Executive Pay vs. Business Operations: Does Transparency Pay?

Today's New York Times Business Section has a special report on executive pay. One key take-away: newly-mandated SEC disclosure rules do little to help investors understand the levels, types and timing of executive compensation. This new purported "transparency" is anything but, leading even compensation consultants to scratch their heads over the new disclosure and the difficultly in extracting meaningful information. This is a theme that has long been on the minds of investors (institutions, unions, pension funds, etc.) and regulators alike. But even in the wake of massive awareness and seeming concern over executive pay levels and practices for many years, is there a relationship between the usefulness of a firm's executive pay disclosure and whether or not investors buy its stock? Is there a true market penalty for having opaque, confusing compensation disclosure, or is all that investors really care about the ability to understand and assess the operating business?

One thing is for sure, there IS a market penalty for companies that have difficult-to-comprehend disclosure of its operating activities. Case in point - Goldman Sachs. I just wrote about this. How is it that Goldman, which has objective, demonstrated superior performance and growth relative to its peers, trades at 10x earnings? Could it be that many are concerned about the level of proprietary trading profits relative to its overall earnings picture, and whether or not these earnings are sustainable? Sounds kind of like the issues facing, say, hedge funds? Then why does Fortress trade at 30x if GS trades at 10x? Does the firm's broker/dealer and advisory activities actually destroy value, or is the market is simply penalizing Goldman for the lack of clarity over its trading activities? I think the answer is pretty clear. If Goldman were to enhance disclosure around its trading activities, I think there is little question that it would trade up on greater understanding by the investor community. And I'm not really sure that the amount of disclosure that would make a difference to investors would provide competitors with meaningful insights into its trading strategies. So why not change, Mr. Blankfein? Maybe they will. The market is clearly calling for it.

But I'm not sure that Mr. Market is exercising the same discipline over issues of executive pay. Maybe at the margins, but, at least anecdotally, it doesn't appear that firms are getting sharply penalized for incomprehensible compensation disclosure. Now, it may be doing so and in a rational fashion, but simply looking at the impact of top-line executive pay as a portion of market capitalization, and penalizing those at the margins. For example, if Mr. Macguire of UnitedHealth's pay package is deemed as hard-to-understand and excessive, it is still only, say, 2% of market value. But what about Goldman's trading activities? This could be 30-50% of the firm's equity capitalization, if fairly valued in the wake of better disclosure. So, it seems that, notwithstanding the headline-grabbing of the executive pay issue, that investors just don't care that much. But better understanding how a firm generates cash and the growth and sustainability of its operating activities? Mr. Market is a harsh and rational disciplinarian, indeed.

Comments

[Yaser Anwar]

this might interest you

"Executives' Compensation of European Banks - Disclosure, Sensitivity, and their Impact on Bank Performance"

http://papers.ssrn.com/sol3/papers.cfm?abstract_id=237250