Why you should sell the stock of companies whose executives are overpaid
di Marco Liera (*) - 17/02/2013
"We are the ones who pay." With this claim, Swiss citizens will be asked on March 3 to vote on the Minder proposal (named after the representative from Schaffhausen who was the initiator) against the "unfair compensations" of some top executives of listed companies of the Confederation. The initiative aims to transfer such matter under control of the annual shareholders' meetings, and to push pension funds to vote on it. Violators will face up to three years in prison, but some political parties and trade associations presented an alternative proposal. Share ownership interests in Switzerland are much more widespread than in Italy, mainly because of the positions that pension funds hold in Swiss corporations. In Italy - where shareholders' meetings have no control on executives’ compensations - there are not so many people who have good reasons to say "we are the ones who pay", as shareholders are few in proportion to the whole population.
“Say on pay" rule came into force in the United States in 2011 and in the first year of implementation only 2.6% of the compensation packages of the companies in the Russell 3000 index has failed to be approved in shareholders’ meetings. It is unknown if such a rule has lowered executives’ compensations, and at the academic level there are critical voices on the effectiveness of these measures. More certainty we do have about the effects of high executives’ incentives on the companies’ stock price performance. Two American researchers, Michael J. Cooper of University of Utah, and Huseyin Gulen of Purdue University explained in a paper released in December 2009 that there is an inverse relationship between executive pay and performance of the company’s stock after the incentives are granted. Indeed, Cooper and Gulen show that a trading strategy based on shorting the stocks of companies granting higher executives’ incentives and simultaneous purchase of the more "stingy" stocks has generated - at least in the past - compelling extra-returns.
The problem of executive pay and its effects on shareholders’ and citizens’ wealth is extremely complex to sort out. One of the most influential professors of management, Henry Mintzberg, argued in the Wall Street Journal of 30 November 2009 that it is not possible to design a fair package of executives’ incentives. It would be better to grant them a fixed salary. And, if they still expect a bonus, "they can always buy shares of their company," says Mintzberg. But even without bonuses, it is necessary to estimate the human capital value of an executive, and explain why it is worth 10, 100 or 400 times that of an employee of the same company. The relative impact on business performance could be an acceptable criterion (which share of the company’s profits is due to executives’ skills, and how much instead attributable to the efforts of the rest of the employees?). But even such criterion is not easy to apply. Clearly, in a self-referential system - which is perfectly reflexed, according to the promoters of Minder proposal, in failing to submit compensations’ packages to shareholders’ meeting scrutiny - it may be easier to untie executives’ pay from business performance. It does seem curious that the imbalance between executives’ and employees’ pay has been widening since the 70s. In finance, higher returns can be achieved only by running higher risks. Unless it is not a free lunch.
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