Firms Give More Stock Options When They’re Committing Fraud

Firms Give More Stock Options When They’re Committing Fraud


When you have a Board role, remember this study and keep your focus straight on the shareholders interest …MALTAWAY BOARD GOVERNANCE AND NON EXECUTIVE DIRECTOR (NED)


Whistleblowers can play in a big role in uncovering financial misconduct. For example, look at Sherron Watkins, formerly of Enron, and Cynthia Cooper, formerly of WorldCom. Both women helped uncover massive frauds inside their organizations that ultimately cost investors billions of dollars.

Research suggests that employees are often in a position to discover and expose wrongdoing in organizations. This may be why the 2010 Dodd-Frank Wall Street Reform and Consumer Protection Act encourages employee whistleblowing: Section 922 of the Act promises to protect whistleblowers from retaliation and offers monetary awards for disclosure, which range from 10% to 30% of monetary damages collected from the company. Since this program was established, the Securities and Exchange Commission (SEC) has granted more than $111 million in awards to 34 whistleblowers, with the largest award of $30 million granted in September 2014.

While protection and rewards may encourage more employees to come forward, firms may be able to counter these incentives by making it beneficial for employees to keep quiet. In a study recently published in The Journal of Accounting and Economics, we examined whether firms use financial incentives to discourage whistleblowing. Although there are many kinds of financial incentives, we focused on stock option grants to rank-and-file employees, as this data are more readily available. Further, since the value of stock options is directly tied to the value of the firm’s stock, and because whistleblowing allegations result in an immediate decline in the firm’s stock price, employees stand to lose financially when they blow the whistle. In addition, employee stock options typically have vesting terms that require employees to wait a few years before they can exercise their options, which may act as a disincentive to blowing the whistle before they’re able to exercise their options.

Using a Stanford Law School database, we identified a sample of 663 firms that were alleged to have engaged in financial misreporting and were subject to class action shareholder litigation in U.S. federal court from 1996–2011. We examined the number of stock options granted to rank-and-file employees during the period of alleged misreporting, and we found that these firms granted more stock options during the misreporting period than did a benchmark sample of 663 similar firms that were not being investigated for financial misreporting. Option grants by these misreporting firms varied over time. Specifically, misreporting firms granted 14% more stock options to rank-and-file employees when they were allegedly misreporting their financials, but the number of options they granted decreased by 32% after they appeared to stop misreporting. These findings suggest that these firms granted additional stock options strategically during periods of alleged misreporting.

We also found that these efforts are effective. Misreporting firms that granted more stock options to rank-and-file employees were less likely to be exposed by a whistleblower. Approximately 10% of the firms in our sample were subject to a whistleblowing allegation. Firms that avoided a whistleblower granted 78% more stock options than these firms did not.

Because our sample consists only of misconduct that was discovered, our findings can’t speak to firms that engaged in financial misconduct without getting caught. In addition, our evidence is circumstantial, in that we cannot directly observe the underlying motivation for employers’ stock option grants or employees’ whistleblowing decisions. Nevertheless, while Dodd-Frank encourages employee whistleblowing by offering financial incentives of up to 30% of recovered damages and penalties, our findings suggest that firms may offer their own financial incentives to discourage whistleblowing.

Although we examine stock options grants as the primary mechanism for employers to discourage whistleblowing, there are others tactics firms can use as well. In fact, recent media reports indicate that the SEC is investigating other ways in which firms subvert whistleblowing, including having employees sign confidentiality agreements and creating severance contracts that prevent employees from contacting regulators or benefiting from government investigations. As legislators evaluate the efficacy of whistleblowing regulations, they should remember that the firms they are trying to regulate are not silent bystanders — companies can take action to discourage employees from speaking up.

Tips from headhunters to Board Members

Tips from three leading headhunters

Directors must ask the right questions and support — and challenge — chief executives


Even here in Malta this issue arises with relevant importance and validity , partly because the high number of foreign companies present in Malta, in order to be compliant with international standards for tax purposes (see the case of dummy company and tax inversion) , must have a board of directors with directors and NON EXECUTIVE DIRECTOR , residents in Malta, supporting and providing clear and convincing evidence that the foreign company is effectively managed from Malta.

