24 Jul. 2012 | Comments (0)
In my last blog, The Rise of “Shareholder Value” and Its Unintended Consequences, I spoke about how “shareholder value” became universally embraced as the primary measure of management success. In this blog, I will further delve into the consequences of this adopted theory of management, and how it led to the decline of the financial sector.
In the early ‘90’s, after “shareholder value” was implemented as the main tool for measuring management success, grumbling began from those in stock option plans about “underwater” options. At the same time, the pure “increase in shareholder value” model of company performance measurement was challenged in a number of academic studies. It became apparent that macro-economic factors outside the control of managers had a very significant impact on share price.
In response, plan designers began “benchmarking” shareholder return against a sector or “peer group” of companies and the concept of “relative performance” was adopted. In effect, this meant that senior executives could be rewarded for “least worst” operation in terms of share price performance. In some cases, options were even “re-priced,” which, in consequence, led to some juicy scandals.
Incentive plan designers began to include other performance measures in addition to share price. In some cases, it was almost as if the performance management of the CEO and the executive team was being delegated by the Board to the bonus plan.
Stock option plans became more and more complicated in an ongoing effort to “cover all the bases” of performance. In the process, many of these plans became so complicated that not even their designers really understood what was being rewarded!
I’m not trying to argue that the “shareholder value” model is “wrong” or that it’s responsible for all that has gone wrong. But, I do argue that taking the idea out of context in a rather simplistic way led to a significant change of focus at the top of businesses, which had the unintended consequence of directing the attention of senior management to short-term share price movements, rather than the effectiveness of the enterprise in serving its intended markets.
So what do you think? Please share your opinions below:
- Has “shareholder value” been over-used as a measure of managerial performance?
- Are the right managerial behaviors encouraged by stock option plans?
- What are the alternatives?
Tune into my next blog when I’ll take a look at how changes in the financial sector impacted the character and culture of financial institutions.
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