Are executive compensation practices to blame?
In part. There’s a great push within public companies right now not to establish ‘competitive’ executive compensation practices. The way this is achieved is by establishing a peer group of similar companies and benchmarking pay packages with respect to these peers. One might also argue that similar practices occur within the strategy groups of organizations because no one wants to be outdone by a competitor.
Unfortunately, one of the byproducts of such benchmarking is that groupthink can manifest itself within a peer group. For example, a firm implements a new policy that is highly controversial but also successful. Another firm then implements this policy hoping to achieve similar success, and then another and another, etc.
Pretty soon, several firms have implemented this once-controversial practice, not because their executives think it’s in their best interest, but because other firms are doing so. This is particularly dangerous, especially if some executives and board members don’t really understand the underlying dynamics of the practice, such as collateralized loan obligations and collateralized debt obligations.
How can that follow-the-leader strategy be overcome?
Perhaps the best piece of advice I’d give executives and those devising compensation packages is to listen to their private beliefs and select actions that they feel are in the best interest of the firm. Don’t switch strategy simply because another competitor does so. While they may experience high returns in the short term by ‘following the leader,’ these practices may prove detrimental in the long run.
For instance, several years ago, when oil prices hit $145 per barrel, many in the industry felt the price had appreciated too quickly. However, it kept rising and rising, arguably because investors dismissed their own private beliefs, instead telling themselves, ‘I’d better get in on this before the price goes even higher.’ Then, Goldman Sachs famously stated oil prices would soon hit $200 per barrel. Well, it never happened.
Oil subsequently crashed to about $35 per barrel, and with rapid speed. It just goes to show that, more often than not, what goes up does comes down, especially when prices appreciate rather quickly.
Harry Cendrowski, CPA, ABV, CFF, CFE, CVA, CFD, CFFA, is managing director of Cendrowski Corporate Advisors LLC. Reach him at (866) 717-1607 or [email protected], or visit the company’s Web site at www.cca-advisors.com.