Thursday, April 21, 2005

Matt-tinged thoughts on corporate incentives

If you haven't been following the sad story of America's biggest automaker, take a look at GM's stock chart over the past 5 years. In addition to economic decline and high oil prices, one of the main causes of GM's 90-to-26 decline has been rising health care costs for employees covered by the company. A whopping 14% of America's GDP goes to health care costs, and these are a huge drag on the business of a high-benefits employer like GM. Now look at Matt's post on TAPPED, which argues that the GM managers of old had only small incentives to prevent this from happening by supporting health care reform:

GM's managers probably didn't side against their own interests when they decided to sink the Clinton health care plan and, with it, their own company. As we've increasingly seen over the past several years, top executives are remarkably insulated against poor corporate performance. If their company's stock shoots up, they make huge sums of money in stock options and other incentive-based forms of compensation. But if their company does badly, they don't lose money the way shareholders do; they just make somewhat less money than they otherwise would have. GM going bankrupt will likely be no real skin off their backs.

Meanwhile, the executives have been paying much less in taxes than they would have had the Democratic Party been seeing more political success over the past 10 years. They used GM's resources in a way that was almost surely contrary to the interests of General Motors, but probably made the right call from an individual perspective. And as long as corporate America is governed in such a way as to create incentives for this sort of irresponsible political behavior on the part of corporate managers, it will be very hard to cope with serious national problems.

One might think that option compensation would give the managers proper incentives to look out for GM's long-term interests here. But that's not the nature of options. Usually your options vest (meaning you're allowed to cash them in) in 3 to 5 years, and the 1994 managers really don't have any incentive to protect the company from a crisis in 2005 -- especially one that's not sexy enough to grab shareholder attention until it's actually killing the company. And as Matt points out, at-the-money options don't expose you to any downside risk. If you get an option grant when the stock's at 50, it makes no difference to your options whether the stock goes to zero or stays put at 50. So wild gambles that aren't in the shareholders' interests are very much in the interests of management.

I remember when Matt considered the way that corporate attitudes towards public policy have changed over the past decades:

But in the 1950s and '60s business groups also spent a reasonable amount of time worrying about issues of broad national concern that also happen to be issues of concern to corporate America writ large. Progressive concern with creating a healthy, well-educated population is pretty well-aligned with the generic business interest in creating a healthy, well-educated workforce. Business interest in, say, lower taxes used to be tempered by this sort of interest in things that require public expenditures and an interest in not wrecking the general economy through out-of-control budgeting.

Somewhere along the way, this kind of thinking has basically vanished in favor of preoccupation with extremely narrow sorts of concerns.

I wonder if changes in the form of executive compensation -- and more broadly, in the ways executives see their jobs and their relations to their companies -- have had a role in diminishing their involvement in issues of broad national concern, like the health care example above.

(And in case you're wondering "How could government-run health care control costs better than the current system?" Matt can start you down the path to knowledge.)


Rousseau said...

Am I the only liberal who thinks Matt's repeated refrains about "once we get universal healthcare we'll never get rid of it" is a reason to wait a bit and make sure we craft the perfect system. I mean it might be a sign of how popular such things are, and also healthcare might be worth it enough that that cost isn't enough. Still "once we have it we'll never get rid of it" sounds like something I expect to hear from a fiscal-conservative libertarian type.

Neil Sinhababu said...

Well, I imagine that once we have it, we might be able to tinker with it a little. Of course, I have only a dim understanding of how this issue works, and all this is at too high a level of abstraction.

Rousseau said...

This is also an interesting situation of "either philosophical extreme provides a solution". You say, government needs to swallow those costs (or at least companies need to realise they don't have much to lose by gov't swallowing those costs). Libertarian-Republicans say "see, this is where unfettered unions get us, they need to be curbed". So sadly, there's not gonna be much convincing done here.