Friday, July 31, 2009

Executive Pay

How much is too much? I don't know, what I do know is that if I own a company I would pay the executives far less than they get paid. Why? Because they don't take the same risk as I do. Why doesn't this happen today? It's because shareholder's are passive investors and the manager's are able to skim off the top.

This is a classic case of dispersed costs, concentrated benefits. The manager's salary is huge, but as a fraction of earnings per share it is insignificant. When you have millions of shareholders they don't notice a fraction of a penny here and there. The manager notices all those pennies and therefore attempts to pad his compensation. Nothing wrong with the manager, doing exactly what any other sane person would do. This is not good for the company.

The solution is more concentrated ownership in companies. These people would feel all those pennies being siphoned away and would put a stop to it. Is there a cost? Yes, reduced capital formation. I think this is a beneficial trade off.

2 comments:

Phillip said...

Just so I understand, are you saying that we should get rid of common stock and only sell preferred shares (which IIRC entails voting rights and are paid off in case of buyout/banruptcy/etc first)?

I like the idea of more active ownership in companies. However, my only concern is that many people would not be able to participate (as preferred stocks do require effort and getting the collective business wisdom of the number of common stock holders would be a nightmare). However, this would be alleiviated by using funds where the funds would have the collective voting power. I am unsure what the ramifications of that would be.

However, I would like to what you think as to how to foster this more concentrated ownership -- or if it would just need a general paradigm shift.

Adam Freund said...

I am not laying out any specific plan for how to do this, but I am suggesting that there needs to be a paradigm shift. I don't like the idea of funds because they have the same problem as stocks. The fund managers skim off the top the same way executives do. They are also face additional obstacles.

I think getting rid of limited liability would go a long way to encouraging active participation but I am open to more ideas. If you read anything on the topic let me know.

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