Saturday, October 25, 2014

Rewarding corporate shareholders and employees, the right way?

This comment looks at how public corporations reward shareholders and employees, and which choices may be more effective and which have some potential flaws.  Why?  It's a long held interest based on work experience  These choices include buybacks, dividends, market share and revenue growth, and EPS growth for shareholders, and for employees there are dividends, stock options, stock grants, salaries, and cash bonuses.  This may take some time.

For shareholders, the more than obvious best way for a corporation to reward shareholders is by growing revenues, being efficient, building market share with quality products, paying attention to customers, and increasing earnings per share.  The stock price should follow good performance in those areas over time.  Dividends are also important for many shareholders, as even though they are taxed, they are cash distributed to be used by shareholders for their own needs or for investments in whatever way they see fit.  The fact that they are taxed could be viewed as unfair, since corporations have already paid corporate tax rates on their earnings, so why they are also taxed when distributed to their owners seems a little like double taxation.  The government is not inclined to see it that way.

Then there is the widely accepted but not so clear cut issue of stock buybacks.  It's just simple math that reducing the number of shares outstanding will increase earnings per share, all things being equal.  It's not that simple.  Buying back stock is unequivocally in management's best interest, not necessarily shareholders, if stock options are a major form of compensation.  Share buybacks, under any general historic analysis, are unfortunately more often done when the stock is at a high price and is no bargain.  That is due to the fact that the idea of buybacks being wonderful usually arises when a company has excess cash, that excess cash being due to good financial results that are probably already reflected in the stock price.  Buybacks can divert cash from R&D, employee compensation, and new investments for growth, as well as from rainy day needs if they unpredictably come.  On the surface one could ask, "if there is no good investment alternative internally, how can a company grow?"  Buybacks done carefully and conservatively can be constructive, but at times they are not.

At the moment Carl Icahn is hysterically lobbying Apple, and the market, for Apple to significantly raise its buyback plans.  Carl Icahn has never done anything to benefit the long term prospects of a company, its shareholders, or its employees.  If he would get his desired level of buyback from Apple, he would more than likely be out of the stock within a year.  Carl Icahn only does things to benefit Carl Icahn.  The market and media seem to treating Icahn with more respect these days, presumably due to his age and staying power and money making prowess.  From this perspective he deserves no respect.

Good straightforward corporate performance and demonstrated growth trumps all financial engineering as way to build shareholder value.  IBM has, without question, reconfirmed that in a negative way.  CEO Ginny Rometty seems clueless when she tries to reassure shareholders about the dilemma the company is now in, now out of tricks.

Looking at employees, they can benefit from an array of compensation plans, and the further these go down into the ranks the greater the potential for better morale if done right.  Stock options offer the potential for a bonanza for upper level employees that receive large allocations.  Referred to by some as "corporate lottery tickets", it is unclear how these restricted benefits directly affect motivation or morale.  If the overall market and the company are doing well three years or so after a grant, and on for another 10 years generally, the big paydays will come, but those paydays can seem somewhat random except for the top tier of the firm, which gets bundles of options year end year out.  Someday they will they have a great chance to win the lottery.  For middle management that potential exists as well, but they don't have control of the buyback plans in order to influence the outcome. Guess who does.  When companies with declining stock prices are stressed and trying to keep employees on board they have a tendency to materially increase the number of stock options awarded, and then risk considerable dilution in the future.  It's worth the risk for the big shots, but it is not necessarily positive for those in the middle.

Stock grants are often seen as a much better near term motivator.  They will generally be restricted as well for around three years, but they represent value in hand when they vest, and any dividends come with the package.  Long term employees tend to be long term holders of this stock, whether it is wise or not.  Cash bonuses are welcome by all even if taxation eats away at the amounts.  Hey, it's immediate cash.  Some firms offer plans to defer that cash into long term annuities that are attractively structured, a great deal if an employee does not have an immediate need for the cash.  These cash bonuses are also welcome and in fact absolutely necessary as the days of automatic salary increases are over.  That was the case before this near zero interest rate environment and is more set in stone now.  To get any notable salary increase requires a meaningful promotion in most companies.

The rewards for shareholders and employees to benefit from a well run company are clear cut, but without question do depend on overall economic outcomes and financial market health.  The one group of people who are both shareholders and employees that seem guaranteed to do well are those at the top echelons of a company if they don't screw up royally, and even then they often end up in amazingly good shape.  Much has been written about this phenomenon, but putting the genie back in the bottle does not seem to be on corporate America's mind, and that is almost certainly not a good thing longer term.  Independent directors and shareholders eventually need to step up to this crucial issue for corporate oversight.

Getting this right will be politically and culturally important over time, or is now.  Change on this issue will be corporate driven or eventually forced by the government at some future time.  Taking on the issue at the corporate level is the much preferred outcome.

It's not too late.



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