Corporate Hissy Fit Over New Proxy Rules Reveals “Shareholder Rule” to be a Canard

It’s simply astonishing how often the myth of shareholder rule is parroted by the business press. Let’s see, average CEO pay was 49 times average worker pay in 1980. As of the most recent tabulation, 2008, it was 319 times average worker pay. And since that was the worst year of the crisis, and top level pay was therefore a tad subdued, one can expect the gap to have widened since then.

Tell me: do you really think the CEOs of 2008 are more than five times better, on average, than their 1980s counterparts? Do you even believe that pay for performance works at the CEO level? The evidence suggests the opposite. In IT, CEO pay is inversely correlated with performance. Pay being correlated with underperformance is particularly strong with particularly well paid CEOs. From a 2009 study:

Compensation, status, and press coverage of managers in the U.S. follow a highly skewed distribution: a small number of ‘superstars’ enjoy the bulk of the rewards. We evaluate the impact of CEOs achieving superstar status on the performance of their firms, using prestigious business awards to measure shocks to CEO status. We find that award-winning CEOs subsequently underperform, both relative to their prior performance and relative to a matched sample of non-winning CEOs. At the same time, they extract more compensation following the award, both in absolute amounts and relative to other top executives in their firms. They also spend more time on public and private activities outside their companies, such as assuming board seats or writing books. The incidence of earnings management increases after winning awards. The effects are strongest in firms with weak corporate governance. Our results suggest that the ex-post consequences of media-induced superstar status for shareholders are negative.

Similarly, Jim Collins’ classic Good to Great found that the CEOs of sustained outperformers were modestly paid (and perhaps more important, appeared temperamentally not terribly oriented towards getting big bucks). Various small scale analyses (see here for instance) confirm this finding.

But why should pay have anything to do with performance? After all, compliant boards keep resetting benchmarks to make sure no CEO is discomfited when stock markets go down, for instance, by lowering hurdles for equity-related incentive awards.

In 1994, Amar Bhide, in a Harvard Business School article, described how efficient equity markets led inevitably to deficient corporate governance. A public share is a very ambiguous promise: you have vote which can and usually eventually is diluted, and the company will pay you a dividend when it earns money and is in the mood. Promises like that are not suitable to be traded on an arm’s length basis, and historically, equity investors typically played a venture capital type relationship: they knew the owners personally and were involved in the company’s affairs. The securities laws of 1933 and 1934 tried to make it safe for shareholders at a remove to participate by providing for timely, audited financial reports, disclosure of information about top executives and board members, and prohibiting insider trading and various forms of market manipulation.

But that turns out to be inadequate. No outsider can know enough to make an informed judement about a company’s prospects; critical information, like merger and new product development plans, must be kept secret until well advanced because they are competitively sensitive. Boards are shielded from liability by directors’ and officers’ insurance (and on top of that, it seems hardly anyone even bothers pursuing board members. For instance, have any Lehman board members been sued?). Moreover, only a comparatively small number of people are deemed public-company-board worthy, and their incentives are to make nice in their community and not rock the boat, which means not making life difficult for the CEOs, since a nominating committee (of the current board) is responsible for nominating directors, which makes the entire process incestuous.

This system has proven to be fairly impervious to outside challenge. Once in a while, a company is so abysmally run that an activist investor will engage in the pitched battle of a proxy fight. But the dog seldom catches the car; instead, they might get a bad CEO to exit or force a restructuring. The stock trades up and the rabble-rousers take their winnings. More polite efforts, even by large, powerful shareholders, are much less effective. For instance, some major institutional investors met with Goldman last year to object to the idea that the firm would pay lavish bonuses for 2009. The session appears to have had no impact.

So the SEC is expected to pass rules that would allow effectively disenfranchised shareholders the opportunity to throw a rope over the castle walls in the hope of gaining entre and hence some influence. Per the Financial Times:

The proposal allowing investors to put their own nominees for board seats alongside the company’s nominees is expected to be approved by the Securities and Exchange Commission…

The new power is expected to be restricted to investors with a 3 per cent or greater stake in the company who have held the shares for at least two or three years, people close to the situation said. The SEC commissioners have the power to exempt smaller companies from the rule, should they wish to do so.

