Author and economist Andrew Smithers dares to challenge Britain and America’s managerial incentives in his new book The Road to Recovery: How and Why Economic Policy Must Change.
Despite relatively high GDP in both countries, business investments continue to fall behind. The reason, Smithers believes, is that today’s managerial bonuses are linked to share prices.
Rather than risk falling short of a company’s quarterly earnings-per-share target, managers will opt for longer-term risks involving lower investment and a reduced threat to their take-home profits.
To support this bonus structure intrinsic to the modern executive salary, Smithers explains that many businesses are buying back shares for a more immediate boost to their earnings. The value of share buy-backs in Britain was reportedly 3.1% of GDP in 2011, worse even than the 2.7% in America.
America’s National Bureau of Economic Research (NBER) confirmed Smithers’ speculations in a recent survey in which the majority of managers said they would not opt in to a profitable long-term project if it meant the company would miss its predicted profits for the current quarter.
This was particularly true of public companies, where lower investment was linked to executive compensation derived from the stockmarket. Yet private firms where salaries are less dependent on bonuses were found to be more responsive to new investment opportunities.
According to this theory, the speed of the economic recovery depends on the greed of company executives. The question is whether they should be making investment choices at a personal sacrifice or challenging the current profit-driven salary scheme.
The world was less inclined to listen to the man behind Valuing Wall Street in 2000, which forecasted problems as a result of the stockmarket frenzy around dotcom businesses. Today’s leaders might be keener to consider his thoughts on this occasion.