What worries me about executive compensation is how much of it depends on stock prices. The stock market is notoriously short sighted. So basing compensation on stock prices means we are training management to look at the very short term.
I’m not writing about top-heavy compensation of CEOs. That’s the more fashionable issue these days. This isn’t about that.
No, I’m writing about the problem of having so many people in so many publicly traded companies getting paid according to stock prices. While that makes make sense in theory, I don’t think it works well in practice. The stock market rewards the short term over the long term. Is that what we want executives to do? Is that good management?
I saw this close up in the 1980s. I was consulting with Apple Computer. Apple’s price premium constrained its market share, but popped its margin up to 50% when the rest of the industry was running 30% gross margins. What kept the market share down kept the stock price up. Apple could have led the market with superior technology, but instead, it made a lot of short-term money.
The way I heard it, Apple chose short-term margins instead of long-term position because the key decision makers were paid to keep the stock price up. You do the math – looking at the long term you make half a million dollars a year, but looking at the short term you make three or four million. Maybe I have that wrong (if you know, tell me) because I was doing strategy for international groups, not the main corporate offices. Still, it seems like an obvious case. Pay the executives for higher stock prices and you get executives who care only about the short term.