If you had the choice of investing in a company or buying real estate? Which one would you pick? For most Kiwis, it’s the latter, with the property comprising 57% of our assets*. Strong house price growth and low-interest rates have fueled recent growth, however, Kiwis have had a love affair with property for decades.
It helps that real estate is easy to understand. You buy a home, take out a mortgage and pay/earn rent. Plus, you are likely to benefit from capital gains. Shares on the other hand can be very complex. In many ways you could say you are buying into a single CEO given the impact they can have on the share price, but how much time do you spend researching the CEO?
Investing in a CEO
CEOs represent the face and voice of their companies. While it’s reasonable to expect that they will moderate what they do and say, there remain many examples of CEOs acting strangely in public. For example, Elon Musk’s recent Twitter takeover bid and his erratic behaviour on social media.
It makes sense to align the incentives of the CEO with the shareholders, yet it’s surprising how often those things often run awry of each other. Most CEOs pocket a large salary regardless of business performance. For this reason, many of the world’s best investors, like Warren Buffett, diligently search for opportunities where the incentives of shareholders and executives are aligned.
Similarly, most private investment funds now seek out investments where CEOs’ risks match those of institutional investors — where the CEO loses money just like shareholders do if things go wrong.
Stock Options with a CEO
What about stock options? Surely if CEOs have significant amounts of stock, they should get some focus. The problem is human nature – we tend to be ruled not so much by what we can potentially gain in any situation, but instead by what we’re afraid to lose (i.e. our big salary).
Public companies often require executive officers to own multiple times their salary in stock. Often this isn’t an adequate incentive for top executives who have already amassed substantial wealth. For a CEO whose net worth is $40 million, $2 million in shares is unlikely to motivate them to act in the interests of shareholders. If the company performs poorly, their shares could become worthless, but their net worth would remain intact.
“Are today’s businesses plagued by short-termism? The narrative is compelling. Executives cut investment to hit short-term earnings targets and trigger bonus payouts, the argument goes. They are egged on by short-term shareholders, who care only about making a quick buck, rather than growing the company for the long term.” Harvard Business Review