Bad managers can wreck your investments – here’s how to avoid them

It looks like we’re set for another round of hand-wringing over executive pay. Some in the EU plan to control the ratio of a board’s pay to that of the average worker in the firm. It’s also a highly controversial topic in the US.

In 1965 the typical American CEO earned around 20 times the average worker; today, it’s well over 200 times.

Concern over income inequality is the latest incarnation of the desire to control pay. A few years ago we worried about ‘golden parachutes’ – the provision of big pay-offs for CEOs who had failed. More recently there’s been a desire for vengeance against bankers. Their bonuses have been regulated, specially taxed and in several high-profile cases, voluntarily waived.

If they’re too embarrassed to draw their pay, you know something really isn’t right.

But I don’t think these governance issues get solved by legislation. Running companies well, which includes setting executive pay and incentives, is largely a cultural issue. In fact, passing laws can do more harm than good. How then do we get the culture right and find those companies that really run themselves well?

They don’t make it easy for us

I don’t think we find them just by looking at how well a company complies with all the rules and codes of practice that have sprung up over the years. Open Barclays’ latest annual report and you’ll find a staggering 78 pages on ‘governance’. I started my working life as a banks analyst and I doubt whether the first annual reports I reviewed were this long in their entirety. The Barclays remuneration committee report alone runs to 41 pages.

Compiling these reports and dreaming up convoluted pay schemes has become an industry in itself. As investors, we’re deluged with information. We’re distracted by it and can’t see the wood for the trees. As a result the whole thing can degenerate into a box-ticking exercise; checking that there’s the requisite number of independent non-execs, or that option schemes have appropriate performance criteria.

It all leaves little time for thinking about qualitative issues, and about what sort of pay is appropriate and sensible.

The truth about bankers: they’re replaceable

But when you try legislating around the problem, some pretty silly things can happen.

For example, restricting the size of a banker’s bonus to 100% of basic pay resulted in salaries being increased to compensate. So more of the pay package is guaranteed and less is variable. Which means the banker will be better off during those tough times when shareholders and the broader economy are suffering. Whatever rules are introduced, you can bet there will be plenty of effort and imagination put into getting around them.

However, none of this addresses the central issue of what’s the right amount to pay people. In the words of Barclays CEO Anthony Jenkins, huge pay packets are necessary to “prevent a death spiral” of staff leaving.

But are those footloose employees really irreplaceable? Why not try calling their bluff? I just don’t believe that there’s such a tiny pool of specialists uniquely capable of running a bank.

For the man at the top of most very large companies, the job’s mainly about administrative skills and the ability to allocate capital sensibly. Those genuinely rare qualities of creativity, entrepreneurial flair and risk-taking, aren’t really that desirable in a big company CEO.

And those star traders and deal makers that Mr Jenkins is frightened of losing aren’t all that rare either. They look good largely because they’re benefiting from the decades of goodwill and capital accumulated by Barclays. The corporate brand name, all those contacts, business flow and huge financial backing are what really delivers the goods. Often those top traders struggle when they move to the unforgiving glare of a hedge fund. Or the great deal maker will find he’s a lot less productive in a boutique bank.

Don’t invest in a toxic culture

What’s needed is a change in the culture. I just wish I knew how to initiate it. Institutional investors must play a bigger role in this. Somehow a broad consensus has to emerge in the business world. Otherwise we can look forward to more half-baked legislation.

In the small company arena that I focus on, these issues are less acute. The resources usually aren’t there to pay outlandish salaries in the way they are in big corporates. On the other hand it can be easier for smaller companies out of the spotlight to coast along without their leaders being put under pressure to perform.

Governments don’t have a good record on this problem, and neither do shareholders as a group. So what can you do as an individual investor to avoid getting fleeced by management?

I look for:

  • Bosses’ salaries that are on the same planet as those paid to the workforce.
  • Incentive plans or share option awards that are simple to understand and linked to the long-term performance of the company.
  • Directors with a meaningful personal shareholding.
  • Most importantly, one or two strong non-executive directors are a great comfort. As well as providing guidance on strategy, I look to them to ensure the business is properly run and to ask the right questions of the CEO.

Ultimately I doubt there’s a single set of rules or formula for governing companies. It’s about paying directors and workers sensibly; having clear, simple incentives; and looking after your customers really well. It’s about getting the culture right, starting at the top. And if the CEO thinks like an owner who’s in it for the long haul… then you’re well on the way.


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  • Dissatisfied

    I have never believed the “lie” so often used by company heads that they have to pay a very high salary to retain the best, otherwise they will leave. The second “lie” used is the one which says that they have to pay the same amount comparable to another organisation’s head. Both are utter nonsense and these organisations know it! There are many skilled men and women who are able to hold these positions and accept a lower remuneration and would do just a good or even better job than the present incumbents.

  • LuckyDave

    Entirely agree that these bankers are replaceable. I cannot think of any other business where the key players get paid more in bonuses than the shareholders get in dividends. Unfortunately our politicians will not get things sorted out until their interests are aligned with the rest of the population. It the pensions of politicians and senior civil servants were defined contribution instead of defined benefit, I am very sure that something would be done. They have already proved that they very focussed on looking after themselves, so that if they saw by changing the game play that they would get better pensions by creating a market which was much fairer to the “squeezed middle” and the prudent who have saved for their future, we would all be much better off. Since this would be like turkeys voting for Christmas, I am not holding my breath. However, I am sure that it would make an enormous difference.

