VIDEO: Are shareholder interests really all that when it comes to executive compensation?

Grit by KC Roberts & the Live Revolution

KC Roberts, Austin Gembora, Rob Christian, Matt Giffin (no socials, sorry), Christian Overton, Alexis Baro, Claire Davis, Genevieve Marentette, Marito Marques, Dionne Wilson (no socials, sorry), Ben Kaplan, Phil Demetro, Kristine Peters (not Leibel anymore, sorry Kristine! Also, no socials)

TRANSCRIPT

I'm arguing fundamentally that a laser focus on aligning executive compensation with the interests of institutional shareholders is unlikely to lead to an optimized set of outcomes for an organization, and that a board by mostly fixating on that is not doing their job as well as they could be. That's my argument and I'm going to put that in the headline. Maybe I should just add that first. Hey everybody, it's Matt looking now that I'm looking at myself on my camera, even shaggier than normal. Apologies. It's for you Canadiens. It's Boxing Day for everybody else. I guess it's the day after Christmas and what you can't see behind the camera as I literally have my feet up, I can show you. I have a beverage pretty large, I guess. Kind of like a margarita. It's for any of you who are I'm a kind of a mixology guy. And so for any of you who like cocktails, this is rail level tequila, lime, Grand Marnier, a little splash of Aperol and salt in I never like salt on the rim it just a mouthful of salt. Anyway so I've got a beverage and I've been thinking about a lot of things. It's the end of the year and you know, I don't want to get super personal, but as for as it has been for everybody, it's been kind of an interesting year. And, you know, if you don't if you're not interested in the personal stuff, you can skip forward like a minute or two and then I'll get to the real governance conversation. I've made some notes for myself, so I want to I want to acknowledge that something really special happened this year that I was a part of, which is my band, KC Roberts and the Live Revolution put out our seventh full length original studio record, and it takes a kind of an amazing, unbelievable amount of work and collaboration and, you know, just kind of internal motivation that seems to just come from magic. And so I want to acknowledge and you should follow them. I'll put everybody's names in the transcript and if you're on social media, you should go check them out. They're all freakin amazing musicians. Our band leader, KC Roberts, who's a friend of mine since we were teenagers, Austin Gembora, our drummer, Rob Christian, who played sax and flute and maybe synthesizers and all, but he's an absolute multi talent. Matt Giffin, who played a whole bunch of different keyboards, Christian Overton on trombone, Alexis Baro on trumpet, Claire Davis on vocals, Genevieve Marentette on vocals, Dionne Wilson on vocals, Marito Marques on percussion and the sort of production staff Ben Kaplan and Phil Demetro and Kristine Leibel and so on and so on and so on. And if you haven't heard it, I'm really proud of this record. It's called Grit by KC Roberts in the Live Revolution. Please have a listen. And if it's not your thing, great. But if it is your thing, you're going to really love it. It's a pretty special piece of work. And, you know, this was also one of the first years, in fact, is probably the first year of my life now that I'm thinking about it, where I've lost multiple people who are really special to me. And this kind of influenced my tone and certainly the level and type of enthusiasm I had going into the launch of Ground-Up Governance. And so this has been kind of an interesting kick in the butt factor. These were really, really amazing and important people who I, you know, kind of hope that they would be proud of me. And part of the reason why I wanted to make this video today is in the spirit of the sort of trolling or reaction episode of Sound-Up Governance that I did a couple of weeks ago, which was really fun, by the way. And I've started crafting one where I'm trolling myself and it's going to be really fun. And so I had a conversation with another longtime friend of mine, Tyler, the creator we met. I think it would have been 11 or 12. He was the guitarist in my very first rock band. He he was gracious enough to join me on my governance journey ten, 11, 12 years ago. And he stayed in the game. And I'm so happy he's here. And we had a conversation the other day, and I think fundamentally we had a misunderstanding. So it was the it was a bit of a disagreement, but based on a misunderstanding and I've taken some notes that well, I think will help to illustrate the misunderstanding, but it's it's illustrating to me some of how, you know, I feel, as you all know, I'm a little bit of a countercultural figure, or at least I disagree with a lot of people in the governance space. And this is maybe one of the most important ways where I think I'm diverging from the norm. So I let me tell you what I argued and then I'll tell you what I think Tyler the creator interpreted, and we'll go from there. So I argued first we were talking about executive compensation. My note here says BS is BS. And what I meant is Black Scholes the the formula to predict the or to create a value for options that have been granted to CEOs this year. And that wasn't the original intention of black Sholes For all you people who are nerds like me, I'm just using it that way for now. So Black Scholes is B.S. is what I meant here. And the reason is it doesn't actually predict anything. It's not intended to predict that, but we use it that way. And so we end up most cases with really low assumptions of what the ultimate cost to the company will be of the option grant. And the ultimate value realized by CEOs is and I don't mind CEOs making a lot of money, but I'm just saying Black Scholes tells us nothing. And then I also argued that the market for CEOs might be a little bit nonsense, first of all, and this was this was illustrated to me by I can't remember the name of the guy who was professor at Stanford that was speaking on a panel a number of years ago. And he he made the argument that we've never studied how low a CEO's pay can go before the quit. It sounds like a silly statement, but then we realized, oh, well, without that variable, everything above it is just kind of guessing, right? So if we don't know what the floor is, then everything above it is a little bit weird. And we also don't focus on much other than alignment with shareholders interests and peer comparisons. Right? So we make sure that the CEO is paid in a way or in amounts that are commensurate with peers or