The Advisors' Blog

– Broc Romanek, CompensationStandards.com

This column by the Editorial Board of the NY Times – regarding stock buybacks & their impact on executive pay – ran yesterday:

In theory, “pay for performance” — linking executive pay to a company’s stock price — aligns the interests of executives and shareholders. It’s supposed to ensure that executives are not tempted to enrich themselves at the expense of shareholders, who are too numerous and far-flung to influence a company’s behavior.

In practice, it hasn’t quite worked that way. Instead, beginning around the 1970s and becoming increasingly common in the leverage-buyout era of the ’80s, the defining characteristic of pay for performance has been an explosion in chief executive pay that exceeds the value that any human being who isn’t Midas could reasonably be credited with producing. In 2015, the median pay package for chief executives at 200 large United States companies was almost $20 million per year, nearly 400 times the pay of a typical worker.

Because executive pay is an expense, excessive pay means that shareholders are losing money. A new study, analyzed in a recent report in The Times, explores that loss and provides fresh evidence that should reinforce the mounting calls for reform of executive pay practices. The study, by Wintergreen Advisers, a money management firm, looked at two hits that shareholders absorb from executive stock awards. The first hit is well known. When a company issues shares under an executive-pay agreement, the increase in the number of shares outstanding dilutes the value of existing shareholders’ stakes.

The second blow, involving share buybacks, is less obvious. Buybacks, in which management reduces the number of publicly held shares by repurchasing the company’s stock, are often pitched as a way to boost a company’s earnings per share. But the study points out that buybacks are aimed not necessarily at benefiting shareholders, but rather at offsetting the dilution that results from awarding stock to executives.

That observation is reinforced by the fact that corporate buyback activity increases when stock prices are high — exactly the opposite of what prudent investing would dictate. In all, the study estimates that the shareholder costs of the dilutions, and the buybacks to reduce that dilution, at companies in the S.&P. 500 index amounted to 4.1 percent of each company’s shares outstanding and 10.2 percent at companies with the highest combination of awards and buybacks. That implies a hefty sum of shareholder money spent to funnel money to executives. Research into the motives and consequences of share buybacks is continuing, so other approaches could yield different figures, but even the lower estimates would represent a significant cost to shareholders.

Excessive executive pay is deservedly blamed for rising income inequality, because worker pay has stagnated as executive pay has soared. But it has not been as widely faulted as a drag on shareholders because the durable pay-for-performance narrative still persuades many investors that they benefit when executives are lavishly rewarded. The Wintergreen study suggests otherwise, that oversized awards can mean diminished shareholder wealth.

Here are two other recent NY Times articles:

– Investors Get Stung Twice by Executives’ Lavish Pay Packages
– How to Fix Wall Street’s Flawed System of Compensation