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The different ways of taking care of your shareholders

Civil servants flock to teaching jobs 24 Feb 2011 In 1976, economists Michael Jensen and William Meckling at the University of Rochester devised a solution to this conundrum — make the managers and executives owners of the corporation.

  1. Its logic is airtight, its execution straightforward.
  2. In fact, configure their compensation so that the bulk of it came from stock and stock options. It might seem fairly self-evident, but when the going gets tough, some CEOs are reluctant to inform shareholders that the business is struggling.
  3. Conventional theory would suggest that corporations whose executives had lavish stock and stock options would out-perform companies whose CEOs had far fewer incentives.
  4. In addition to the articles of association, any company that has more than one shareholder would do well to draw up and sign an agreement with each of its shareholders.

In fact, configure their compensation so that the bulk of it came from stock and stock options. That way, the interests of the executives and the interests of the shareholders would align.

  • However, creditors , bondholders , and preferred stockholders have precedence over common stockholders;
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  • In fact, configure their compensation so that the bulk of it came from stock and stock options;
  • Shares in firms that paid their CEOs in the top 10pc of incentive pay typically saw their share price decline — and they fared considerably worse than the shares of companies in the bottom 10pc.

Few have challenged the idea — and for good reason. Its logic is airtight, its execution straightforward. In a searing new book, Fixing the Game, Roger Martin, dean of the Rotman School of Management at the University of Toronto, declares that the emperor presiding over corporate governance for the last four decades has no clothes.

There is no clear data supporting the notion that making shareholder value maximisation the objective of the firm actually does maximise shareholder value over the long term.

Paying back your shareholders

But from 1977 to the end of last year, the return was 6. In other words, during the very era their interests were ascendant, shareholders did worse. In a recent paper, Raghavendra Rau, a finance professor at the Judge Business School at the University of Cambridge, along with two colleagues, examined the link between executive incentives and company stock performance in about 1,500 large corporations.

  • Because executive compensation hinges so heavily on performance in this expectations market, CEOs and others often spend more time smoothing earnings to benefit themselves personally in the short term than they do building companies and benefiting shareholders in the long term;
  • Conventional theory would suggest that corporations whose executives had lavish stock and stock options would out-perform companies whose CEOs had far fewer incentives;
  • In a recent paper, Raghavendra Rau, a finance professor at the Judge Business School at the University of Cambridge, along with two colleagues, examined the link between executive incentives and company stock performance in about 1,500 large corporations;
  • If a company liquidates its assets, its shareholders have a right to a proportionate allocation of the proceeds;
  • Shares in firms that paid their CEOs in the top 10pc of incentive pay typically saw their share price decline — and they fared considerably worse than the shares of companies in the bottom 10pc.

They compared companies whose CEOs were in the bottom 10pc for compensation levels with those in the top 10pc. Conventional theory would suggest that corporations whose executives had lavish stock and stock options would out-perform companies whose CEOs had far fewer incentives.

Alas, the results showed precisely the opposite.

  • However, creditors , bondholders , and preferred stockholders have precedence over common stockholders;
  • Conventional theory would suggest that corporations whose executives had lavish stock and stock options would out-perform companies whose CEOs had far fewer incentives.

Shares in firms that paid their CEOs in the top 10pc of incentive pay typically saw their share price decline — and they fared considerably worse than the shares of companies in the bottom 10pc.

So what is to be done? The most radical step is to eliminate stock-based compensation, something that Martin has proposed, but that might be difficult given how entrenched the practice has become.

But perhaps three other steps would help.

How to Establish a Good Relationship With Your Company’s Shareholders

Second, get rid of corporate guidance, usually quarterly. Because executive compensation hinges so heavily on performance in this expectations market, CEOs and others often spend more time smoothing earnings to benefit themselves personally in the short term than they do building companies and benefiting shareholders in the long term. If guidance disappears, the distracting, often counterproductive expectations market loses its oxygen.

Third, and most important, rethink the underlying theory of the corporation. If shareholders are no longer at the centre of the corporate form, who should be?

Forget shareholders, maximise consumer value instead

In his view, companies that serve and delight customers — for whom that is the animating purpose — will do just fine. Take care of your customers and put their interests first. My guess is that your shareholders would approve. Daniel H Pink is an author and business leader who writes about the world of work. His most recent book is Drive: