10 October 2011

Capitalism Is Still Broken Until We Punish Downside Losses

The CEO of Gannett, Craig Dubow, is quitting for health reasons, but his golden years will be very comfortable: He stands to collect as much as $37 million in retirement and disability benefits. During his five years as CEO, Gannett’s stock price dropped from $72 to $10, and the company laid off hundreds of journalists, including people I know to have been very good journalists. I’m pretty sure that none of the fired journalists received a $37 million retirement package. I’m not even sure if collectively, all the journalists fired by Dubow’s company received $37 million.

Via The American Conservative, ultimate factual source here.

The economists are right. Incentives matter. But, in our current self-dealing big business culture, executives have reasonably great incentives from stock options to foster upside gains, but don't significantly bear downside losses so they are prone to taking the kind of risks that sooner or later destroy a company.

Some of the solution could be pretty straightforward. Pay executives the bulk of their compensation not in stock options, but in stock that they cannot dispose of until their tenure is over.


John Thomas said...

Wouldn't that just encourage people to inflate stock prices at the end of their term as CEO? Stock prices are tricky because they aren't a measure of company health (or at least just a measure of company health). Dividends get factored in, and of course the hype factor. It's hard ultimately to account for all the micro-factors of how a person is paid and adjust one without unintended consequences.

It would be nice though, if corporate boards were generally less orthodox about how they pay their CEOs and if they played with the different formulations of payment, then history could gather up the best strategies.

But I wonder how salaries get up that high. Once the average salary in the market is a some level, I understand it's hard to pay less, but between the push and pull of CEO's available and boards hiring, why this high?

Of course I also wonder at a certain salary level how much incentive an extra $1 million is, but that may in part explain why it gets so high. If you're earning $1 million at a job you really like, maybe $1.5 million wouldn't matter.

In any case, the argument against simply "we need to punish losses" can be best seen in bonus-heavy compensation on Wall Street which encouraged hyper-risky behavior.

Then on the third hand, there's also the dilemma of punishing losses as discouraging talented CEO's from taking on failing companies. It makes perfect sense to reward someone who does well when everywhere else is failing (if half your industry is gone and your company's down in the quarter, well, I think you're still doing okay).

So in conclusion, I don't know. But it's not simple. But like I said, the best thing to do would be to get companies to experiment more with their compensation packages and let history anoint the best ones.

Andrew Oh-Willeke said...

"the argument against simply "we need to punish losses" can be best seen in bonus-heavy compensation on Wall Street which encouraged hyper-risky behavior."

To the contrary, Wall Street bonuses were classic heads I win, tails you lose compensation systems. Good results increase copmensation, bad results don't reduce base pay. The goal of stock compensation for executives is to align the incentives of executives more strongly with those of shareholders than they are now.

A CEO who starts out at a failing company shouldn't be taking the job if he doesn't sincerely believe that he can make it better than it was when he took the reins.