maybe a little bit above or we stick a pin and we say we want to be at the 67th percentile, and then we're interested in making sure that we have incentives that are well aligned with what we perceive to be shareholders interests. And when I kind of dissed the this idea that, you know, the market is nonsense because of those factors, Tyler, the creator, said that he thought and this is my interpretation. So Tyler, the creator, you can push back. He said that he thought I was saying that alignment with shareholders interest doesn't matter. And I've been thinking about that a little bit. And I think maybe it I mean, it matters. I don't want to trivialize it, but I don't think it matters that much with the WhatsApp conversation. And Tyler, the creator, forgive me, but he said it's a job at the end of the day and boards need to meet their shareholders expectations with defensible processes so they can be held accountable. And that's a perfectly reasonable statement. I just sort of wonder about what do shareholders interests have to do with anything in the real world other than their own interests. So I did a quick search just because I was curious in 2017. This is U.S. data, so apologies to the Canadian audience and elsewhere. But it's still interesting. In 2017, institutions and institutional shareholders owned 78% of large cap, S&P 500. 78%. So big, significant majority. And in 2021, institutions made up 90% of trading volume on the Russell 3000. So they own most of the shares and they trade like crazy. And so first of all, shareholder interest is not me. It's not individual shareholders and not even the interests of the the constituents of the institutions. It's the interests of the institution itself. And we're talking about shareholder interests, not me but them. And we're also it's not if they make up 90% of the trading volume, this is not in general, I'm sure there are lots of exceptions, but in general, we're not talking about long term interests, right. We're talking about how can we protect the value of our fund. That's fine. I'm saying that my interest in the interests of any individual, including a CEO, are not going to be very well aligned with this ethos of protecting the value of a fund over a long period of time and ultimately the the shares, the share price that the institution is interested in is how much that this institution can sell it to some other institution at another date. And so we're kind of taking a lot of the human and also multi-stakeholder perspective out of it. Just we're talking about institutions trading with institutions. I personally think that this is likely to lead to organizational behavior, hiring behavior when we're talking about CEOs and then ultimately operational behavior and in governance decision making, if were influenced mainly by institutional shareholders, it's going to lead to behavior that's not really well aligned with what I believe in. It's not really well aligned with. I suspect, what anyone is believe in or anyone believes in, or at least most people, except by accident. And so my argument when it comes to executive compensation is forget the fact that Black-Scholes means nothing. That's a disclosure problem more substantially. The problem here is that if we're not asking ourselves, A, what's the point of this organization, Why does this organization exists? Why does it exist if it exists only to maximize the or to to optimize our alignment with the interests of institutional shareholders, then fine. But I suspect any of the leaders of any of the organizations I know are going to be a lot more interested in how can they do good stuff. And good stuff obviously doesn't preclude us from being interested in shareholder interests or the creation of value for institutions. But cool stuff also means innovation. Cool stuff might mean environmental and social stuff. Cool stuff might mean any number of different things that ultimately may not be very well aligned with the interests of institutional shareholders, especially not along their particular time horizons. And so if we if I was a board, if I was on a board, especially in Canada, where our job is not explicitly to look out for shareholders interests, I'd be really interested in having a conversation with a CEO and wondering what are the mechanisms in terms of compensation and otherwise, What conditions can we create for that CEO to make them excited to get out of bed every day and optimize their team in service of the purpose of this organization, which I hope is much more nuanced and complex than just maximizing shareholder value or institutional shareholder value. And that question is hard to answer, but it's not impossible. And it begins with asking the question. And I suspect and I don't know for sure, I suspect if I if that board were really deeply interested in exploring that question with their CEO, however long it took to find answers or try different things and get somewhere, we probably end up with compensation structures that look really different than they are now and still ultimately over the long term would serve shareholder interests because this is it's the organization creating value over the long term, not necessarily just being laser focused on shareholder interests. Anyway, I'm really interested. I kind of feel like executive compensation is like one of the the most stuck in bad behavior, stuck in bad habits, areas of corporate governance. And every conversation I have with people in the space, I come out of it feeling like this. Maybe I'm misunderstanding something, or maybe they're missing my point. I'm not sure, but I just have a real hard time finding my comfort zone here. So I'm very, very eager to engage in a conversation with anyone who's seeing this, who understands what I'm saying. You can even say only articulating myself poorly and take it from that. Whatever you like. I'd really like to get some more perspectives. I'm arguing fundamentally that a laser focus on aligning executive compensation with the interests of institutional shareholders is unlikely to lead to an optimized set of outcomes for an organization, and that a board by mostly fixating on that is not doing their job as well as they could be. That's my argument and I'm going to put that in the headline. Maybe I should've said that first. Anyway, thanks for listening. Happy holidays. I probably won't see you, any of you, until the New Year. And so thank you for following along. This has been a really, really valuable, joyful part of my year is communicating with you and providing content through Ground-Up Governance. So thank you. Happy New Year. See you soon.