Note that this is a severely restricted form of access; only very big and longstanding investors can put up director nominees. A much bigger number of shares held by a group of equally longsuffering investors has no such privileges, when by any common-sense notion of democracy, all shares should be equally influential, and any group that in aggregate met the 3% threshold and the length of ownership test should be granted the same power. And note this is merely the right to put candidates up for a vote of all shareholders; there is no guarantee any outsider candidates will prevail.

Not surprisingly, the leaders of the CEO/board club responded as if this proposal represented a mortal threat to capitalism:

Corporate America senses a revolution in the offing on Wednesday – and one it finds deeply alarming.

“The implications of [Wednesday’s] decision will be far-reaching and likely will have a major impact on how all US publicly traded companies are governed,” the Business Roundtable, which represents chief executives of the biggest US companies, said in a letter last week to the White House. It warned of “a major threat to the ability of US companies to grow and create jobs”.

Ten senators, led by Richard Shelby, senior Republican on the Senate banking committee, urged the head of the Securities and Exchange Commission to be “particularly careful” to ensure that Wednesday’s planned change did not impose unnecessary requirements on companies “at a time when capital formation and job creation are in jeopardy”.

Yves here. The Ministry of Truth speaks. There is so much nonsense in this salvo that it is hard to know where to begin. First, big public companies weren’t in the job creation business in the last expansion, and aren’t anticipated to be this cycle (if and when we have something that can credibly be called a recovery). Second, big companies hardly ever tap the public markets for equity, so the idea that (first) having an outside nominee which might (second, horrors!) be elected which would (third) would be bad for share prices (very questionable, why the hell would they have won a majority?) and then (fourth) the resulting poor share price would hurt the ability of said company to raise needed equity capital to grow. The reality is the converse for big public companies; in aggregate, they’ve been net savers (which means they are shrinking rather than growing). In general, they fund themselves first from cash flow and retained earnings and second, from debt. The equity markets have perilous little to do with the funding needs of major corporations.

So what additional scare tactic do CEOs and boards that might have their imperial right to loot curtailed? They invoke rule by the modern equivalent of commies, namely, unions:

Their concern centres on fears that the new investor right will be hijacked by unions and other special interest groups to force boards to accede on particular issues. The Business Roundtable asserted that the threat of a director election contest could “place unnecessary pressure on a company to improve short-term financial performance” at the expense of long-term growth.

Yves here. So get this: the business lobby is trying to rebrand highly respected institutional investors like CALPERS and TIA-CREFF as “union” pension funds. And in complete through-the-looking-glass nuttiness (projection is too weak a term), they act as if UNIONS or evil activists of other unnamed types might produce more short-term orientation than already exists? The current order has led to a near-complete breakdown of pursuit of long-term objectives (and this is not based on a reading of the media; I hear it consistently from all sorts of advisors to big companies, from attorneys to consultants to marketing specialists. Expedience and cost cutting are the order of the day).

Fortunately, pretty much anyone with an operating brain cell can see through these patently phony arguments:

Investors on Tuesday rejected these assertions. Kurt Schacht of the CFA Institute, which represents investment professionals, dismissed the industry warnings as “complete and utter camouflage”. Mr Schacht, who sits on the SEC’s investor advisory committee, said it was “insulting” to shareholders to suggest that they would not be able to recognise if a fellow investor, such as a hedge fund, was trying to misuse the new power.

Yves here. The real shocker is that some of the defenders of the failing corporate oligarchy (well, failing at anything other than increasing bottom lines by starving top lines, disinvestment, and squeezing pay to workers, both in job additions and pay levels) is that they are pathologically unable to see that they have enriched themselves to the detriment of shareholders. The pretty looking earnings were at the expense of future prospects. As one savvy investor friend said, circa 2006, “Why should I invest in these companies if they aren’t investing?” They cannot conceive that investors as whole (when the proxy vote DOES require a majority) would vote against them. No, it has to be a pinko plot against their rights as anointed members of the elite. Only peasants would want to storm the castle.

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13 comments

  1. Daniel Nicolas

    Q: do you really think the CEOs of 2008 are more than five times better, on average, than their 1980s counterparts?