Furthermore having a NED with international experience in the BOARD, reinforce widely the diversity, independence and compliance requirements for a better Corporate Governance, Leadership and Business results

30+ years Board, Governance, Investment’s  experience and practice for YOUR BOARD needs and solutions


Virginia Bottomley
Chairman, Odgers Berndtson’s Board & Chief Executive Practice

The former Conservative cabinet minister turned City headhunter joined Odgers in 2000 and has battled to change attitudes towards women in senior roles. Key appointments by her team have included Carolyn Fairbairn as the first female director-general of business lobby group the CBI, Susan Kilsby as chair of pharmaceutical company Shire and Inga Beale as chief executive of Lloyd’s of London, the insurance market.

Ms Bottomley was born in Scotland and educated at the University of Essex and the London School of Economics.

What is your best advice for someone seeking a board position?
Excel in a particular area, whether that is leadership, finance, managing large profit and loss accounts or international exposure.

What makes a successful chief executive or board member?
Courage, tenacity and values. Listening is also an essential and underrated quality. Being in the right stage of one’s career in the right place and at the right time means that luck inevitably plays a role. But truly talented individuals with distinct experience and perspectives will always be singled out.

Excel in a particular area, whether leadership, finance, managing a large P&L or international exposure

Virginia Bottomley

Why has progress in increasing diversity on boards been so slow?
Only five years ago, barely 10 per cent of FTSE 100 board directors were female, so, while it may feel slow, there has been progress. But more work is needed. It is increasingly important to identify those less obvious aspects of diversity, such as diversity of thought, perspective and experience.

There is growing concern about executive pay. Are you concerned that chief executives are paid too much?
Some executives are paid too much relative to performance and the value they end up delivering. Equally, chief executives who create long-term, sustainable shareholder value are worth every penny. We are encouraged to see shareholder initiatives that keep the spotlight on this critical issue, such as the report by the Investment Association earlier this year, which noted growing investor and company concern about the level and complexity of executive pay.

To what extent are headhunters responsible for creating a market struggling to keep a lid on executive pay and to create more diversity?
We put forward the best possible candidates for each and every role based on a large number of considerations, of which remuneration should be only one.

Ultimately, pay is for boards to decide. We act as an independent third party, so play a part in encouraging boards to consider the widest pool of talent.

Raj Tulsiani
Chief Executive, Green Park Interim & Executive Search

Raj Tulsiani has pressed for greater ethnic diversity on City boards, most recently contributing to a review by Sir John Parker, chairman of mining company Anglo American, which recommends that boards appoint at least one non-white director to every FTSE 100 company by 2021.

An adviser to the Metropolitan Police and the Prime Minister’s Implementation Office on diversity, Mr Tulsiani also won the mandate to refresh the board at Transport for London. Before co-founding Green Park, Mr Tulsiani, who is of Indian and French descent, was a manager at Michael Page, the staffing agency.

What is your best advice for someone seeking a board position?
You have to have some of the skills and background, which you can often gain by joining voluntary or third-sector boards and learning the language. People can become pigeonholed as a good hospital non-executive director or school governor, but the difference with company boards is not as big as you think.

Also, understand the rationale behind each appointment. People might think the process of appointing non-executive directors is a meritocracy and that they can turn up and be the best candidate. But there are a lot of opaque and unwritten rules. Ask questions, test the waters and bring something authentic to the table.

What makes a successful chief executive or board member?
Realistic optimism, a strong way of communicating risk, being able to increase organisational trust and being able to see order in anarchy.

Understand the rationale behind each appointment. There are a lot of opaque and unwritten rules

Raj Tulsiani

Why has progress in increasing diversity on boards been slow?
People do not want greater diversity on boards. They quite often want people who are the same but “different” — they want skin-deep diversity. For example, you include women but they all come from upper middle-class backgrounds.

Also, progress has been slow because the headhunters who execute the majority of board appointments have very little credibility with diverse communities, partially because they have no experience of them and they do not understand the differences between mindsets and cultures.

Most search firms have been trying to boost their diversity credentials through marketing and so forth in the past few years. But you do not build insight, resonance and trust through expensive coffee mornings or posts on a website.

What role do headhunters play in increasing diversity and to what extent are they responsible for the lack of it?
Headhunters often decrease diversity, so they are as responsible as the clients. Executive search is also an institutionally prejudiced industry sector, which gives bad or “safe” advice based on “expert testimony” without data or real insight.

