Stock Ownership by Management
I just heard a proposal that companies should require of their top employees, that they own an amount of stock in the companies they run equivalent to 4 years salary.
This is in contrast to the common practice of granting options at specified future times to buy stock.
This proposal causes these executives to focus on the long term state of the company and take a portion of the downside as well as the upside that stock options provide.
The comment was the Gerstner imposed such conditions when he headed IBM and that preceded a turn-around for IBM.
This sounds like a good plan but it raises two questions:
It seems to me like institutional investors are in a good position to push for such requirements on management.
- Not all companies are in a situation where the best interest of the stockholders is to grow the company.
In 1910 builders of buggy whips could best serve their share holders by efficiently winding down the business and this would provide the maximum return to the investors.
This is predicated on a few things:
Assuming that the company was making a modest profit in the supposedly commodity buggy whip market, production can be wound down, prices maintained, and assets sold off.
The alternative often taken is to lower prices to an unprofitable level and go bankrupt.
Even in this case proceeds of sales of assets can be distributed to shareholders as dividends and the managers owning stock are correctly motivated.
- There is no significant institutional strength other than making buggy whips.
- The assets are not so specialized that they cannot be sold off.
- The other question is whether stock prices reflect preparation for long term growth.
If they did then effective short term planning and long term planning would have equivalent positive effects on the stock price and stock options would not have the reported disadvantage.
I think that prices usually don’t reflect long term planning and this needs to be explained.
Perhaps it is as easy as ‘asymmetric information’ between the company and stock purchaser.
This in turn has two possible sources:
Even if stock price reflected good long term preparations, requiring stock ownership sounds like a good requirement on management.
- Some long term plans are validly confidential,
- The plans are valid but difficult for a non specialist to comprehend.
How do you attract competent management to a company with poor prospects?
It seems clear that you must pay them more under this plan.
If you cannot afford that, it is perhaps time to close down the company.