I am committed to the highest level of management ethics.  I would rather see the company struggle financially than see it compromise on its ethics.  With this in mind, I articulate four management ethics principles that capture the responsibilities management has to its investors.  Principle 1 is:  Treat shareholders as long-term business partners; and view management as managing partners.

Principle 1 has two parts.  1a is:  An enterprise must be managed with the perspective that investors (not management) own the assets contained within the company.  

I’ve seen too many situations where management teams lose sight of their role as managers of a company.  At the end of the day—and at the beginning of the day for that matter—the company belongs to the investors.  A company’s purpose is to maximize value for its owners.  Conversely, an enterprise does not exist to serve management nor its employees.  This might sound cold—but it is essential belief a for-profit enterprise must have to maintain long-term success.  When it loses this perspective, it begins to make inappropriate decisions.  Over time, the viability of the business erodes.  As this happens, investors suffer but so do employees and customers.

How many of the disaster stories circa the telecom, dot.com, or housing meltdowns are attributable to management teams failing to treat their shareholders as long-term business partners? Lots!

By the way, “long term” is an important part of this principle.  Without doubt, short-term extraordinary high-risk tactics were at the core of the 2008 housing and banking collapse.  A management team that consistently focused on the long-term treatment of their business partners will resist tempting short-term tactics.

Now, let me shift to 1b:  It is management’s responsibility to ensure all executive compensation and perks are clearly understood and approved by its investors.

I am a staunch advocate of the Free Market.  Whether a star athlete, talented movie star, or effective executive, an individual should be paid as much as the market dictates.  It is not government’s role to restrict this, any more than it is government’s charter to dis-allow LeBron James from signing a $100M+ contract.  Likewise, government’s role in “helping” investors do a better job of managing executive pay is limited. Instead, the primary role in determining executive pay falls on the market.

In my career, I have been a director of multiple companies and have served on certain compensation committees. As is typical with directors, I am limited in the amount of time I can spend in these duties. As such, I know first-hand that there is a strong dependency on management when it comes to structuring and understanding executive compensation packages.   This leaves directors necessarily dependent on those executives whose compensation packages they are determining.

The extreme importance of executive compensation and these inherent conflicts of interest are why I include it as part of the first management ethics principle.  Even when the topic is his compensation, an executive must embrace (a) their shareholders as long term business partners and (b) the enterprise must be managed with the perspective that investors (not management) own the assets contained within the company.

Again, I believe in the Free Market.  The top 1% of executives—just like a top tier NFL quarterbacks–creates enormous value relative to the business-world equivalent of a middle-of-the-road NFL quarterback.  The executive should be rewarded accordingly. However, unlike a professional athlete, a CEO/executive team has more of an opportunity to game the compensation dynamic. The fact that this opportunity exists does not entitle managers to exploit it.  If they do so, they are violating principle 1a.

When it comes to executive compensation and perks, management’s responsibility to ensure compensation implications are clearly and completely understood by directors.  This principle sounds basic, but consider what temptations management must resist.

  • Allowing employment contract language to be unnecessarily complex, thereby making it difficult for investor representatives (e.g., compensation committee) to evaluate
  • Presenting summaries that, although technically accurate, are incomplete or misleading
  • Providing supporting analysis that fails to identify relevant scenarios—such as a quirk that allows the executive makes substantial sums while the company is crumbling
  • Failing to identify flaws in the plan—for example, if the plan encourages management to pursue inappropriately risky investments which conflict with the overall Management Ethics #1 principle
  • Manipulating accounting results to benefit management compensation without the intended benefit to the owners
  • Initiating compensation negotiations when the company is vulnerable to the departure of the executive, especially if the threat of departure is used as leverage
  • Using professional services experts—such as human resource or financial analyst consultants—who are inappropriately influenced by management
  • Appointing directors (especially compensation committee members) that have inappropriately cozy relationships with management

When executives make large sums of money, their compensation packages will be scrutinized.  A great executive—and an effective director—will not fret when such scrutiny is applied, so long as the compensation package held up to these principles.  In fact, the director will feel like the executive received a just reward for the job that was done on behalf of their stakeholders.

One Response to “Management Ethics: Dissection of Prinicple 1”

  • Parkite says:

    What does Buffet say about HR consultants? Consider the incentives (follow the money). Is it in their best interests to provide analysis that supports lucrative comp packages? Of course, if they like working with said company.

    Same with BOD. Do they like the financial package associated with BOD position? You bet. One can make a *very* good living serving on the BOD of public companies. Just don’t rock the boat.

    Dan, unfortunately very few companies think like you do about corporate governance. Good for you. Hope you don’t change.

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