It is impossible to have more diverse boards without more diverse supply chains. Look at what percentage of ethnic minorities on the boards of the UK’s biggest listed companies are British passport holders or how many women on boards went to the same six elite universities.

Are chief executives and board members paid too much?
No, they deserve the money they earn and more — but only if they drive performance and inclusive cultures.

Jan Hall
Chairman and chief executive of Heidrick & Struggles/JCA’s UK Chief Executive & Board Practice

Jan Hall sold JCA, the headhunting business she co-founded in 2005, to Chicago-based Heidrick & Struggles in August. Heidrick promptly added JCA to its name, underscoring her power within the City.

Ms Hall’s placements include Marc Bolland, whose tumultuous time as chief executive of Marks and Spencer came to an end in April, and Carolyn McCall, chief executive at easyJet. Before founding JCA, she was a senior partner at Spencer Stuart, another executive search firm.

Try to understand the business in the round — the entire company. And make sure people know you are there

Jan Hall

What is your key tip for securing a board-level appointment?
Understand the business in the round — get to grips with the entire company. Make sure people know you are there.

What makes a successful chief executive or board member?
The ability to ask really good questions in a constructive manner. To challenge executives in difficult times and to support them at others.

What role do headhunters play in increasing diversity and to what extent are they responsible for the lack of it?
The argument has been won that diversity is a good thing. The real issue is getting diversity coming up through businesses. We need the skill sets in the candidate pool to be there. But if boards are focused on looking for diversity, they are more likely to find it.

Are chief executives and board members paid too much?
In a global marketplace there is a real problem with levels of remuneration. In the US people are paid much better so we have to compete with them.

Thx to FT, see the article here 

The Real Cost of an MBA and US ranking

The Real Cost of an MBA

To figure out the true price of a business degree, you have to factor in the opportunity cost.


After working for eight years in accounting and finance, most of it at PwC, Tully Brown knew it was time to deepen his business skills. So he did what a lot of young professionals in his shoes do: He went for an MBA.

For Brown, who enrolled at Emory University’s Goizueta Business School in 2015, the biggest cost wasn’t tuition, fees, and housing. It was the six-figure job he gave up to attend school full-time. “Being a numbers guy, I actually modeled it out,” he says. “I looked at what would happen, because there was the possibility I’d end up leaving and making the same that I did before going in. I decided it was worth the risk.”

The typical incoming MBA student at Emory earns $67,000 the year prior to enrollment. Multiply that by the length of a two-year MBA program, then add to it Emory’s cost of attendance, and you get $296,536. Using the forgone salaries reported by thousands of recent graduates as part of Bloomberg Businessweek’s annual ranking of the top full-time MBA programs, we were able to create a similar “real” cost figure for several of the schools on our list. Stanford Graduate School of Business had the highest full-freight cost, more than $434,000, because those in its MBA program earned more when they enrolled.

Each year, we rank business schools by polling students on topics such as academics, career services, and campus climate. We also ask employers about the skills they seek in MBA hires and which schools best prepare their graduates. Starting in 2015, we began surveying alumni, asking them how well their degrees had delivered on the promise of a fulfilling and profitable career.

For the second year in a row, Harvard Business School came out on top—and this time by a wider margin. HBS was rated No. 1 by the more than 1,000 corporate recruiters we surveyed and No. 3 among alumni. Competition for the No. 2 spot overall was particularly close this year, with Stanford edging out Duke University’s Fuqua School of Business by less than one index point.

Unlike undergraduate students who are often giving up low-paying jobs to return to school, MBA students are typically in their late 20s or early 30s and leaving well-paid positions. That makes calculating the opportunity cost even more significant for MBA seekers. Because Bloomberg Businessweek surveys B-school alumni on the salaries they drew before enrolling in a full-time MBA program, we were able to calculate the true cost of the degree. Our formula isn’t perfect. It includes the loss of two years’ worth of wages, even though some students don’t go a full 24 months without working, and some have well-paid internships during the summer break. In addition, we weren’t able to factor in financial aid or scholarships.

