Management-shareholder "alignment" is over-rated
Shareholder interests are not uniform
Corporations are a legal fiction created for one purpose - to allow people to put invest risk capital in businesses without being personally liable for the acts of the corporation. Directors elected by shareholders owe duties to act in the best interest of the corporation, not in the interest of shareholders whose benefit from ownership is derivative, not direct. Directors choose managers they hope bring a level of competence to build a robust business capable of a return on capital sufficient to fund growth at least in line with the overall economy, attract new investors if more capital is needed, and pay a growing stream of dividends to those who put their money at risk.
Trading in the secondary stock markets should be of little concern to management or boards of directors if they are effective stewards of the corporation and the capital entrusted to them. Stock prices will be affected by investors sentiment, taxation regimes, central bank policies affecting interest rates and the level of inflation in the economy none of which are under the control of the board of directors or managment.
The idea of “shareholder alignment” was created by compensation consultants hired by management to develop compensation systems that favored their chances of becoming wealthy based on the specious argument that shareholders benefited from higher stock prices and management should be motivated to take actions that would increase the trading price of the company’s stock in the secondary markets. The argument is specious since investors benefit from low stock prices when they acquire an interest in a company. Buying an interest in the same earnings and dividend stream at a lower price can only benefit a potential investor and paying a higher price tautologically leads to a lower return. Including stock options or similar derivatives like restricted stock units (RSU’s) motivate managers to take actions that drive up stock prices without necessarily improving corporate economic performance - stock buybacks being one example.
I think it is great for managers to buy shares in the company they run with their own money. Having their own money at risk and with a risk of loss as well as gain brings greater sense of responsibility to their stewardship of the company. One-sided compensation systems like options are toxic, not constructive.
To me it is more important that managers’ compensation be tied to work they do which improves the economic performance of the company over the long term. For commodity based companies, stock options and RSU’s are often wasteful since managers are rewarded for changes in global commodity prices over which they have no control and made no possible contribution. One of my first assignments at McKinsey & Company, Inc. was to design a compensation system for George Albino, then CEO of miner Rio Algom, a major copper producer later acquired by Noranda Inc. It took me several months of work to come up with a three-page system that tied Albino’s compensation solely to items he was able to control and manage and carved out economic benefits or penalties to the company from changes in copper prices. His board of directors loved it, Albino not as much. But it was very effective in motivating Rio Algom to become one of the lowest cost copper producers. [Rio Algom also produced gold, zinc, uranium and tin and Albino’s compensation was insulated from the prices of these commodities as well].
Stock options and RSU’s are particularly offensive for oil & gas companies since management can have a real impact on exploration, operating and processing costs and little impact on energy prices. The success of Peyto Exploration & Development (PEY.TO) has been its focus on low costs and its record as the lowest cost natural gas producer in Canada.
Shareholders have varied interests. Fund managers want higher stock prices to collect higher fees for assets under management (AUM’s) where fees are a percentage of AUM. Brokers want their clients to trade to increase their commission incomes. Traders want prices to rise once they own stock and could care less once they sell their position. Option traders want volatility to widen premiums creating more trading opportunities. Long term investors want lower stock prices to add to their holdings at the lowest cost and prefer higher dividends since that is where their income comes from. Acquirers and activists accumulate stock to benefit from potential synergies in the case of acquirers or to compel changes in policy they believe they will benefit from in the cast of activists. All shareholdes have an axe to grind and it is rare to find unanamity among their wishes.
In summary, “alignment” with “shareholder interests” are both buzzwords and an impossibility. Since the set of shareholders changes every day, “alignment” is not even possible and if it were would be undesirable. I don’t want the people entrusted to manage the capital I have invested in the oil & gas corporations they manage to spend their time looking at trading screens instead of seismic reports or drilling contracts.
It is time for serious investors to stop pretending higher stock prices are a benefit and that “management alignment with shareholders” will improve company performance over any sensible term beyond the current quarter or year.
Good one, Mr. Blair! Even a single investor is not constrained to have one strategy. I am happy to hold PEY, WCP and PPL for dividends, other names for capital appreciation. Those dividends allow me to redeploy cash on a regular basis in whatever opportunity is most interesting. When no dividend is paid, there is an incentive to trade the stock and there are volatile names that lend themselves to that, too. Broadly speaking, that may be part of corporate strategy, but the main focus should be on performance of the business, not the stock.