Why Credentials Matter

It is difficult to know what is really going on in our federal government these days or to know what the extent of their involvement is in the private businesses to which that have loaned money. Why they have become the nation’s banker is not entirely clear either, but now that they have decided to do so, it is also unclear what the long term strategy is.

Recently, the Administration has proposed to establish pay guidelines for executives within the auto companies and financial institutions that have become their borrowers. They have either directly or indirectly helped to decide the changing of management and decide what products to offer to the public. In other words, they have taken on the role of the board of directors of these companies. That raises new questions about how business in general around the nation will be run. If the bankers are allowed to make the executive decisions of any company to which they loan money, what is the likely success of those businesses?

In a capitalist system, business must be able to survive or fail based on its ability to meet the demands of the market place. The ability of a business to meet those demands lies primarily in the skill, knowledge, and experience of its management. That management must understand the market in which they sell, the complexities of its own operations, and its capabilities to participate. Few lenders are qualified to make a company’s decisions and therefore do not participate directly on a company’s board. In the rare instances that they might, they occupy but one seat among many others. When that one seat becomes the only voice in the room, that business may find itself in great peril. If this is occurring with federal government involvement in the management of private businesses, it would be hard to understand why any federal bureaucrat would deem themselves more qualified to make decisions than those who manage day to day operations.

I have long been critical of the compensation structures of many corporations. I’ve felt that many senior level executive pay plans have been excessive in terms of the kind of compensation they receive. However, these matters must be decided by board members who are elected by the stockholders. Stockholders also decide through their willingness to purchase stock. The market place decides through their willingness to pay the price of a product. Finally, like all jobs, it is decided by the availability and competition for the skills of those managers in the job market. Arbitrary limits on compensation do not work and upset the fundamental controls of competition. It would be far wiser to look at how executives are compensated rather than in how much. My personal concern has been in the way executives are incented to perform. Many CEOs and top level executives receive very large numbers of stock options in addition to their salaries and bonuses. Too often, the value of these options has considerably exceeded all other compensation combined. The intent is to incent management to protect stock value for the stockholders and theoretically to increase the profits of the corporation. The argument is that the higher the profits, the stock price will follow. The problem becomes that when a manager’s financial goal is based primarily on stock price, the decision paradigm dramatically shifts from financial growth to profit maximization. To increase profits it is unnecessary for a company to increase sales, revenue, or market share. One simply has to reduce costs proportionally against existing available revenue. Revenue can actually go down, but as long as costs are cut proportionally, a business can continue to show an increase in profits. This has been happening within many American companies as executives try to maximize profits and increase the price of their stock and personal options. This is what needs to be reevaluated, not how much an executive makes.

Before you invite your banker into the boardroom, it would be my opinion that you should be very certain of their credentials for making operational decisions. I would suggest the same consideration when voters go to the polls to elect those who are going to run their federal business.