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What's Wrong with the Current System? Compensation without Long-Term Value Creation

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The problem with the current corporate compensation system may lie in the fact that it rewards stakeholders for behavior that does not create long-term value for shareholders. Compensation has been and continues to be a major issue that needs to be addressed one way or another as corporate accountability comes to the fore.

High Compensation without Revenues—Now That's a Problem

Reflecting on the spate of dot.com explosions and implosions during the past few years, selecting stocks based on fundamental analysis seems more difficult than ever.1 In the late 1990s, some stocks went up without profits and, in extreme cases, without revenues. Spirited M&A activity and soaring compensation didn't always coincide with stock price increases and the only ones who seem to have prospered were the deal makers, consultants, bankers, and executives who cashed out along the way. The current system seems broke and it's already attracting the attention of regulators. Change is inevitable and companies will need to grow revenues and compensate people in a different manner. Management can wait for new regulations or risk using old methods. Alternatively, management can pursue an SEU path now.

Part of the problem with the current system may lie in compensation that rewards stakeholders for behavior that does not create long-term value for shareholders.2 But these highly compensated individuals may be simply taking advantage of a configuration and playing by rules that they didn't create. Each may be trying to move the company in a way that provides personal benefit at the expense of another party. And this is just a start. There may be plenty of other parties with specific biases that may not necessarily move the company forward in a path beneficial to all.

Identifying the problems is only part of the battle. Getting people to fix a situation when it runs counter to their financial best interests is appreciably more complex. However, in recent years, developments in the financial community suggest that major change may be imminent. The SEC has fined major Wall Street firms over $1.4 billion in inappropriate business practices and has permanently banned certain research analysts.3 Furthermore, senior U.S. senators and other government officials are now pushing for reform because they see self-regulation by the capital markets "as a complete abject failure."4 Such contemplation may have been inconceivable even a few years ago. However, the poor economy early in the new millennium and the revelations of gross improprieties and conflicts of interest may provide a window of opportunity for changing compensation models.5 The rules for growing a company are absolutely changing and senior management needs to stay current with new conditions. The first change will undoubtedly focus on money and be forced on major institutions by regulatory agencies. That is, unless companies choose to change on a voluntary basis. Compensation has been and continues to be a major issue that needs to be addressed one way or another.

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