Schools’ cost-of-attendance breakdowns don’t reflect the income students give up during their time in school. B-school officials say MBA applicants should definitely add that cost to tuition and other expenses when calculating a projected return on their investment. It’s “a large number, there is no doubt about it,” says Douglas Skinner, interim dean of the University of Chicago Booth School of Business, noting that some students may need to take out loans to also cover the lost wages. Still, Skinner stressed that prospective students need to understand that the knowledge obtained through the degree will help boost their earning power not just immediately after graduation but throughout their careers.

That’s why Brown says he didn’t mind leaving a well-paying job at a community bank in Atlanta to enroll at Emory. “It’s hard to know in 10 years whether I get something I want because I have an MBA,” says the 33-year-old who took out $53,000 in student loans, partly so he wouldn’t have to miss out on student networking opportunities like international trips. “But I decided I wouldn’t want to wonder in 10 years if not having the MBA was holding me back—because then it might be too late to do it.”

Although Brown chose the one-year, or fast-track, MBA at Emory, he still went without income for about 15 months. As he’d hoped, he landed a job at an investment bank, where he’s earning more than he did before.

Data from our surveys show that the typical graduate at the schools we ranked earned a positive return on her investment. Alums of the 87 schools ranked this year earned a median $50,000 prior to starting an MBA program and saw that salary rise 80 percent upon graduation. And six to eight years on, the median salary hovered around $145,000.

Students who enroll in MBA programs are usually further along in their lives and therefore more likely to be married. That can make the degree even more pricey. Spouses who quit their jobs and move to such places as Hanover, N.H. (home of Dartmouth College) or New Haven (Yale) to accompany an MBA student may face poor employment prospects.

That was the case for James Mansour, a recent graduate of Texas A&M University’s Mays Business School, and his wife. They relocated from the Washington, D.C., area, where he worked as a consultant and she as a dental hygienist, pulling in a combined $160,000 a year. After the move the couple learned that they were expecting a child and that she’d have to get relicensed to work in Texas. Fortunately, the couple was able to get by on savings by cutting out vacations, dining out, and shopping. Mansour, who graduated in December, now works at Delta Air Lines in Atlanta, and has a higher salary than he did before he went for his degree.

The typical 2016 MBA graduate from Dartmouth College’s Tuck School of Business earned $80,000 before enrollment. So if a student were to forgo that income for two years and pay the full cost of attendance, his or her real cost would amount to $360,100. Matthew Slaughter, dean of Tuck, says that while most graduates receive a large earnings boost after graduating, that isn’t always the case in the short term. “For a lot of programs like ours, there are a lot of people career-switching,” he says. “So that might entail giving up industry- or company-specific capital to really build capital in a totally different area that’s more satisfying.”

Katherine Earle graduated from Stanford’s MBA program this spring. She walked away from a well-paying position in the technology sector to go back to school. Still, she says she’s confident she made the right choice. “I’m already making more now,” says Earle, “and that increase will hopefully continue to compound itself, partly because of the inherent value of the degree but more likely because I had the opportunity to study my personal strengths and weaknesses and career interests at school.”

Teaching an Algorithm to Understand Right and Wrong

Teaching an Algorithm to Understand Right and Wrong


In his Nicomachean Ethics, Aristotle states that it is a fact that “all knowledge and every pursuit aims at some good,” but then continues, “What then do we mean by the good?” That, in essence, encapsulates the ethical dilemma. We all agree that we should be good and just, but it’s much harder to decide what that entails.

Since Aristotle’s time, the questions he raised have been continually discussed and debated. From the works of great philosophers like Kant, Bentham, and Rawls to modern-day cocktail parties and late-night dorm room bull sessions, the issues are endlessly mulled over and argued about but never come to a satisfying conclusion.

Today, as we enter a “cognitive era” of thinking machines, the problem of what should guide our actions is gaining newfound importance. If we find it so difficult to denote the principles by which a person should act justly and wisely, then how are we to encode them within the artificial intelligences we are creating? It is a question that we need to come up with answers for soon.

Designing a Learning Environment

Every parent worries about what influences their children are exposed to. What TV shows are they watching? What video games are they playing? Are they hanging out with the wrong crowd at school? We try not to overly shelter our kids because we want them to learn about the world, but we don’t want to expose them to too much before they have the maturity to process it.


In artificial intelligence, these influences are called a “machine learning corpus.” For example, if you want to teach an algorithm to recognize cats, you expose it to thousands of pictures of cats and things that are not cats. Eventually, it figures out how to tell the difference between, say, a cat and a dog. Much as with human beings, it is through learning from these experiences that algorithms become useful.

