Monday, June 26, 2006

Is there a relationship between executive performance on the one hand, and corporate earnings or rises/falls in share prices on the other?

Let's put the question this was: Is there really any relationship between executive performance on the one hand, and corporate earnings or rises/falls in share prices on the other?

Well, those who determine executive pay seems to be coming around to the view (rightly or wrongly) that top executives are good for many things but that their compensation should not be directly related to either corporate earnings or rises/falls in share prices. What other conclusion to draw is difficult to see from the following figures released by The Corporate Library, an independent corporate governance watchdog (http://www.thecorporatelibrary.com): the earnings of U.S. corporate bosses increased by 11 percent in 2005, versus 30 percent the previous year, despite record profit growth among U.S. companies in 2005.

The Economist's view of this was that the drop in pay inflation was mainly due to renewed struggles between shareholders and executives. A growing number of major shareholders (often large hedge-fund managers under pressure to boost their returns) are actively fighting executives for greater control over companies. Executive pay excesses are a symptom of weak corporate-governance, argue shareholder activists. U.S. bosses already face widespread public criticism, the greater threat of legal suits and more red tape resulting from Sarbanes-Oxley. However, they need to steel themselves for further changes, warns The Economist. The SEC has proposed new rules requiring the fullest possible disclosure of executive compensation. Yet instead of weakening companies, as some fear, more transparency and shareholder democracy may even boost their performance, concludes the magazine.

I remain sceptical, because it has always seemed to me that most of the success of companies is dependent on factors that are entirely extraneous to the business (such as which country the company is based in, at what point in history, since economic power is always related to economic openness and the terms on which the openness is obtained depend on a complex mix of military, technical, legal and political arrangements). Even in these days of internationalisation and globalisation, and even in the case of the most globalised industry (financial services), stock price has a positive or negative premium depending on country of headquarters which, among other things, dictates the principal currency in which earnings are calculated – which is itself dictated by the country of headquarters.

Further, the success of a company is dependent on which sector of the economy one operates in (e.g. utilities, retail, financial services or whatever) and the relative amount of money being put in or pulled out of that sector by global investors and traders.

Still further, the success of a company is dependent on comparative size (for example, the top 3 companies in any particular sector of the financial services industry (e.g. FX Trading), as a rule of thumb, earn something like 50% of the entire earnings of the sector).

Next, earnings by size of company are dependent on further complex factors – e.g. from WWII onwards, taxation, economies of scale, economies of scope, the power of a brand and other such matters favoured greater size; by contrast, it now seems that other factors (vastly improved availability and price-to-performance ratio of technology, availability of money and of expertise for hire) make it entirely possible for niche companies even to outdo the largest companies in terms of profitability.

However, as I have argued elsewhere, middle-sized companies are finding (and will find it increasingly) difficult to compete for revenue let alone for profitability with large companies on the one hand, and niche companies on the other hand.

I have also argued elsewhere that, barring the exercise of political will (which really means the exercise of political pressure by individuals and by non-political groups on politicians) we will see the rise of what I have called mega-corporations that span not merely today's nations (as is already somewhat and increasingly the case) but will also span today's industrial divisions, reversing today's "back to the core" or "back to the knitting" philosophy.

By the way, the piece that inspired the above reflections can be found under the title: "Battling for corporate America" in The Economist (11 March 2006). You need to search for the title, in the archive, to retrieve the article. Subscription is required.

Alternatively, a brief version of the story can be found on: http://www .globalautoindustry.com/article.php?id=655&jaar=2006&maand=4&target=Ameri




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