Greedy Management and the Decline of Equity Returns

by Mr. Cheap

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About a year ago I read Stephen A. Jarislowsky’s “The Investment Zoo” and the idea behind this post was stolen from it, and has been bouncing around in my head long enough that I feel like it’s my own. If you feel like reading a far better presentation of it (along with a bunch of other killer ideas), check out the original source.

Supposedly up until 20 years ago or so, upper management (CEOs and whatnot) were paid about 40 times what the average worker earned. High income without being obscene. People would work their way up the corporate ladder, have a very affluent lifestyle, and typically do the work they loved to do (run a large business).

As athletes commanded increasingly insane salaries, top CEOs started saying that as the “superstars” of the business world they deserved similarly extravagant salaries. Boards and shareholders bought in to this idea, and competition pulled up compensation packages for upper management to the nose-bleed inducing heights they’ve reached.

A favourite way of hiding how much they’re raping their business is for upper management to issue themselves stock options. Presented under the guise of “rewarding the management for increasing shareholder value” this lets the company buy back shares (pretending this is a good thing for shareholders), issue these shares to themselves (without having to dilute outstanding shares) and over time steal a major portion of the company from the owners (they’re buying shares for themselves with money that belongs to the shareholders). Apparently Jack Welch and his cronies went from owning nothing of the company to 30% of GE when he retired.

People like to say that the expected nominal return from stocks is 10% over the long term. Whenever the market exceeds this and they say “the rules are different this time” a correction hits and brings us back down to Earth. Any time you hear that phrase or get stock tips from a shoe shine boy it’s time to sell.

I wonder if this time the rules ARE different, and we’re having part of our 10% return stolen from us by the people we’ve entrusted to grow it?

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{ 6 comments… read them below or add one }

1 Four Pillars

I still have to read that book.

I was thinking of doing a post on executive compensation – a different look though so it won’t be the same post! :)

2 Nobleea

By far, the most dangerous phrase to utter when it comes to investing (or financial stuff in general) is: “This time it’s different…”

…P/E ratios don’t matter any more.
…real estate will always go up due to .

3 Alex Givant

Just finished “The Big Investment Lie: What Your Financial Advisor Doesn’t Want You to Know” by Michael Edesess – excellent book.

He is talking about high fees of mutual funds managers and even higher fees for hedge funds and why they bring nothing to your bottom line on the end.

“Where is a customers yachts” – still the valid question.

4 Four Pillars

Nobleea – very true.

Alex – I’ll have to check that out. I have a post on hedge funds coming up so you can give your opinion on it (or them).

Mike

5 Plop

The only guys making money on the market are the MM, and the guys on the inside.

They’ll give you your small cut to keep you interested (10% is a joke). I would rather invest in something more tangible that gives me a 30-40% return (like real goods).

6 Mr. Cheap

HeMan: Fair enough, although perhaps as a “young executive for a publicly traded company” you’ll admit that you aren’t the most unbiased person.

I would prefer to invest in companies that have reasonable executive compensation. When/if enough investors care about this issue, the market will bring compensation back to a reasonable level.

“Whining shareholders” are the company owners. You should consider working elsewhere if you don’t like being accountable to the people who own the company you work at.

Plop: I’m pretty happy with a 10% return. Power to you if you can consistently get more than this!

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