However, the process can go horribly awry, as in the case of Microsoft’s Tay, a Twitter bot that the company unleashed on the microblogging platform. In under a day, Tay went from being friendly and casual (“Humans are super cool”) to downright scary (“Hitler was right and I hate Jews”). It was profoundly disturbing.

Francesca Rossi, an AI researcher at IBM, points out that we often encode principles regarding influences into societal norms, such as what age a child needs to be to watch an R-rated movie or whether they should learn evolution in school. “We need to decide to what extent the legal principles that we use to regulate humans can be used for machines,” she told me.

However, in some cases algorithms can alert us to bias in our society that we might not have been aware of, such as when we Google “grandma” and see only white faces. “There is a great potential for machines to alert us to bias,” Rossi notes. “We need to not only train our algorithms but also be open to the possibility that they can teach us about ourselves.”

Unraveling Ethical Dilemmas

One thought experiment that has puzzled ethicists for decades is the trolley problem. Imagine you see a trolley barreling down the tracks and it’s about to run over five people. The only way to save them is to pull a lever to switch the trolley to a different set of tracks, but if you do that, one person standing on the other tracks will be killed. What should you do?

Ethical systems based on moral principles, such as Kant’s Categorical Imperative (act only according to that maxim whereby you can, at the same time, will that it should become a universal law) or Asimov’s first law (a robot may not injure a human being or, through inaction, allow a human being to come to harm) are thoroughly unhelpful here.

Another alternative would be to adopt the utilitarian principle and simply do what results in the most good or the least harm. Then it would be clear that you should kill the one person to save the five. However, the idea of killing somebody intentionally is troublesome, to say the least. While we do apply the principle in some limited cases, such as in the case of a Secret Service officer’s duty to protect the president, those are rare exceptions.

The rise of artificial intelligence is forcing us to take abstract ethical dilemmas much more seriously because we need to code in moral principles concretely. Should a self-driving car risk killing its passenger to save a pedestrian? To what extent should a drone take into account the risk of collateral damage when killing a terrorist? Should robots make life-or-death decisions about humans at all? We will have to make concrete decisions about what we will leave up to humans and what we will encode into software.

These are tough questions, but IBM’s Rossi points out that machines may be able to help us with them. Aristotle’s teachings, often referred to as virtue ethics, emphasize that we need to learn the meaning of ethical virtues, such as wisdom, justice, and prudence. So it is possible that a powerful machine learning system could provide us with new insights.

Cultural Norms vs. Moral Values

Another issue that we will have to contend with is that we will have to decide not only what ethical principles to encode in artificial intelligences but also how they are coded. As noted above, for the most part, “Thou shalt not kill” is a strict principle. Other than a few rare cases, such as the Secret Service or a soldier, it’s more like a preference that is greatly affected by context.

There is often much confusion about what is truly a morale principle and what is merely a cultural norm. In many cases, as with LGBT rights, societal judgments with respect to morality change over time. In others, such as teaching creationism in schools or allowing the sale of alcohol, we find it reasonable to let different communities make their own choices. 

What makes one thing a moral value and another a cultural norm? Well, that’s a tough question for even the most-lauded human ethicists, but we will need to code those decisions into our algorithms. In some cases, there will be strict principles; in others, merely preferences based on context. For some tasks, algorithms will need to be coded differently according to what jurisdiction they operate in.

The issue becomes especially thorny when algorithms have to make decisions according to conflicting professional norms, such as in medical care. How much should cost be taken into account when regarding medical decisions? Should insurance companies have a say in how the algorithms are coded?

This is not, of course, a completely new problem. For example, firms operating in the U.S. need to abide by GAAP accounting standards, which rely on strict rules, while those operating in Europe follow IFRS accounting standards, which are driven by broad principles. We will likely end up with a similar situation with regard to many ethical principles in artificial intelligences.

Setting a Higher Standard

Most AI experts I’ve spoken to think that we will need to set higher moral standards for artificial intelligences than we do for humans. We do not, as a matter of course, expect people to supply a list of influences and an accounting for their logic for every decision they make, unless something goes horribly wrong. But we will require such transparency from machines.

