Today’s Globe contains news of potential inquiries by Congressman Barney Frank’s Financial Services Committee looking at the ‘perverse incentives’ (love that term!!) in executive compensation and how that may have contributed to some of the inordinate risks afflicting many financial firms.
At the end of the day, this space believes that the oversight of executive compensation lays with an engaged board of directors that properly aligns the interests of executives and shareholders. Warren Buffett has written early and often on this topic. This quote from a 1985 letter to shareholders (which should be required reading for everyone interested in the markets) brings up the key issues behind that misalignment:
Ironically, the rhetoric about options frequently describes them as desirable because they put managers and owners in the same financial boat. In reality, the boats are far different. No owner has ever escaped the burden of capital costs, whereas a holder of a fixed-price option bears no capital costs at all. An owner must weigh upside potential against downside risk; an option holder has no downside. In fact, the business project in which you would wish to have an option frequently is a project in which you would reject ownership. (I’ll be happy to accept a lottery ticket as a gift – but I’ll never buy one.)