Monday, January 22, 2007

Who Says CEOs Are Worth Their Compensation?

Another tiresome Op-Ed piece in the Washington Post about executive compensation, this one by professor of finance, Roy C. Smith, at New York University. Roy’s claim to a stake in this controversy is co-authorship of Governing the Modern Corporation. Not to short-change his authority, Smith is a former general partner at Goldman Sachs.

Roysmith Another tiresome Op-Ed piece in the Washington Post about executive compensation, this one by professor of finance, Roy C. Smith, at New York University. Roy’s claim to a stake in this controversy is co-authorship of Governing the Modern Corporation. Not to short-change his authority, Smith is a former general partner at Goldman Sachs. He is also the author of Comeback, The Money Wars, and The Global Bankers.
All of which gives him serious-authority-status in peering through the microscope at business, taking business’s temperature, evaluating the potential of business to cough as he juggles its testicles. Roy Smith isn't exactly an Adam Smith, but he publishes on the creation of investor wealth, peels the onion of corporate sloth back to its core and stakes a position on comebacks, money-wars and international banking.
Roysmithbook1 But it’s an observer’s position. Without knowing Smith more personally than his available bio (and meaning him no individual injustice), I’m compelled to put forward the argument that the observation of business and the skimming of cream from its efforts is exactly what has contributed to its decline.
Decline? Are you mad? With the Dow-Jones at all time highs and American business at an apex of world domination, you dare to speak of decline?
Yeah, I dare.
My credentials are not academic, nor are they derived from the heady raking in of chips that attend partner status at investment banking firms. I come from considerably further down the food-chain, the murky waters of small-business ownership and its under-funded, scratching-for-payroll, sweaty, entrepreneurial warfare. Those like me form the great undefined and undefended underbelly of American private enterprise—half the U.S. economy by some estimates.
The steady half—the half that frequently struggles, that hopes to pass something of value to sons and daughters and stumbles, but seldom crashes.
Let me define decline. For me, it’s evident that the business climate is measurably in decline when
  • A particular enterprise is worth more chop-shopped down to its spare-part value than it is as a viable, whole company
  • Stock value is measured by quarterly earnings rather than the long-term considerations of product viability, research and development, financial stability and market penetration
  • Investor confidence and share-price depends more upon herd-mentality than underlying strength.
  • Profitability depends solely upon lowest cost, lowest quality and lowest investment to force-feed highest profit
  • CEOs concentrate on the game of corporate musical-chairs, with both eyes focused on nailing own their next job when the music stops
Roysmithbook2 Each of these points has in common the chilling fact that the Harvard Business School model promotes its worst aspects as evidence of profit potential. Like automobile-theft, the profits are made, not in the car itself, but in the bits and pieces of the car. Investors, in an act of metaphoric corporate car-theft, thus maximize their profits. But don’t expect the consequent rusted hulk to run on all eight cylinders or get you to the church on time.
The miracle of capitalism has always been its ability to attract capital, reward excellence and punish error. For centuries, that attraction was tempered by the steadiness (longevity) of continued value. We used to have an informal class of stocks called ‘blue chip’ that was the repository of conservative ‘old money.’ Old money didn’t like volatility. Old money liked railroads, steel companies, coal-mines and all the heavy industrial trappings of yesteryear.
The fall began, not with the obsolescence of steel and cotton mills, but with the increasing dependence for profit on consumer-driven products. We no longer made the steel, but we sold the cars, even if they were Japanese. Consumerism, in all its glory, drives
  • the consumer to max-out his seven credit cards,
  • the producers to treat product development like fashion accessories
  • and the investors to reward only the quick, the conglomerators and the deconstructionists.
If that sounds pessimistic, read Smith's column  further;
If you want to blame anything for today's inflated compensation packages, blame the hostile takeovers and the leveraged buyouts of the 1980s. Remember the days of the corporate raiders? Twenty years ago, those guys were everywhere, cruising the market for likely takeover targets and offering hostile bids, at premium prices, on well-known but poorly performing companies. The raiders would claim that management had failed to perform its basic duty to the companies' shareholders, which was to increase the value of their investment. These bids put management on the defensive, forcing it to justify both past performance and future plans.

The takeover effort led to a prolonged legal struggle to determine what managers could and could not do to defend themselves against hostile offers. But in the end, investors supported the bidders. And in doing so, they revolutionized corporate boardrooms, establishing the principle that if boards and managers did not create shareholder value, then shareholders would seek others who would.

By the mid-1980s, leveraged buyout (LBO) firms joined the pursuit of large underperforming companies using borrowed money. The LBO operators, however, believed that if certain management principles were followed, the risk of carrying all that debt could be greatly reduced. One of these principles required all-out managerial attention to increasing the company's operating cash flow so that debt could be repaid as quickly as possible. This in turn would improve profitability and increase the value of shareholders' equity.

Another principle was that the firm should retain the most effective managers it could find. That meant providing powerful compensation incentives. Managers who succeeded in meeting the LBO firms' performance benchmarks would be paid handsomely in company stock or options.
Roysmithbook3 Listen to that crap and weep. Corporate raiders, leveraged buyout, hostile takeover, performing their basic duty to the companies' shareholders, which was to increase the value of their investment. Not a word about duty to product or employee. This clap-trap made stockholder billionaires and wrecked companies. Not a single influence that worked against a CEO/worker compensation ratio nearing 500 to one. Not one contribution to good governance or a single reward of improved product. The corporate cowboys of the last two decades rewarded quarterly earnings and destroyed long-range planning.
Talk about quarterly results! The last quarter of the last century all but did us in as a producing power. Now we try to ride the bucking bronco to the bell by rearranging products produced elsewhere.
They have made of America a first-rate earner and a third-rate producer. What we have done with those earnings is to fracture employee compensation into haves and have-nots—a near classic description of a banana republic. We have thus contributed to and witnessed the destabilization of family income, wrecking of the pension and medical insurance benefits, polarization of politics, off-shored everything worth keeping, while celebrating a get-while the getting’s good mentality.
Small wonder ex-Goldman Sachs’ partners are the revered go-to guys when a discussion of corporate governance is afoot.
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