Opinion: Executives called to account

By Michael S. Olympios

Perhaps the least investigated area of corporate governance in Cyprus is executive compensation. Disclosure of executive compensation as required by the corporate governance code is insufficient for investors and analysts to understand how professional managers are paid. Although the majority of CEO’s of listed companies are the majority holders one should inquire whether their compensation is related to corporate performance. Some companies link incentives with stock performance. On the surface of it a similar practice of stock options was played out in United States for decades only to realize that in the end many managers were spending more time and energy managing the stock rather than the business. “Managers manage in their self interest”, arguers Michael Jensen who is emeritus professor at Harvard Business School. Although such claims are deeply resented by managers the fundamental argument is basically true enough. According to Mr. Jensen a rational manager with no investment in his firm would have little incentive to maximize its value, and every incentive to use it for his own ends. Ceteris paribus the smaller the ownership stake a manager has the more likely he is to channel corporate resources in directions that give him value (perks, fame, power) and the more effort shareholders have to make to monitor the manager’s behavior to stop him feathering his nest at their expense. Taken to extreme, a boss without shares might build a comfortable but profitless empire that squandered excess cash flow on shareholder destroying acquisitions a la Globalsoft.

Private firms on the other hand don’t need to worry about this since the boss’s performance will ultimately determine his total return often expressed in the value of the company itself. The problem however arises once controlling shareholders sitting in the executive office tap into corporate expense accounts in the order of tens of thousands a year, reporting from yacht gasoline and dinners to business class vacations as corporate expenses. In fact it is possible to argue that poor stock performance of family firms may have a strong link to poor compensation practices as family managers entrenched in their positions are reporting left-over revenues. Such companies however lack a truly independent compensation committee and in fact lack a board that if necessary can replace the CEO. That may explain why in fact board independence in family firms remains a taboo. Restricted stock options expensed at the end of the year are what many compensation consultants are now recommending. There is a robust way of pricing options, first developed in 1973 by two economists, Fishcer Black and Myron Scholes. These stock options should be tied to long term performance and offered instead or in parallel with cash bonus.

Bonuses are largely in the control of a company’s compensation committee, a small group of hand picked “non-executive directors”. What these committees actually do in most companies is rubber stamp executive compensation packages proposed from those who appointed them with little or no questioning as to their relevance to performance and other business variables. But unlike Cyprus these committees in many European markets are being encouraged to talk regularly with leading shareholders about what are suitable levels of compensation for top executives, and they are increasingly sensitive to the reaction to the amounts they award. CEO’s are being advised that they will be excluded from much coveted appointments in the future if they have been too greedy during the executive careers.

[email protected]