That's the theory, anyway. You've probably heard it before. Now the time has come to take a critical look at it.
Why now? you might ask.
Because there are some good reasons to think that this practice is bad business for the companies doing it, and also because it has been harmful to America's overall economy in the recent past, and--if the practice is allowed to continue--it will once again harm the country at some unknown time in the future.
Executive stock payments are bad business
First, the obvious: paying senior executives in stock is bad business for the company doing so. One of the foundations of good business management is "pay for performance." In other words, an employee's earnings are tied directly to that employee's success in carrying out the duties and attaining the objectives associated with that person's job. Employees typically are paid based on an evaluation of how well they achieved their business or work objectives during the most recent work evaluation period. If you are an employee, just try justifying to your manager that you deserve a pay raise mostly because of how much better you will do in your job in the upcoming year when compared to your lesser performance in the year past. I think that most people realize this is not a compelling case, with the exceptions of people who are CEOs and other C-suite residents.Paying an employee--any employee--in stock is not paying for performance. Why? Because the nature of financial markets is to value a corporation's stock more on future expectations than on past events. Therefore, paying an executive with stock is basing that employee's compensation on future expectations and not on measurable, tangible and actual attainments. Doing so is bad business management, not only for the reason described earlier, but also because it does nothing to foster the concept of teamwork. Teamwork depends upon mutual respect among the team members, but how can mutual respect be accomplished when the financial rewards that are offered are performance-based for some members, but are expectations-based for other members? Perhaps it can be done, but I suspect that would be the exception rather than the rule.
Proponents of the executive stock compensation scheme will argue that such payment will motivate the individual to perform at the highest level, because that will tend to maximize the future value of the company's stock. In some cases this might happen, but it doesn't change the basic fact that this is still payment for expectations, and not payment for performance.
Is the truth out there?
Which takes us to the second, and not so obvious, objection to this practice: paying senior executives in stock is an open invitation to misrepresentation of the company's expected future performance. The stock market values securities largely on expectations of future performance; how are those expectations developed? Good for you! You've already figured this one out -- expectations about a company's future performance are built in large part on statements made by that company's senior executives, as well as information provided by key employees who work under the directions of those same executives. This is clearly a conflict of interest.The opposing argument here is going to say that the system is self-policing, whether by an errant executive being fired or by that person eventually suffering a loss in wealth due to the eventual depressing effect on the stock price once a misrepresentation is found out. To which I would rebut: So what?!? The executive in question didn't pay anything for the stock in the first place, so that person lost nothing, but just didn't profit as largely as originally expected (perhaps).
A more thoughtful rebuttal--and a more compelling one--would be: Well, what about all the other people who might simply be outside investors and who become "collateral damage" to the offending executive's implosion? And, what if such downstream damage becomes so widespread that it threatens wealth destruction on a major scale?
Watch the dominoes fall down
And so now we come to the third and most important reason to cease this practice of compensation-by-stock: When misrepresentations--or even unintentional misstatements--snowball into a perfect storm of systemic value destruction, then America's economy will once again face an existential threat, just as we did a few years ago in 2008 and 2009.After all, what was at the center of the failures of Bear Stearns, Lehman Brothers, AIG, Countrywide Financial, Washington Mutual and hundred of other companies if not misrepresentation about future performance, and senior executives whose compensation plans included generous grants of corporate stock?
It all comes down to this: use the basics and succeed
There's merit in employee ownership of an employer's stock. Management and senior executives are employees, too, and are entitled to participate in the ownership of publicly-traded stock in their employer. However, there is no merit in creating an environment where a select few employees become highly-favored participants in that ownership, thereby making them different from all other employees in substance--methods of performance evaluation and of ownership acquisition--as well as different in degree--amount of compensation. Such an environment is counter to fundamentals of good business management, and it creates opportunities for manipulative behavior.The American economy does best when its publicly-held businesses are guided by the best business management possible, and when opportunities for financial manipulation are quashed as soon as they are found out. Executive compensation that includes generous stock grants goes against both of those themes, and that's why it's a practice that must be stopped.
