owners. This detracts from management's ability to focus on the long term growth in business value which is what ultimately matters to end investors and to society as a whole.
The proper incentives to manage executive pay also arise from a concern for long term value creation. Fake owners find it much easier to collude with a culture of high executive pay, because they themselves like high pay and because they are not personally damaged by the negative long term effects of overpaying executives.
All of us who hope to live off pensions or savings in the future are dependent on a healthy environment for business ownership and efficient capital allocation. Without a healthy investment environment the value of the investments that underwrite our savings and pensions will be seriously damaged in the long term. We therefore need to champion real ownership and try to minimize the influence of fake owners. Here are some suggestions for how this can be done:
1) Invest in simple financial products that select good businesses to invest in and invest in them for the long term.
2) Avoid investment products that pay high fees to the investment managers.
3) Seek to invest in large funds, so that the cost of management is small compared to the size of the fund. Insist that the savings are passed back to the investor.
4) Only accept performance payments to an investment manager if the performance is measured over the long term. An investment that makes a good return four years out of five, but a serious loss in the fifth year should not get any performance payment.
5) Ensure that the fund manager can never receive commission payments directly for decisions about how your capital is invested. Hedge funds sometimes pay managers a proportion of the commission associated with stock leading. If the manager is influenced by this commission it means that the best interests of the investors is taking second place.
6) Encourage your pension fund trustees to follow these principles.
03 August 2006
Antitrust case against the Business Roundtable
On 3rd August 2006 I sent the following e-mail to the Antitrust Division of the US Department of Justice.
To the Citizen Complaint Centre
Antitrust Division
Department of Justice
I would like to report an antitrust violation in the market for executive talent.
Companies justify paying their top directors very generous salaries, bonuses, pensions, benefits and stock option allocations by claiming that very generous overall packages are needed in order to recruit and retain the best executive talent in a competitive market for executive recruitment and retention.
However the market for executive talent appears to be very uncompetitive in respect of the very top jobs at the very top companies. The prices that executives are able to earn in this market are extremely high and growing.
The prices that are attained in the market cannot be explained in terms of supply and demand. The number of MBA graduations is many times higher than it was twenty years ago, but the price of a CEO has still risen dramatically. Increasing executive pay does not increase the number of potential new CEOs who become available. Potential CEOs have to be trained up, given exposure and opportunities by exiting CEOs. The CEOs therefore have considerable control over supply in their own market.
The members of company boards are both hirers and providers of executive talent. This fundamental conflict of interests gives them very considerable market power in the executive talent market.
In any negotiation between a CEO and compensation committee about pay, the CEO has huge power. This is very fully documented by Lucian Bebchuk and Jesse Fried in their book Pay without Performance: The Unfulfilled Promise of Executive Compensation (Harvard University Press, November 2004) (see http://www.pay-without-performance.com/)
There is considerable coordination of the supply side of the market by the main players. Coordination takes place through the Business Roundtable. According to its November 2003 publication Executive Compensation: Principles and Commentary the Business Roundtable “is an association of chief executive officers of leading corporations”, which, “has developed six interrelated principles…to serve as best practice for the design, implementation and oversight of executive compensation at publicly held corporations.” (See http://www.businessroundtable.org//publications/publication.aspx?qs=2806BF807822B0F13D142 pages i and ii. Through the Business Roundtable forum senior CEOs work together to coordinate how they should be paid.
The CEOs of America’s largest corporations also work together, through the Business Roundtable, to defend high levels of executive compensation. This can be seen in the Business Roundtable press release of 7.5.06. (See http://www.businessroundtable.org//newsroom/document.aspx?qs=5906BF807822B0F1AD2408522FB51711FCF50C8 .) It is clear that consultants have been hired and analysis completed with the express aim of defending the rate of growth of CEO compensation over the last 10 years.
In the press release, the Business Roundtable asserts that, “Executive compensation has closely followed the growth that companies have experienced in the last ten years.” The press release is supported by analysis by Frederic W. Cook & Co. using the Mercer Human Resources Consulting database of executive compensation. The analysis shows (in chart B) a strong correlation between CEO pay and Total Shareholder Return (TSR). It seems that shareholders are prepared to accept growth in executive pay, provided the rate of growth is no greater than the rate of return that shareholders see from their investments. The relationship between TSR and growth in CEO pay suggests that CEO pay is constrained by what shareholders find politically acceptable. This demonstrates that CEOs have sufficient market power to increase pay at the maximum politically acceptable rate. It is clear that CEO pay is not constrained by market considerations such as the price of hiring a replacement CEO.
Co-ordination of the market prices is also brought about by the use of compensation consultants. Such consultants (e.g. Frederic W. Cook and Mercer) are very widely used. They compare practices in different companies and advise on levels and structures compensation that are politically acceptable. The consultancies have strong incentives to push executive pay upwards because their sales pitch to management is far more effective if they are saying, “We think you guys deserve a pay rise”.
The natural allocation of one CEO per company forms a natural market allocation scheme that executives use to keep reward packages high. Very seldom does the CEO of one large company to seek to replace the existing CEO of another. On the rare occasions when this does happen (most commonly through a take over bid) it is usually necessary to pay the outgoing CEO a very significant compensation payment. Such payments cannot be explained by the need to recruit, motivate or retain the executive; they are best explained a payment to buy the CEO out of the cartel.
IRS data tables on the internet suggest that high income (>$500,000 per annum) employees earn in total about $300 billion per annum in salaries and wages. This makes executive pay a major sector in the US economy. Even if executive pay levels are only 20% higher than competitive levels then the detriment to US economy is already $60 billion per annum.
