Every shareholder expects that company directors, board members, and executives are fully aligned with their interests. Creating long-term value for owners is the name of the game.
But sometimes executives play a different game. Often without even realizing it. There are lots of subtle ways executives can put their short-term personal interests ahead of the long-term interest of owners, and they are more common than you’d think.
This phenomenon is known as the ‘Agency Problem’, and often stems from mis-aligned incentives between managers and owners. It’s often not intentional, but it eats away at shareholder value creation.
Charlie Munger is very familiar with this problem in business, and has a favorite saying:
The trouble for investors is that leadership incentives are harder to quantify than financial results, and they tend to be overlooked because of their qualitative features. Imagine trying to compare companies on things like CEO motivation, or CEO risk-taking ability. No simple task.
But just because something is hard to measure, doesn’t mean it shouldn’t be or can’t be measured.
So when I decided to study the incentives driving America’s auto CEOs, I used four ‘metrics’ to help me understand how well CEO incentives are aligned to shareholder incentives.
1. CEO Equity
2. CEO Trading
3. CEO Pay
4. CEO Reputation
First let’s examine CEO equity. We really want to know how much of the company the CEO owns, and whether that ownership makes up a good chunk of the company equity.
Both Ford and GM are run by CEOs who own miniscule portions of the company, having inherited the CEO role without much equity. Tesla on the other hand, is being run by a CEO founder who is the company’s largest shareholder.
This is the latest data I found on auto CEO equity ownership:
Ford CEO James Hackett
Owns 871,074 Shares as of Feb 1, 2019 ($8.2 million USD). This is equal to 0.02% of Ford’s market cap.
GM CEO Mary Barra
Owns 3,703,390 Shares as of April 1, 2019 ($135.4 million USD). This is equal to 0.26% of GM’s market cap.
Tesla CEO Elon Musk
Owns 38,572,790 Shares As of Feb 14, 2019 ($16.6 billion USD). This is equal to 21.2% of Tesla’s market cap.
This first dataset is very clear. Elon’s ownership stake in Tesla dwarfs those of James and Mary. He is even the largest shareholder of Tesla, which can’t be said for the other CEOs. Simply put, Elon is all in. Mary and James are not.
And I know what you’re thinking... “Elon started the company, which gave him an unfair advantage over the other CEOs. Therefore these ownership numbers are flawed”.
It’s a nice theory, and it’s not wrong in isolation, but it won’t hold water after we examine our next data point.
Next let’s look at how America’s auto CEOs are trading their company stock. This will help us understand the conviction each CEO has in the future of their company. It puts all CEOs on an equal footing, no matter how much equity a CEO owns.
The key question we want to figure out is what they do with their stock and earned salaries. Since these CEOs have more control of their company’s future than anyone else, this really comes down to their belief in themselves. CEOs that think they can create value would be crazy to get rid of their shares.
Ford CEO James Hackett
Sold 120,000 shares in 2019 (- $1.2 million USD). That represents a 15% reduction in his existing equity ownership.
GM CEO Mary Barra
No trades in 2019 ($0)
Tesla CEO Elon Musk
102,880 shares bought in 2019 (+ $25 million USD). That represents a < 1% gain in his existing equity ownership.
So among America’s automakers, Elon Musk is the only one who bought shares this year.
He’s also the only one who doesn’t take a salary; likely buying these shares on a loan backed by his existing shares.
So why aren’t the other CEOs buying? Maybe they’re out of cash too? Unlikely.
James Hackett’s Ford salary in 2018 included $1.8 million in cash (plus another $15 million in other compensation). Mary Barra received $7.2 million of cash from GM in 2018, (plus another $14 million in other compensation).
So these CEOs are not buying their own stock, and they’re taking multi-million dollar salaries against Elon’s $0.
Why are Ford investors putting up with James Hackett’s selling habits? He has already made 6 sales in 2019, and he’s only been Ford’s CEO for two years. If he actually thought he could add value to the organization, he’d be buying shares instead of dumping them on retail investors.
By now we can see that Ford and GM are being run by CEOs with very little skin in the game, and neither one is making an effort to change that. Instead, they get large salaries, bonuses, and additional equity that they can turn around and sell, no matter their performance.
GM hasn’t beat their 2015 net income in the last five years, and Ford hasn’t beat their 2017 net income in the last two. And both companies stock prices have been trending downwards since 2017.
Tesla has yet to earn positive net income over a full calendar year, but that’s not the point. The point is that if Elon doesn’t make Tesla shareholders rich, he doesn’t get paid. James and Mary get paid regardless.
Elon’s pay is entirely rooted in Tesla’s most recent incentive package. You can read it all here, but the crux of it is that Elon can’t earn any of his incentive package until Tesla’s valuation exceeds $100 billion, and can’t earn the entire package unless Tesla’s valuation is over $650 billion.
No automaker in history has ever been worth $650 billion. Elon has his money where his mouth is.
Finally, let’s examine the one incentive more powerful than money. Reputation.
Anyone can earn back lost money, but repairing a broken reputation is much tougher. And there’s a very real distinction between the reputational harm each CEO would feel if their company went under tomorrow.
James Hackett is the newest of the bunch, who became Ford’s CEO in mid-2017. If Ford went bankrupt tomorrow, he could probably brush it off and blame previous management. He’d probably be head-hunted for a new CEO position within months too.
Mary Barra on the other hand has been at GM since 1980. She risks serious reputational harm if the company goes under. This has been the work of her entire adult life, and it would look awful if she dropped the ball.
Same with Elon Musk. He has a reputation built entirely on his achievements with Tesla and SpaceX. Nobody knew Elon’s name when he sold PayPal in the early 2000s, and now he’s a global celebrity. But if Tesla ever went under, Elon’s reputational harm would extend far beyond just his career prospects. His entire brand and celebrity image would be tarnished.
Among America’s 3 automaker CEOs, Elon Musk has far more at stake than anyone else. And he’s designed it that way. Whether that’s money or reputation, he practically lives with his neck on the line. And that’s exactly how leaders should run companies. When shareholders win, Elon wins. When shareholders lose, Elon loses.
Yet many investors prefer to avoid this conversation of accountability and instead attack Elon’s eccentric behaviour and unorthodox style. They assume Tesla is doomed because of it, but this idea is completely detached from reality.
It implies that conforming to an ‘acceptable’ management style is more important than financial and reputational incentives. Mary Barra and James Hackett would love for you to believe this, but it’s just not true.
Neither of them have the conviction to put their money where their mouths are, and they have designed their compensation packages for personal gain over long-term shareholder value. They won't buy their own company shares with their multi-million dollar salaries, and James is regularly dumping his existing shares on retail investors as they continue to lose value.
So the real question is how much longer can Ford and GM investors justify the lack of accountability of their CEOs?
I’m sure that clock is ticking much faster now that Tesla is worth more than Ford and GM combined.