“With another human, we often assume that they have similar common-sense reasoning capabilities and ethical standards. That’s not true of machines, so we need to hold them to a higher standard,” Rossi says. Josh Sutton, global head, data and artificial intelligence, at Publicis.Sapient, agrees and argues that both the logical trail and the learning corpus that lead to machine decisions need to be made available for examination.

However, Sutton sees how we might also opt for less transparency in some situations. For example, we may feel more comfortable with algorithms that make use of our behavioral and geolocation data but don’t let humans access that data. Humans, after all, can always be tempted. Machines are better at following strict parameters.

Clearly, these issues need further thought and discussion. Major industry players, such as Google, IBM, Amazon, and Facebook, recently set up a partnership to create an open platform between leading AI companies and stakeholders in academia, government, and industry to advance understanding and promote best practices. Yet that is merely a starting point.

As pervasive as artificial intelligence is set to become in the near future, the responsibility rests with society as a whole. Put simply, we need to take the standards by which artificial intelligences will operate just as seriously as those that govern how our political systems operate and how are children are educated.

It is a responsibility that we cannot shirk.

The Compass of Success the rules to have a successful carreer, while remaining free

The Compass of Success

the rules to have a successful carreer, while remaining free


«The most important jouney is not the one in distant lands but within ourselves»


This book starts from powerful questions such as: how can I find out what are my strength and talent? Do you love what you do? How can I understand the complexity of organizations? How can I find a job in a company that fits with my values? How can I build trust and meaningful relations? What is the price you are willing to pay, the difficult trade-off, the time to go? How can I protect my ethical values, while remain free? What really matters? How can I then define a successful career?

The book explains with a creative and engaging mix of coaching, management theories short cases and storytelling, how you can find your compass, you true passion, how to find the job that fully fits with your talent and values. Then the author helps to intelligently use your radar to understand organizations, their cultures, how to decode complexity and build authentic trust and cooperation. The author offers meaningful questions, reflections and many helpful and practical tools to find a job and on developing a moral compass, a solid value system that will anchor you with your jobs, whatever it will be.   Chapters like the “Price you pay,” and “The pact with the devil” will offer practical tools, thoughts and learning about trade-off and difficult choices that everybody will have to make in their careers and, again, how important is to have a strong moral compass. By reading Paolo’s book, the very same concept of successful career will be radically transformed in something very different from our current mental model, more profound and relevant to all of us, not only for few elected. The new concept of what is a successful career and what really matters, will contribute to improving the way we relate to each other as human beings while having a successful career.

In the mist of the 4th industrial revolution, in an age of radical transformation and upheaval, we need to anchor our being to our values. The “Compass of success” helps us to pause and reflect about who we are, what do we stand for and how to remain free.

Paolo Gallo is the Chief Human Resources Officer at the World Economic Forum. The author has been the Chief Learning Officer at the World Bank in Washington DC and Director of Human Resources at the EBRD in London. Paolo Gallo has worked in more than 70 countries and also at the International Finance Corporation in Washington DC and, at the beginning of his c. areer ,at Citigroup in Milan, London and New York. Paolo Gallo is a certified coach at Georgetown University, he graduated from Bocconi University in Milan and Chartered Fellow FCIPD, UK, collaborates with Bocconi University and Hult-Ashridge Business School UK and he is a regular author and for the World Economic Forum agenda Blog, Forbes and HBR Italia

Italian version and deeper details here

Index Funds Are Fueling Out-of-Whack CEO Pay Packages

Index Funds Are Fueling Out-of-Whack CEO Pay Packages

CEOs get paid handsomely. The pay of top managers has risen faster than those of other star earners. Often they’re paid generously even as the firms they head underperform relative to their peers.

Such performance-insensitive pay packages seem to defy both common sense and established economic theory on optimal incentives. Top management compensation packages guarantee a high level of pay, but are often only weakly linked to the performance of the firm relative to its industry competitors. Why, then, do company boards and shareholders of most firms approve those packages?

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We propose an answer to that question in our new research paper. By endorsing performance-insensitive compensation packages, broadly diversified investors are indeed incentivizing CEOs for good performance. Except that the performance that they’re rewarding is industry performance, not company performance. Why? These days, most firms’ most powerful shareholders tend to benefit more from the performance of the entire industry than the performance of an individual firm.

