Wealth Shift: The Decline of Ethics in America
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Lesson #2 – Do As I Say, Not As I Do

I often hear executives complain about how they wish their employees would take a greater ownership role within the company. They are sick of their Wealth Shiftless employees hardly working, when they should be working hard, instead. To hear them talk, employees everywhere should just get their act together, pick themselves up by their bootstraps, and start independently motivating themselves to go the extra mile (regardless of whether the effort to do so will result in any additional pay or not). They see nothing wrong with the notion that all the damn lazy workers out there should hurry up and get on board the ethics bus while they take the Gulfstream instead.

But the employees of today are not the same as the employees of yesterday, and for a reason that management needs to take at least some ownership of. Over the same period of time that executives have become increasingly clever about the way they structure their own compensation packages, they have also been very clever at scaling back on the kinds of regular employee benefits that used to be considered basic (like adequate health care and salary-based pension plans). While most executives wouldn’t dare show their faces on the golf course without bragging rights to medical offset payments, life insurance, and a lovely golden parachute, similar benefits for rank-and-file employees have been whittled down to all but the barest of bones.

At the same time that executives everywhere keep exhorting their employees to step up to the plate and work harder, they, themselves, are constantly on the lookout for additional loopholes in the employment laws that would allow them to get even more bang for their compensation buck. Loopholes such as the one that says part-time employees and independent contractors don’t have to be given benefits, or salaried employees don’t have to be paid overtime, or employees who make tips don’t have to be paid minimum wage -all are designed to take more money out of the employee’s pocket and put it in the executive’s or shareholder’s. Too bad, so sad, you are poor. But the poorer you get, the richer I become, so I want you stop complaining, mend your unethical Wealth Shifting ways, and get back to work right now!

Yes, executives have learned how to squeeze every last dime out of the compensation structure of their companies. And now that they’ve found they can’t squeeze out any more over here, executives are shipping jobs overseas to countries that don’t have our strict labor laws. Why? Because, ultimately, the end-all and be-all of the executive decision making process in publicly held companies is “maximizing shareholder wealth” - a term that is stale with overuse and sickening in its ethical implications.

Look, I am not a communist, a socialist, or even a dyed-in-the-wool Democrat. But I am a humanist. A humanist, by definition is someone who studies human beings and their values, capacities, and worth. To quote Albert Einstein, one of the most famous humanists in the world, “A man's ethical behavior should be based effectually on sympathy, education, social ties, and needs; no religious basis is necessary.” In other words, humanism is not charity -it is doing the hard work to wisely allocate wealth based on each person’s contribution to the whole. Humanism will never, ever, be about finding another creative way to screw your employees in order to make more money for yourself.

In humanistic terms “maximizing shareholder wealth” – the capitalistic pursuit of one more incremental share-price dollar is not an appropriate goal. In my mind, the extent to which shareholder wealth has been maximized should never be measured solely by the price a stock is trading at on any given day. Rather, “maximizing shareholder wealth” should mean making decisions that are in the long-term best interests of the company as a whole, even if this means sacrificing a few executive and shareholder dollars in the short run.

So if it’s in everybody’s best interest to do so, why don’t we focus on the big picture that is the overall health of the company and the people who comprise it rather the just on share price? Why is share price the ultimate determinate?

Unfortunately, the reason is because companies are run by executives who care more about having healthy stock options than they care about having healthy companies. And since companies are not democratic organizations, it is the executive’s vote that counts.

But, you say, “Stock options can’t really be as bad as all that, can they?”

Well, they wouldn’t be if they were being used for the purpose they were originally intended -namely to reward executives and other employees for taking start-up companies and sick companies and turning them into something great. They aren’t bad when they reward executives for taking the risk of earning hardly anything at all for a long time working for this company, when they could have chosen a nice, safe, well-paying job at another company, instead.

Stock options were originally designed to reward people for working on the come, for taking entrepreneurial risk, for sacrificing their own short-term interests for the greater good of the whole. But they’ve evolved into something sinister and now everybody’s getting in on the act. In the last twenty years, stock options have become a component of nearly every executive’s compensation. They are the way in which officers, directors, and other highly-paid employees are able to Wealth Shift to themselves a portion of the future value of a company.

I say future value, because the share price of a company is rarely based on the current value of a company. Except in the most desperate of times, share price is never equal to book value, or even the current fair-market value of a company’s assets less its liabilities. Share price is based on a (usually optimistic) view of a company’s potential (aka its P/E multiple). When an executive works for a company for a few years and then cashes in on his options and leaves, someone else has to fill his shoes and complete the job of turning all that forward-looking optimism into reality.

Stock options typically vest over a very short period of time. Most fully vest over four years and expire after ten. Executives can usually start exercising and selling a quarter of their options just one year after the date of grant. This is a very short period of time in the life of a company. It is very tempting for executives to focus solely on implementing short-term profitability strategies (like highly leveraging the balance sheet), even when this ultimately ends up benefiting nobody but themselves.

Stock options are also particularly fraught with the potential for manipulation. For example, an unethical CEO might exaggerate negative information about the company just prior to the grant date of a significant amount of options to ensure that the share price on the date of grant is lower than it would have been otherwise. Or an executive might set up 10b5-1 trading plans and cash out of a troubled company the way Angelo Mozilo did. Or the CEO of a company might borrow heavily to execute a company’s share repurchase plan in order to drive up share price just prior to exercising and selling his own options during a window period. Think this doesn’t happen? Look at the corporate and insider trading history of Chuck E. Cheese (CEC) for 2007-2008. It amazes me to see how quickly a company’s share price goes downhill after it buys stock back at the exact same time that its executives are out selling theirs.

