Saturday, July 21, 2018

Managers Behaving Badly

This has been a banner week for embarrassing corporate manager stories.  In addition to the sudden resignation of Texas Instruments CEO Brian Crutcher for unspecified code-of-conduct violations (echoing the earlier, sudden firing of Rambus CEO, also for unspecified conduct violations) and Paramount’s firing of Amy Powell for racist commentary, Tesla’s Elon Musk ran into public relations trouble after a revelation that he donated to a Republican PAC, from which he cannily diverted attention by accusing one of the Thai cave diving rescuers of pedophilia.  Meanwhile, Papa John’s Founder and Chair John Schnatter – who previously was forced to resign as CEO after white nationalists were too enthusiastic about his condemnation of the NFL and protesting football players – was revealed to have used a racist slur on a conference call designed to prevent his racism from creating PR disasters.  That incident caused the Board to strip him of his chairperson title and remove his face from marketing materials, while the University of Louisville took his name off of its stadium.  Later, Forbes published an expose on the sexist and unprofessional culture at Papa John’s that he enabled – which incidentally confirms Ben Edwards’s post linking corporate cultures that tolerate sexual harassment to corporate cultures with other kinds of dysfunction.

Schnatter plans to fight to have his position restored.  Meanwhile, there’s no sign that shareholders or the Board of Tesla plans to remove Elon Musk, but shareholders are certainly beginning to chafe at his relentless attention-seeking

In both the Musk and Schnatter cases, the shareholders may have minimal options.  Schnatter owns roughly 30% of Papa John’s stock, and he has not resigned from the Board.  It is unclear what the next steps are going to be but he may be tough to oust, and may even be able to regain his Chair position.  (It would be awfully entertaining if he was forced to mount a proxy contest to maintain his seat but I assume one way or another it won’t come to that).  Meanwhile, Musk, who owns around 21% of Tesla’s stock, was deemed to be a controlling shareholder by a Delaware court, and thus would also be difficult to dislodge even if shareholders were so inclined.  Moreover, both Schnatter and Musk are paid in additional stock, which only increases their hold over their respective companies.  When Schnatter was CEO, roughly half of his compensation came in equity; as a director, his compensation package is smaller but still includes equity.  Musk shareholders, meanwhile, recently approved a massive equity award that could be worth as much as $50 billion if Musk meets certain milestones.

(Of course, it’s not impossible to get rid of a troublesome board member with a large but minority position -– as American Apparel can attest – but it isn’t a picnic, either).

Now, the trend of paying corporate executives in stock rather than cash is relatively recent; it took off in the 1990s as a way of aligning executives’ interests with shareholders’ interests.  And there are arguments about it back and forth – some say it encourages short-termism, others respond by saying you can have long term vesting schedules that alleviate that effect, there are disputes about how to design pay packages so they reward shareholder return rather than market conditions, etc – but one remaining concern might be that stock awards result in greater managerial control over their companies and therefore insulate them from shareholder discipline.

So, I ask – and I’ll admit, there are a lot of people who have thought very deeply about executive compensation and appropriate incentives, and I am … not one of them, so this may be either unhelpful or banal – but since dual-class stock is all the rage, have we considered paying corporate executives at least partially in nonvoting stock?  It could be structured to have all of the economic benefits of ordinary stock, and even automatically convert into voting stock as soon as the executive transfers it to a nonaffiliate (assuming, of course, the stock comes with the same restrictions/vesting schedules etc that ordinarily accompany such awards to prevent short-termism).  That way, corporate executives would be rewarded financially for increasing shareholder value, but their control over their companies would not be tightened.  The thinking here is that corporate execs already have plenty of control – they don’t need more – and shareholders may want to reward their financial performance without simultaneously further insulating them from market discipline. 

(To be sure, managers’ control doesn’t come from stock compensation alone – in Papa John’s case, for example, it appears that Schnatter increased his control from 27% to 30% in part through aggressive corporate buybacks, in which he did not participate, than through awards directly.)

But it seems like this is something worth trying.  Sure, there are plenty who argue that managers/founders should have more voting control so that they have room to innovate – here’s the latest paper I saw on that subject, which says yes but only under certain conditions – but that’s not usually the goal of stock compensation, which may unhelpfully conflate two separate things, namely, economic compensation and insider voting power.

https://lawprofessors.typepad.com/business_law/2018/07/managers-behaving-badly.html

Ann Lipton | Permalink

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