To understand this new explanation for seemingly exorbitant CEO pay, it’s important to understand a recent, fundamental shift in the ownership of U.S. public companies. Nowadays, the same handful of large, diversified asset management companies controls a significant proportion of US corporations.

For example, BlackRock is the largest shareholder of about one in five publicly-listed US corporations, often including the largest competitors in the same industry. Similarly, Fidelity is the largest shareholder of one in ten public companies and frequently owns stakes of 10-15% or more. Even Bill Gates’ ownership of about 5% of Microsoft’s stock is small compared to the top five diversified institutional owners’ holdings, which amount to more than 23%.

Magnifying their already large individual power, large asset managers also appear to coordinate many corporate governance activities, including those regarding compensation. The potential of coordination among BlackRock, Vanguard, and State Street is particularly potent given that their combined power makes themthe largest shareholder of 88% of all S&P 500 firms.

This sweeping development known as “common ownership” – the same firms owning the competing firms in the same industry – is relatively new. Twenty years ago, BlackRock and Vanguard were only very rarely among the top ten shareholders of any firm. On average, common ownership concentration has almost doubled in the last 20 years in the construction, manufacturing, finance, and services sectors.

Our research reveals that common ownership has had a significant impact on the structure of executive compensation. In industries with high common ownership concentration, top executives are rewarded less for the performance of their own firm but rewarded more just for general industry performance.

To understand the effect of common ownership on CEO pay packages, we analyzed total pay (including the value of stock and option grants) of the top five executives of S&P 1500 firms (which cover 90% of U.S. market capitalization) and 500 additional public companies. We studied those pay packages in relation to the firm’s performance, rival firms’ performance, measures of market concentration, and common ownership of the industry. We also examined interactions of profit, concentration, and common ownership variables. This allowed us to estimate both the sensitivity of CEO compensation to the performance of their own firm and of the industry’s other firms, as well the impact that common ownership has on these sensitivities. (We used a variation in ownership caused by a mutual fund trading scandal in 2003 to strengthen a causal interpretation of the link between common ownership concentration and top management incentives.)

We found that when firms in an industry are more commonly owned, top managers receive pay packages that are much less performance-sensitive. In other words, these managers are rewarded less for outperforming their competitors. This difference in compensation has a sizeable effect. In industries with little common ownership, executive pay is about 50% more responsive to changes in their own firm’s shareholder wealth than in industries with high common ownership.

What’s more, in industries with high common ownership, top managers receive almost twice as much pay for the good performance of their competitors as managers do in industries with low common ownership. This effect is even more pronounced for CEOs alone. Essentially, CEOs are rewarded more for the good performance of their competitors than they are for the performance of the company they run.

It’s not just the incentive package. The base pay reflects this, too. Our research shows that top managers’ base pay – the part of pay that does not depend on firm or industry performance – is also higher in industries with high common ownership.

In short, our research suggests that BlackRock, Vanguard, State Street, and other large asset management companies may be endorsing high, performance-insensitive compensation packages, because those don’t encourage competition among portfolio firms. These packages may be inducing managers to carefully consider the impact of their strategic choices on other portfolio firms.

Large asset managers have economic reasons not to incentivize competition among firms they own. After all, their revenue and their investors’ wealth depend on the total value of the portfolios they hold. As a result, it is not in their interest that one portfolio firm competes vigorously against another firm in their portfolio, such as engaging in a price war.

It is not clear that large, diversified shareholders such as BlackRock intentionally choose performance-insensitive CEO compensation for the explicit goal of discouraging intra-industry competition. They may choose it for other reasons, for example, to encourage cooperation or innovation. Maybe it’s not a conscious choice at all. It could simply be that large, diversified investors let performance-insensitive executive compensation slide because their corporate governance efforts are more passive than those of undiversified activist investors.

Still, other empirical studies have identified anti-competitive effects of common ownership. It has resulted in higher prices in the airline and banking industries. The underlying economic rationale is quite simple: if shareholders own not only one, but two or more firms competing in the same industry, these shareholders reap larger gains if the firms they own cooperate rather than compete aggressivelyagainst each other.

A question left open by the previous research is exactly how investors manage to convince the top executives of portfolio firms not to engage in costly price wars against each other, and instead to practice restraint when it comes to competitive strategy. One way to induce managers to act in their investors’ economic interest is executive pay.