    A: They’re certainly better at evading and even changing the law so that their fraud is legal. In the 1980s the corporate ‘masters of the universe’ went to jail by the hundreds!

    Back then we had people who were willing to enforce the law. Today, the mantra is, make it good for the shareholders and a minor fee ye shall pay.

  2. Francois T

    The documentary “Inside Job” does a great job of exposing this bullshit about CEO’s arrogance and hubris, among other things. Now, it is futile to ask how I know that. Let’s say that I had a, ahem, shall we say, “preview viewing”?

    But I’m ready to bet my last n’gwee that movie distributors will spare no expense nor effort toward extreme passivity in promoting this documentary. Too many pitchforks would be sold afterward.

    It’s one thing to say so-and-so pocketed a 100 million. It’s another thing entirely to see what so-and-so bought with that money.

    1. Rex

      Thanks for mentioning this film.

      I want to see the “Inside Job” documentary now. If my searches are correct, it won’t be released until around Halloween this year. I wish there was a way to see it sooner.

      1. Francois T

        I wish it would be released on Halloween Day. The powers that be would witness the Rise of the Dead getting out of the theaters!

        Just a little note: the movie specifically mention the fact that the present Administration hasn’t launch a meaningful investigation of the financial collapse.

        The Obama bots will truly hate the answers as to why it wasn’t done. As a matter of fact, one does not have to be a paranoid conspiracy theorist to rage about the genesis and the making of the actual (so-called) Commission led by Angelides. It is a total joke, allowed to stand as it is only because NO mainstream media has ever grilled the politicians (Beohner, Pelosi) responsible, nor gave any context to their listeners/viewers.

  3. Positroll

    “they act as if UNIONS or evil activists of other unnamed types might produce more short-term orientation than already exists?”
    The funny thing is that in Germany half of the (supervisory) board of a corporation is composed of labor representatives … they gotta be sooo communist and short-term oriented over there …

  4. dcb

    the corporations will win, they always win, it doesn’t matter whyat administration. For some reason the press reports what they say but does nothing about the lies. They mainly do the same thing with administartion officials.

    There isn’t going to be any6 changes until it is forced on the system. *It can’t be forced in the voting booth because the same people determine who runs in both parties.

    Amazing though how in places like Germany the system works.
    when americans wake up to the fact that we have been at wor withj our own corporate and government leaders maybe something will happen. Clearly the government sees this as a future (look at the great increased domestic spy programs, cameras on the streets, etc). they clearly are already preparing for the time they know is going to come.

    Peaceful proptestors sitting in a park in pittsburg during the g20 tear gas (freedon of assembly), internet neutrality and cut off switch (speech), domestic spy operations without aa warrent (ready to go after trouble makers), Gitmo (rendition without trial for ever). it’s amazing how the media doesn’t put the pieces together.

    1. Chris

      They don’t have to win though. If the public would rise up en masse and confront this crap, we’d force them to back down. The power is already in the hands of the working class; the only thing we need to do is ACT. The only thing preventing action is mass class conscience.

  5. Francois T

    To the CEOs who agree with the missive ““The implications of [Wednesday’s] decision will be far-reaching…”

    The simple recognition that everyone else wants to be happy and not to suffer, just as I do, serves as a constant reminder against selfishness and partiality. It reminds us there is little to be gained from being kind and generous while hoping to win something in return. Actions motivated by a desire to earn a good name for ourselves are still selfish, even if they appear to be acts of kindness.

    — Dalai Lama

  6. Daniel Greenwood

    It is absolutely correct that stock prices depend largely on faith that managers, trained to be entirely cynical maximizers with no respect for the people they work with or any interest other than their personal ones, will then turn around and altruistically share their gains with the financial markets.

    It is also correct that highly paid CEOs will always have bad incentives: once they understand that they are in this game for money, many will have no trouble figuring out, just like any corrupt official, that the easiest route to personal riches is looting as quickly as possible before they are replaced, not building institutions for the greater good of the commonwealth.

    However, it is simply weird to think that the country would be better off if we dealt with this by increasing shareholder power — i.e., financial market power — even more.

