You say, "And he also has a generous long-term incentive package with stock price targets...Personally, I really like these sort of incentive packages as it incentivizes long-term thinking."
Unfortunately, it is the other way around. Incentives should never be linked to share price. Share price can be manipulated upwards while the fundamentals of the business decline. Slash R&D, advertising and other OPEX costs and short term earnings jump higher. If the multiple remains the same, the share price jumps up, but what do you think happens to the long term prospects of the business?
Management can asset strip the company, selling core assets to improve short term cash flows. It won't help the business in the long term.
Overpriced share repurchases destroy balance sheet equity, but they create artificial demand for the shares pushing them up temporarily. Momentum investors then jump on the bandwagon causing the share price to jump higher. The bubble keeps inflating until it goes pop. Meanwhile, so much capital has been pumped into repurchases, that reinvestment in the actual business itself gets neglected. That's not good for the long term either.
All of these things happened under the tenure of Lous Gerstener when at IBM from 1993 - 2002. All because the incentives were wrong. The same thing happened under Sir Terry Leahy at Tesco during his tenure that ended around 2011. There are loads of case studies for this kind of thing. Check them out.
For me this is a huge red flag! Not only is the remuneration committee incompetent, but the CEO has acquiesced in this nonsense which doesn't tell me anything good about him either.
Thanks for the comment! How do you think about the fact that the market is a weighing machine in the long term? Short term price targets linked to comp is terrible, I agree. But eventually the stock price follows earnings right? If they don’t grow revenues and earnings over the next 6 years, the stock won’t appreciate.
He borrowed money to repurchase 25% of the shares outstanding, which were already overpriced. The artificial demand for the shares pushed the share price still higher. A reduced share count improves EPS, not because the earnings are improving, but because the denominator is contracting. Overpaying for buy-backs destroys shareholder equity, which flatters the ROE metric, again not as the result of improvement in the numerator, but a contraction in the denominator.
Foolish investors were fed the improvements in these metrics when quarterly results were published and swallowed them without looking beneath the surface. The herd mentality kicked in and dumb money pushed the share price even higher. To put things in perspective, sales declined from 1998-2001, but share price doubled.
In answer to your question about the Graham quote (voting machine vs weighing machine), this happened. IBM reached a peak market cap of $208bn because of all the accounting alchemy being done by Gerstner. After he left the business and it became clear that his tenure was all about smoke and mirrors, the market cap collapsed to $98bn. That was over 20 years ago. Today the market cap is only $128bn as IBM was irreparably damaged by Gerstner.
That's what the wrong incentives do to what was once the most valuable company on the planet, and one of the most successful. It is now a shadow of its former self. 80 years of building a wonderful business by Thomas Watson and his son was all undone in the space of 9 years due to share price based incentives offered to Gerstner!
I am a published author on the topic of how public companies ought to be run. If you would like to learn more about this kind of thing, may I suggest that you buy my book "Fabric of Success" which is available on Amazon (https://amzn.eu/d/8g3DmLo)
You say, "And he also has a generous long-term incentive package with stock price targets...Personally, I really like these sort of incentive packages as it incentivizes long-term thinking."
Unfortunately, it is the other way around. Incentives should never be linked to share price. Share price can be manipulated upwards while the fundamentals of the business decline. Slash R&D, advertising and other OPEX costs and short term earnings jump higher. If the multiple remains the same, the share price jumps up, but what do you think happens to the long term prospects of the business?
Management can asset strip the company, selling core assets to improve short term cash flows. It won't help the business in the long term.
Overpriced share repurchases destroy balance sheet equity, but they create artificial demand for the shares pushing them up temporarily. Momentum investors then jump on the bandwagon causing the share price to jump higher. The bubble keeps inflating until it goes pop. Meanwhile, so much capital has been pumped into repurchases, that reinvestment in the actual business itself gets neglected. That's not good for the long term either.
All of these things happened under the tenure of Lous Gerstener when at IBM from 1993 - 2002. All because the incentives were wrong. The same thing happened under Sir Terry Leahy at Tesco during his tenure that ended around 2011. There are loads of case studies for this kind of thing. Check them out.
For me this is a huge red flag! Not only is the remuneration committee incompetent, but the CEO has acquiesced in this nonsense which doesn't tell me anything good about him either.
Thanks for the comment! How do you think about the fact that the market is a weighing machine in the long term? Short term price targets linked to comp is terrible, I agree. But eventually the stock price follows earnings right? If they don’t grow revenues and earnings over the next 6 years, the stock won’t appreciate.
I mentioned Lou Gerstner's tenure at IBM.
He borrowed money to repurchase 25% of the shares outstanding, which were already overpriced. The artificial demand for the shares pushed the share price still higher. A reduced share count improves EPS, not because the earnings are improving, but because the denominator is contracting. Overpaying for buy-backs destroys shareholder equity, which flatters the ROE metric, again not as the result of improvement in the numerator, but a contraction in the denominator.
Foolish investors were fed the improvements in these metrics when quarterly results were published and swallowed them without looking beneath the surface. The herd mentality kicked in and dumb money pushed the share price even higher. To put things in perspective, sales declined from 1998-2001, but share price doubled.
In answer to your question about the Graham quote (voting machine vs weighing machine), this happened. IBM reached a peak market cap of $208bn because of all the accounting alchemy being done by Gerstner. After he left the business and it became clear that his tenure was all about smoke and mirrors, the market cap collapsed to $98bn. That was over 20 years ago. Today the market cap is only $128bn as IBM was irreparably damaged by Gerstner.
That's what the wrong incentives do to what was once the most valuable company on the planet, and one of the most successful. It is now a shadow of its former self. 80 years of building a wonderful business by Thomas Watson and his son was all undone in the space of 9 years due to share price based incentives offered to Gerstner!
I am a published author on the topic of how public companies ought to be run. If you would like to learn more about this kind of thing, may I suggest that you buy my book "Fabric of Success" which is available on Amazon (https://amzn.eu/d/8g3DmLo)