In recent months the scandal about backdated stock options has revealed that some aspects of executive pay have had far more to do with extracting rent than they have had to do with providing the right incentive or the need to offer competitive compensation. The fact that the SEC has recently found it necessary to intervene to make executive pay more transparent (http://www.sec.gov/news/press/2006/2006-123.htm) further suggests that there are serious problems in this market.
Executive compensation and the market for executive talent should be urgently and thoroughly investigated by the Antitrust Division.
Patrick Gerard
http://www.performanceandreward.blogspot.com
A copy of this e-mail has been sent to the Federal Trade Commission: Bureau of Competition, for information.
*************
*************
Solihull
West Midlands
United Kingdom
To the Citizen Complaint Centre
Antitrust Division
Department of Justice
I would like to report an antitrust violation in the market for executive talent.
Companies justify paying their top directors very generous salaries, bonuses, pensions, benefits and stock option allocations by claiming that very generous overall packages are needed in order to recruit and retain the best executive talent in a competitive market for executive recruitment and retention.
However the market for executive talent appears to be very uncompetitive in respect of the very top jobs at the very top companies. The prices that executives are able to earn in this market are extremely high and growing.
The prices that are attained in the market cannot be explained in terms of supply and demand. The number of MBA graduations is many times higher than it was twenty years ago, but the price of a CEO has still risen dramatically. Increasing executive pay does not increase the number of potential new CEOs who become available. Potential CEOs have to be trained up, given exposure and opportunities by exiting CEOs. The CEOs therefore have considerable control over supply in their own market.
The members of company boards are both hirers and providers of executive talent. This fundamental conflict of interests gives them very considerable market power in the executive talent market.
In any negotiation between a CEO and compensation committee about pay, the CEO has huge power. This is very fully documented by Lucian Bebchuk and Jesse Fried in their book Pay without Performance: The Unfulfilled Promise of Executive Compensation (Harvard University Press, November 2004) (see http://www.pay-without-performance.com/)
There is considerable coordination of the supply side of the market by the main players. Coordination takes place through the Business Roundtable. According to its November 2003 publication Executive Compensation: Principles and Commentary the Business Roundtable “is an association of chief executive officers of leading corporations”, which, “has developed six interrelated principles…to serve as best practice for the design, implementation and oversight of executive compensation at publicly held corporations.” (See http://www.businessroundtable.org//publications/publication.aspx?qs=2806BF807822B0F13D142 pages i and ii. Through the Business Roundtable forum senior CEOs work together to coordinate how they should be paid.
The CEOs of America’s largest corporations also work together, through the Business Roundtable, to defend high levels of executive compensation. This can be seen in the Business Roundtable press release of 7.5.06. (See http://www.businessroundtable.org//newsroom/document.aspx?qs=5906BF807822B0F1AD2408522FB51711FCF50C8 .) It is clear that consultants have been hired and analysis completed with the express aim of defending the rate of growth of CEO compensation over the last 10 years.
In the press release, the Business Roundtable asserts that, “Executive compensation has closely followed the growth that companies have experienced in the last ten years.” The press release is supported by analysis by Frederic W. Cook & Co. using the Mercer Human Resources Consulting database of executive compensation. The analysis shows (in chart B) a strong correlation between CEO pay and Total Shareholder Return (TSR). It seems that shareholders are prepared to accept growth in executive pay, provided the rate of growth is no greater than the rate of return that shareholders see from their investments. The relationship between TSR and growth in CEO pay suggests that CEO pay is constrained by what shareholders find politically acceptable. This demonstrates that CEOs have sufficient market power to increase pay at the maximum politically acceptable rate. It is clear that CEO pay is not constrained by market considerations such as the price of hiring a replacement CEO.
Co-ordination of the market prices is also brought about by the use of compensation consultants. Such consultants (e.g. Frederic W. Cook and Mercer) are very widely used. They compare practices in different companies and advise on levels and structures compensation that are politically acceptable. The consultancies have strong incentives to push executive pay upwards because their sales pitch to management is far more effective if they are saying, “We think you guys deserve a pay rise”.
The natural allocation of one CEO per company forms a natural market allocation scheme that executives use to keep reward packages high. Very seldom does the CEO of one large company to seek to replace the existing CEO of another. On the rare occasions when this does happen (most commonly through a take over bid) it is usually necessary to pay the outgoing CEO a very significant compensation payment. Such payments cannot be explained by the need to recruit, motivate or retain the executive; they are best explained a payment to buy the CEO out of the cartel.
IRS data tables on the internet suggest that high income (>$500,000 per annum) employees earn in total about $300 billion per annum in salaries and wages. This makes executive pay a major sector in the US economy. Even if executive pay levels are only 20% higher than competitive levels then the detriment to US economy is already $60 billion per annum.
In recent months the scandal about backdated stock options has revealed that some aspects of executive pay have had far more to do with extracting rent than they have had to do with providing the right incentive or the need to offer competitive compensation. The fact that the SEC has recently found it necessary to intervene to make executive pay more transparent (http://www.sec.gov/news/press/2006/2006-123.htm) further suggests that there are serious problems in this market.
Executive compensation and the market for executive talent should be urgently and thoroughly investigated by the Antitrust Division.
Patrick Gerard
http://www.performanceandreward.blogspot.com
A copy of this e-mail has been sent to the Federal Trade Commission: Bureau of Competition, for information.
*************
*************
Solihull
West Midlands
United Kingdom