  • I read this as meaning I could apply for ‘fixed protection’ now, if I ceased making further contributions. Not as simple as that. As well as there being varieties of ‘protection’, none of them seem to apply unless you already have, now or on 5/4/2014

    The Swiss recently had a referendum to limit top brass pay to a multiple of the lowest paid employee in the same company. They picked an aggressively low multiple (20 iirc?) and it did not pass. But not by too much and the thought is out there now. Maybe if they try again at 25 or 30?
    The new EU rules on bonuses are puerile, as in a child could see how to get around them. As you say they just increase the fixed costs, which is far worse. And why only on bankers? Having spent a career in investment banking, some of the top guys are seriously impressive, but most are quite average really. As for traders, many a bear of very little brain has moved from the back or middle office to the front office, if their face fitted. In many cases the same people then developed monstrous egos in a hurry. But they are completely replaceable. The bonus culture should at least weed them out fairly quickly when they fail, except that it encourages extreme risk taking and short-termism. Also even the failures still seem to get taken on again somewhere else. So what to do? Well the Swiss solution tickles my fancy, for base salary. But also shareholder governance on incentives. Can we please have some legislation on both? So base salaries could be capped at some vaguely realistic multiple of the lowest. And incentive packages need to be governed more strictly by the owners of the business. One problem I see here is the nominee system of share holding. I own shares in many companies through a SIPP, but I do not get to vote at any of their meetings (nor get any shareholder perks)(nor do I get to veto lending of my stocks, to allow hedge funds to crash the prices of them). So I propose that it be mandatory that individual shareholders get these facilities. I know it will increase admin a little, but the providers will enhance their systems to cope and competition will still keep them honest. I strongly suspect that if the non-voting nominee holdings suddenly become active, the remuneration committees will fail to get their ludicrous proposals passed.

  • Chris N

    You’re quite right about calling the bluff of the irreplaceable bankers
    A few years ago a senior trader at a boutique did an experiment where he hired 8 people off the street – gave them £1mm of his own money to invest and then compared their performance to that of his regular trading staff. The housewife / the student and the IT technician all comfortably outperformed the ‘star’ traders over a 3mth period.
    It made great TV and also showed that most out-performance is luck not skill.
    As for compensation inequality, I’ve thought hard about this and think there is a simple way to start to reverse the trend …
    … compel every company as part of its annual return to provide a stratified analysis of employee compensation.
    There could be some flexibility in how this is compiled (you could separate full-time / part-time and consultants say) and it should also comprise ‘total’ compensation including base salary / bonus / benefits / pension contributions … again segregated if desirable. After a couple of years of reporting we would revert to a more directly comparable mean as the results would be discussed in the public domain.
    This would also be fascinatingly illuminating for main sectors other than banking bonuses … we would see that the pension entitlement benefits accruing to Firemen, say, were worth 50% of base salary … we would see board members of very modest charities taking six figure packages in salary / benefits in kind
    I truly believe this would force the full glare of public anger to force many companies to change their policies and it could be accomplished by a very simple Accounting Standards change

  • Radicalman

    13/3/2014, Radicalman wrote:
    Anyone who has worked in the finance and banking industry knows that for the upper echelons there is a very cosy tacit understanding that outrageous remuneration packages will continue to be paid because they simply go unchallenged and in those circumstances everyone in the “club” wins. The argument that “stars” will walk if they don’t get paid is absurd; that can be easily tested. All of this is the fault of the shareholders as represented by their similarly overpaid fund managers who are also focused on short term gains and have no wish to rock the boat. It’s called greed and it is made possible because the bankers know that their bank will not be allowed to fail. That would cause national chaos. The remuneration committees, which the bankers love to cite as a safeguard, are ridiculous because the members sit on each others remuneration committees with totally predictable results.
    These people follow the old rule, “charge what the customer will stand” – the customer in this case being the unwitting shareholders. It does need a shake up.

  • Longtermyieldman

    I agree that most executive directors are overpaid, and in particular that LTIP schemes are bad at aligning managements’ interests with investors’. In particular, managements can only gain in good times – they don’t lose in bad. And if the business goes through a bad patch, resulting in the LTIP not paying out, there’s a perverse incentive to throw in the kitchen sink and drive down the share price as far as possible to ensure the next options are rebased to the lowest possible price.

    Underlying causes? I’d highlight three:

    1. Managements are largely answerable only to themselves, not to shareholders. This could be solved by electing non-execs from within the shareholder group and putting them on a supervisory board with the power to hire, fire, and set pay;

    2. Companies have fewer long-term shareholders than ever before: the average hold period for a London-traded stock is around six months. This could be changed by altering the tax treatment of swaps/CFDs, share trades and dividends. Currently society imposes the lowest taxes on the highest-frequency stakeholders and the highest taxes on the long-term holds: this should be reversed;

    3. More diversity needed. I don’t mean hiring one-legged black lesbians (unless they’re good at the job) to hit quotas, just taking a more open-minded approach to senior hires. Alumni of investment banks and McKinsey do not have a monopoly on high IQs (still less, EQs), nor on good ideas – as is shown by the achievements of maverick entrepreneurs, many of whom would never make it to the conservative headhunters’ shortlists. Oh, and talking about being short, in the UK and US our archetype of what makes a good leader includes, strangely, the idea that he or she should be abnormally tall. So if you want to save money on your next board appointment, put together a shortlist of shorties. Chances are they’ll be flattered by the approach, and won’t demand top dollar…

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