17 August 2009

Quote of the Day

Executive compensation in large publicly traded firms often is excessive, because of the feeble incentives of boards of directors to police compensation.

- Judge Richard A. Posner, of the United State Court of Appeals for the Seventh Circuit.

The case involves mutual fund advisor fees. As the New York Times in the story linked above explains:

Mutual funds are odd enterprises. They are typically formed and run by their investment advisers, which select the fund’s board of directors. That board then negotiates the adviser’s fees.

Here is how Warren Buffett analyzed the situation in his 2003 letter to shareholders: “Year after year, at literally thousands of funds, directors had routinely rehired the incumbent management company, however pathetic its performance had been. Just as routinely, the directors had mindlessly approved fees that in many cases far exceeded those that could have been negotiated.”

Arguments for the status quo argue that the ability of mutual fund investors to take their money out of the fund and choose other funds creates the market discipline needed to control excessive compensation grants.

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