But paying executives more when they outperform a competitor (academics call such a reward scheme “relative performance evaluation”) would have the effect of pitting one firm’s CEO against the other and of inducing such costly price wars.

There’s evidence of this dynamic in the tension between smaller undiversified investors (such as hedge funds) and large asset management companies. Whereas the former fight for more performance-sensitive pay that is benchmarked against competitors, the latter vote against them, instead often passing high and performance-insensitive pay that discourages competition between firms in the same industry.

This is an issue – and a tension – that we expect to grow as the trend toward common ownership continues. Our research sheds light on the changing nature of executive compensation, and apparent negative effects of weaker competition and more performance-insensitive pay. However, there may also be positive effects to common ownership. It’s possible that increased cooperation between firms benefits consumers. Certainly, people have benefited from the low-cost, diversified exposure to the stock market that large asset managers offer.

We hope our findings will lead to a better understanding of the effects of common ownership. Shareholders appear to benefit from diversification and higher industry profitability, and there are potential benefits to society from greater cooperation between firms. However, there is a negative impact on consumers due to reduced competition. Ultimately, we hope effective solutions can be reached to resolve the growing tension between shareholders, consumers, and society.

The over-representation of the top executives inside the Board need a rebalance with Shareholders Independent Directors

The over-representation of the top executives inside the Board need a rebalance with Shareholders Independent Directors

Worker-directors are no governance panacea


MALTAWAY BOARD GOVERNANCE AND NON EXECUTIVE DIRECTOR (NED) …. NED with international experience in the BOARD, reinforce widely the diversity, independence and compliance requirements for a better Corporate Governance, Leadership and Business results

30+ years Board, Governance, Investment’s  experience and practice for YOUR BOARD needs and solutions

Adopting German-style system requires changes to UK corporate culture

The question of why the UK economy cannot be more like Germany’s has been a perennial concern of British policymakers down the decades. Where, they ask, are the indigenous high-productivity companies? Where is the spirit of co-operation rather than confrontation in industrial relations?

A solution often mooted is to adopt the German practice of worker-directors — members of boards elected by the employees. This has popped up again as part of the changes to corporate governance mooted by Theresa May’s government, backed by the Trades Union Congress.

Worker-directors can fulfil useful functions, have played a supporting role in the success of some German corporations, and indeed of companies in other European countries. Yet airlifting them into the UK’s very different institutional context is only likely to work if it is part of a bigger shift in employee and corporate culture.

German “co-determination” is an idea deeply embedded into the country’s corporate tradition. The idea is that by making trade unions — and workers — partners rather than adversaries, companies can improve information flow and productivity, and avoid strikes. Worker-directors are often credited with having helped in Germany’s postwar economic miracle, providing a wider range of perspectives and binding the workforce more closely to management decisions.

They may be less useful in today’s business environment. Most growth in modern economies is driven by small and medium-sized companies where the co-determination rules do not apply, usually in the service sector. Germany has retained a cohort of highly successful export-oriented manufacturers, but has been less impressive at creating dynamic service companies.

Whether or not they are the future for Germany, implanting worker-directors into a British corporate context will be intrinsically tricky. German companies have a two-tier structure with a management and a supervisory board, with the legally mandated worker-directors sitting on the latter.

This does not translate directly into the UK practice of a unitary board, whose members are charged with pursuing the interests of the company as a whole. The governance of UK companies could certainly do with improvement. If worker-directors turned employees into partners rather than adversaries or widened the range of perspectives around the board table on issues such as executive pay, that would be progress. But making the board a collection of individual representatives of different interests within the company is not the way to do it.

The principle of worker-directors also requires a degree of co-operation from employees and unions. Where a workforce is unionised, it seems likely that the worker-directors will be union officials. But unlike its German counterpart, the British trade union movement has traditionally operated on the principle of free collective bargaining rather than corporatist co-operation.

Effecting a culture change within unions to make them part of the management process is unlikely to be straightforward. In parts of the economy where there is still an antagonistic relationship between unions and management, such as the rail sector, putting an employee representative on the board is more likely to result in stasis or conflict than co-operation.

If worker-directors could form part of a shift towards co-operation in the mindset of employees, they could play a useful role. But it is optimistic to imagine that a governance function can cross borders without requiring wider changes in practice along the way. via @FT