Incentives as ideology

Bosses need big bonuses and share options to give them an incentive to work harder. Everyone knows this.
But it ain’t true. In this new paper, Wendelin Schnedler says:

There are plausible situations in which paying a bonus reduces the incentive to exert effort.

These situations, he shows, are those in which the marginal effect of effort upon the probability of success is low, relative to the chances of success if no effort is exerted.
Although he doesn’t say so, I suspect this might be true for quite a few CEOs with stock options. They might figure:

It’s going to be really hard work to genuinely improve this business. And even if I do so, it might not raise the share price by much, because equity analysts are stupid buggers and the company’s share price depends upon stock market conditions.  I’ll just talk a good game and hope the market rises - as it usually does over time - taking the company‘s share price up with it. If I must do something, I’ll increase the gearing of the company by buying back shares. That’s easy to do, and it’ll increase the share’s beta and hence its chances of the share price rising a lot if the market rises. 

Perhaps, then, talk of incentives is just cover for rent-seeking.

Comments

[dearieme]

Well of course it bloody is; cover for rent-seeking I mean. Looting the shareholders is what senior executives do for their money. For fun, they might run the company.

[Bruce]

Chris
A lot of long-term incentives are now based on a relative total shareholder return metric. In effect this means they have to beat at least half the companies in a comparator group. This approach has its failings, but it does mean just sitting about and watching the market raise all boats is not really an option.

[james C]

'a relative total shareholder return metric.'

Why has this use of 'metric' become common?
It is rather like 'inflection point', another mathematical term that was bandied about by silly analysts.

[reason]

I'm wondering why "work harder" is expected of CEOs. Getting everybody else to worker harder (well really more effectively) is what they should be about. CEO's don't actually work to produce anything. And why can't they be incentivized like everybody else - perform or else.

[reason]

Please excuse the deliberate Americanism. I realise this is a pommie (oops British) blog.

[dearieme]

Yeah, and most of the pills who use 'inflection point' actually mean 'turning point'. So, innacurate as well as pompous.

[andrew]

As a liberal shareholder, I can tolerate a fair amount of capitalism. But nothing makes my blood boil more than one of my companies announcing a big share buyback programme - in other words using the money in my company to buy shares in the company for cancellation, thereby boosting the share price and triggering hefty option windfalls for management.

If the money really is spare, announce a special dividend and give it back. Or at least, options should always be rebased for share buybacks.

[Marcin Tustin]

I have experienced this effect on my motivation.

[Marcin Tustin]

The best part was that as more of my colleagues worked harder, I had even less incentive to stay late.

[kinglear]

Incentives shmincentives. Warren Buffett measures success by how much CASH hios satelites give him back every year whilst still growing the business, hence doing more with less.This ought to be the only measurement. So buying back the shares, as long as it's done intelligently ( HA!)is just the very reason that executives should get a bonus.

[dsquared]

isn't it a bit odd to have this post coming hard on the heels of the last but one, puporting to show that "incentives work" for racehorse trainers, who must surely have a low marginal effect of effort on the probability of success if anyone does.

[Mark Wadsworth]

Agreed. What Dearime says.

Andrew might be missing point. If shares are bought back for exactly market value, then it shouldn't (in theory) have much effect on share price.

If Andrew thinks shares in companies are being bought back at too high a price, then he should sell (taking part in a 'super dividend'). If he thinks they are being bought back at too low a price, then he can benefit by keeping his shares.

[reason]

dsquared...
You obviously don't know much about racing. Race horse trainers talk to jockeys.

[jameshigham]

You don't need reports and articles to tell you this, Chris.

[andrew]

Mark - you're missing the point, I'm afraid, which may be because I didn't make it clearly.

Paying dividends reduces the share price compared to using the same money to buy back shares. Dividends can usually be received for free, whereas unlocking a capital gain usually incurs dealing costs.

It's particularly irritating when you can see that the directors are changing dividend policy for their benefit rather than for shareholders' benefit.

[Mark Wadsworth]

Andrew.

Yes, on face of it, dividends reduce share price (there is less cash in company). On the other hand, regular and rising dividends increases share price (makes shares a good investment).

But, as I said, the impact of share buy backs on share values depends on whether they are bought back at under- or overvalue (bearing in mind that nobody knows what the true value is).

Please, don't lecture me on tax and dealing costs.

Dividends do attract tax, depending on income of recipient. Capital gains on the whole cost less in tax. What dealing costs? D'you mean the Stamp Duty and so on?

Yes, these directors are pirates and sharks, sure that much I agree with.