Woah... halt.... slow...
We were almost at the point of agreement, and then in a slip of semantics I seem to have lost you.
I used the word "reflecting". By reflecting you in the mirror I am not modifying you. Or relocating you. I am showing you what you look like as others might see you. Which is something you would ordinarily have difficulty seeing.
Same as in the case of options.
Let's go back to the "big if"
IF management is exercising fiduciary duty
THEN employees get less value from shareholders than the cash they forego
ELSE employees get more value than the cash they forego
As far as a company is concerned, you and I both define "Profit" as an increase in value to shareholders. And also as a matter of shared definition, a decrease in value to shareholders is what we call a cost.
So then we have another "big if"
IF management is at the helm of a profitable company
THEN revenues minus costs are greater than zero
ELSE revenues minus costs are less than zero.
As shareholders, we want a mechanism to hold management's feet to the fire on both of these big if's. On the first one, we want to whack them if they dip their hand into the cookie jar too deeply. On the second one we want to reward them in proportion to how profitable the company is to shareholders.
Tucked into that little word "costs" up in the profit equation is something we can call salary, also by way of definition. Management has a choice: salary can consist of compensation actually paid (e.g. in cash and benefits at cost), plus either (a) the cash which employees will not forego if they do not get stock options, or (b) the value that they attract later from shareholders if they do.
But one way or another and depending on which one management chooses, and the degree, amounts (a) or (b) represent a reduction in value to the shareholder. Either one is a cost, by definition. However, neither of amounts (a) or (b) show up in the "accounting profit" reported by the company.
If management is judged only on the basis of accounting profit, then management has an incentive to maximize (a) and thereby increase (b). This is because management is currently reporting only the part of salary that isn't (a). The lower a salary they can report, the bigger a profit they can report.
But the actual profit (increase in value to shareholder) of the company is equal to the accounting profit (reported revenue minus reported costs), minus (a) or (b) as appropriate. This assumes that management is diligent in reporting things that increase shareholder value, and indications seem to be that if anything they are overly diligent in this regard.
If, and this is your big if, management is exercising its fiduciary duty, then (a) is bigger than (b), thereby increasing the actual profit of the business, and all is well and good.
By subtracting amount (b) from accounting profit to get something I might call "management measurement profit", and measuring various management teams by this amount instead of "accounting profit", we end up with a very interesting result.
Firstly, shareholders have one place in which to figure out whether or not their value is getting bigger or smaller, merely by looking at the sign of "management measurement profit". They do not have to perform dilution calculations to determine whether $0.20 per share "profit" offset by 4% increase in share count issued at 60% discount gave them more or less in the end.
Secondly, as this correction factor (b) increases, management is penalized, and as it decreases, management is rewarded. Management therefore no longer merely has an incentive to increase (a) and (b). Instead management has a direct incentive to minimize the amount (b) that employees will take instead of (a), and indeed if (a) is less than (b), then management will be rewarded to choose (a) instead of (b). In other words, management will have an incentive to exercise their fiduciary duty.
My suggestion is to create this "management measurement profit"... a "reflection" of what is going on. Like a mirror to the truth.
John |
