SEC Rules Linking Exec Pay and Stock Price Miss the Mark

On April 29, 2015 the SEC released a Fact Sheet regarding “rules that would provide greater transparency and better inform shareholders.” The proposed rules would require companies to disclose executive pay and stock performance information for itself and companies in a peer group. This proposal places emphasis entirely on the wrong results and is an example of needless regulation.

Corporate executives should be judged on improvements in the underlying drivers of the business that they control. They should not be judged based on a stock price they don’t control.

Stock price movement often has nothing to do with management. Why should corporate executives be judged by stock price movements (up or down) that are unrelated to their actions?  Particularly in the short term, stock prices are influenced by industry activity, interest rates, and the trend of the overall market among other things. For example, a competitor being acquired often raises a company’s stock price.  Actavis (ACT) announced the acquisition of Forest Labs on February 18, 2014. In the next 3 days (in a slightly down market) Teva Pharmaceuticals stock rose 6.3%. Is Teva’s stock price move attributable to anything management did? No.  So why would an investor use that to judge the appropriateness of executive compensation?

Executives should be judged on how they impact the business.  Growth in revenues, earnings per share, and cash flow are all important.  Capital allocation is critical. Returns on invested capital and return on equity capital are important indicators of value creation.  Corporate executives should have their eye on factors like these, not the gyrations of their stock price.  Investors would be well served to do the same.

Can shareholder oriented executive compensation packages incentivize managers to influence fundamentals in a constructive way and improve the value of the company? Yes! But sometimes industry or market factors might cause a company with terrible executive comp policies to also do well.  The proposed rules do nothing to help investors distinguish one from the other. Evaluating the effectiveness of executive comp is difficult because executive comp does not always drive stock performance. The SEC is proposing a short-cut to this process that misses the point. The free market understands this and will pay little attention to the information the SEC is requiring to be compiled.  The cost of companies complying with this requirement will certainly outweigh the benefit to investors and be a drag (albeit modest) on investor returns.

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