    The core problem is the de-professionalization of CEOs — that they no longer think of themselves as public servants and managers paid a respectable amount to build an institution that provides good jobs and better products. Instead, we’ve taught them to see themselves as stock traders in another guise: individual wealth maximizers with no responsibility to anything but the price of stock, rewarded not by a professional’s understanding of a good job well done but by a wealth maximizer’s balance sheet.

    It is no surprise that after the stock market taught them how rich they could get by abandoning any sense of empathy with their fellow workers, restraint by conventional notions of reciprocal obligations, and long term planning, that CEOs turned on their erstwhile colleagues in forcible redistribution of wealth and class warfare. Once a CEO has learned to be ruthlessly exploitative of the people he actually works with on a daily basis, why would you expect him to suddenly turn into an altruistic saint when it comes to voluntarily sharing his ill-gotten gains with the stock market?

    But the solution can’t be to give still more power to the stockmarket. That’s what got us into this bind in the first place. The stock market and its traders are inherently short-term oriented. They have regularly supported high CEO salaries — there is no evidence whatsoever that stock prices drop when CEO pay increases, nor is there any history of major investors campaigning for a return to the old days when CEOs were paid like managers instead of Louis XIV. Presumably this is because the stock market players recognize that high CEO salaries tend to make CEOs think more like investors, just as the HBR promised two decades ago: more short term oriented, less able to empathize with employees and their needs, more likely to fight unions, more likely to use accounting to goose stock prices than provide accurate information, far more likely to kowtow to the latest stock market fads, less likely to “waste” money on building an institution of committed workers, researchers and managers planning for a long term future together, more likely to take advantage of any immediate opportunity to exploit the trust of consumers or employees or the inattention of government regulators.

    The stock-market/CEO alliance, fueled by options and other CEO emoluments, broke the historic link between productivity and pay. It is the major reason why the middle class is in distress and the top 1% and tenth of 1% has seized essentially all the benefits of economic growth for a generation — why, despite enormous growth in the economy, the real median wage is basically the same as 40 years ago.

    Now that the CEOs are powerful enough to ignore the stockmarket’s piteous demands for its fair share of the money stolen from the employees, shareholder advocates are demanding help. But the stock market is not what we should be feeling sorry for.

    Instead, we need to be looking for a power base that will actually have an interest in running corporations in order to create good middle class jobs and quality products and services. That means empowering employees, not stock investors. (A drop in the dollar, to make exports more competitive and imports less, would help too).

  7. Chester Genghis

    Re: Myth of Shareholder Rule – Sometimes numbers convey what words cannot.

    In the 10 years previous to its demise, Lehman Bros. paid out approx. $3 billion in shareholder dividends. In the same period Lehman execs paid themselves approx. $50 billion in bonuses. (This from a TV interview I heard w/ Elizabeth Warren.)

    As Warren says, “This is a simple, amped-up illustration of who these companies are being run for.”

  8. readerOfTeaLeaves

    Ten senators, led by Richard Shelby, senior Republican on the Senate banking committee, urged the head of the Securities and Exchange Commission to be “particularly careful” to ensure that Wednesday’s planned change did not impose unnecessary requirements on companies “at a time when capital formation and job creation are in jeopardy”.

    IIRC, Sen Shelby of Alabama was the guy who held up about 70 Obama admin nominations (including judges) so that he could screw Boeing in order to get more ‘jobs’ for an Airbus subsidiary based in — you guessed it, ‘right to work’ state Alabama.

    So was the US corporation advantaged?
    Or the non-US based corporation advantaged?

    It’s worth noting that the anti-union screeching in the lobbying points are precisely the notes that would need to ‘dog whistle’ to the southern GOP senators who might happen to sit on the banking committee.

    This looks to be at least 50% politics, 50% business.
    Errr… I think the ‘politics’ part of that ratio is probably low, given the players — starting with Sen Shelby — mentioned in this post.

  9. John Wilson

    Just a quick technical correction – proxy access does allow shareholders to aggregate their holdings for the purpose of nominating a director. However, the top ten public pension funds (which does not include TIAA-CREF, BTW) would not jointly be able to nominate a director at some of the biggest US corporations.

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