Executives with stock and options must be very careful not to let their greed for share price accretion drive them to do illegal things that will have a negative impact on a company’s reputation for a very long time to come. Our reputations are just so fragile. And yet we fail to do everything we can to prevent them from being hurt. Executives need to be ever mindful of the old axiom, “trust is the hardest thing to earn and the easiest thing to lose”.

Dell is a perfect example of how such actions can end up costing a company (through the loss of credibility) far more value than they can ever generate. Between 2003 and 2007, an internal probe revealed that reserves and accrued liability accounts had been manipulated to meet Dell’s quarterly financial reporting targets. Although the cumulative adjustment turned out to be just 92 million out of more than 12 billion earned during the period (roughly ¾ of 1%), Dell is still recovering from the fiasco.

In another matter, a judge in New York recently ruled against Dell Inc. for claims brought by customers asserting fraud, false advertising, deceptive business and abusive debt collection practices, to which Dell has responded “we don’t agree with this decision and will be defending our position vigorously. Our goal ha been, and continues to be, to provide the best customer experience possible.

Whether the judge’s ruling was right or wrong is not the issue. Customer perception is the issue. Customer dissatisfaction is a snowball rolling down the hill. All it takes is a little clump of dissatisfaction and some inertia to make a huge big snowball of impact on long-term profitability.

Employees, customers, investors and lenders. They all occupy one side of the Wealth Shift teeter-totter. Faith in the management of the company occupies the other. When faith evaporates, the teeter-totter comes crashing down, spilling people all over the playground. No executive should ever want to be the cause of this kind of Wealth Shiftastrophy. The money really, really isn’t worth it.

It will come as no shock to you to learn that C.P.A.s are expressly prohibited from owning stock in the companies they audit. Why? Because doing so is a conflict of interest between what is best for the company’s shareholders and what is best for the C.P.A. Why, then, should executives, who have so much power to affect the company’s share price, be allowed to indulge? The reason is quite simple - they have decided they want to.

Outside of the option arena, CEOs who have performed poorly need to think twice before accepting a golden parachute designed to ensure that the CEO goes quietly. Even though you may be on your way out the door, you still shouldn’t take advantage of the situation and think only about yourself. And, even if it means risking a breach of contract lawsuit, companies need to think twice about giving such packages to people who haven’t really earned them and don’t truly deserve them.

Companies aren’t personal piggy banks to be raided while employees (who are powerless to do anything) and shareholders (who don’t want to spend five years of their lives involved in a lawsuit) look on helplessly. We must face the unvarnished truth that the absolute power of the past several decades has, indeed, corrupted us absolutely.

In a period of economic prosperity when a rising tide lifts all boats, many companies do well not because of, but in spite of, the management at the helm. When a stale company’s stock goes up just because the price of a particular commodity goes up, how are employees and shareholders supposed to have respect for an executive who is suddenly worth millions through no particular effort on his part? Or if an executive mortgages the farm to the hilt and commits his company to great deal of debt in order to leverage equity and squeeze out that much more profit in the short run, how are shareholders supposed to respect the executive when they finally realize what a bad gambit this was?

Yes, I understand that there is a lot of pressure on management to “beat the street” quarter-after-quarter, year-after-year. It is unrealistic to expect that the party will never pause, and yet that’s exactly what Wall Street expects. Management is constantly being pressured to deliver. Scratch that – over-deliver. That pressure, combined with personal ownership of stock and the rights to stock, make it very tempting to do unethical things that are only good for the company (and the value of the executive’s options) in the short-run.

But when the good time run out, where are all the unethical executives? Out cashing in stock and options as fast as their Rule 144 and 10b5-1 plans will allow them to, that’s where. If executives want their employees to start taking greater responsibility for their actions, then these same executives are going to have to start taking responsibility for their own actions first. You can’t be in for the good times and out for the bad and still expect someone to respect you and follow you through the gates of hell, if need be. You can’t resent shareholders when they fire you for failing to perform when you’re the one who set yourself up for disaster by negotiating an outlandish employment contract that raises false hopes and unrealistic expectations in the first place.

Trust and loyalty is a two-way street, and it works at all levels of a company. Shareholders are not as fickle as executives think they are. They will stick by you through thin as well as thick if they think your heart is in the right place and your actions support the trust they have placed in you. Frankly, I would love to be present for a conference call in which a CEO actually refused to be lambasted for failing to meet Wall Street’s expectations by saying, “Look, I’m not at the helm of this ship to watch it take on water. I’m going to do what I need to do to make sure this ship stays in good repair and my sailors stay healthy for as long as we are at sea. I’ve got my eyes on the far horizon and I’m going to keep them there because that’s what’s in the long-term best interest of this company. I bought my shares on the open market just like you bought your shares on the open market, and I fully intend for my grandchildren to still own my shares fifty years from now.”

Executive Summary: CEOs and other members of management should “aspire to inspire”. They should implement long-term plans and objectives, and establish long-term rewards, and instill long-term confidence in their shareholders and employees. They should lead by example rather than by rhetoric, and they should never ever again say, “Look. Just do what I tell you to do.”


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