
When CEOs’ Equity Is About to Vest, They Cut Investment to Boost the Stock Price - joeyespo
https://hbr.org/2018/02/study-when-ceos-equity-is-about-to-vest-they-cut-investment-to-boost-the-stock-price
======
ucaetano
In other news, people are found to act in their own self interests and game
whatever rules and systems are in place for their own personal advantage.

Further research reached the surprising conclusion that CEOs are people too,
and game the system just like any other person.

[Edit: adding color, as my comment lacked substance to abide by HN's
guidelines]

Snark aside, this is a great example on how we need to design robust incentive
systems that minimize the chance of gaming them. People are amazing
optimizers, and will find any loopholes or gaps that allow them to use any
system to their advantage.

CEOs delaying investments, CFOs colluding with industry analysts, rushing
product launches, technical debt, etc. are all examples of the same symptom.

"Detecting Earnings Management", by Richard Sloan (a former professor of mine)
is a great article that shows the same behavior as this article: managers will
anticipate or delay earnings and investments in a way that maximises whatever
metric they are evaluated on.

This is further exacerbated by the non-linearity of the market response to
earnings surprises. Unsurprisingly, the distribution of earnings surprises
over time are not symmetrical to the average market return.

~~~
dang
Sure, but your comment breaks the HN guidelines, which ask:

 _Please don 't post shallow dismissals, especially of other people's work. A
good critical comment teaches us something._

It also breaks this guideline, since you've ignored the substantive core of
the article:

 _Please respond to the strongest plausible interpretation of what someone
says, not a weaker one that 's easier to criticize._

We all know how easy and satisfying it can be to fire off a bit of snark into
the internet, but it makes for poor discussion, and actually causes harder
systemic problems than outright personal attacks and the like. So please don't
post like this to Hacker News.

[https://news.ycombinator.com/newsguidelines.html](https://news.ycombinator.com/newsguidelines.html)

~~~
ucaetano
I added some content making it more useful, thanks for the feedback :)

~~~
dang
Much better—thanks!

~~~
Bombthecat
Dang!

Sorry, couldn't resist.

I will show myself out now.

------
dv_dt
I think this is one of many bits of data that I add to support my personal
hypothesis that public equity markets are increasingly failing at their job of
being an efficient way for our economy to allocate capital.

~~~
cryptonector
They almost certainly can't be too efficient. There's a proof that if markets
are efficient then P = NP.

This isn't really about whether markets are or can be efficient. This is about
corporate governance. Boards of directors should not permit CEOs to play these
games, and compensation of CEOs should be structured to not create such
destructive incentives.

~~~
goldenkey
Perfect efficiency does not exist. Some efficiency does. There are three
variants of the hypothesis: "weak", "semi-strong", and "strong" form. [1]
Insider information isn't some conspiracy -- people have gone to jail over it
year after year. With information disparity, efficiency is always going to be
a fraction of what it could be. Just think about two parties -- one thinks the
stock should be high because of insider information. And lets say they are
also mega-rich big bucks. The other party is people without the insider info,
they think the stock should be low. So Mr. Mega-Rich buys a lot of shares, the
stock goes up. Then it falls back down because no one else wants to buy it at
that high price. These oscillations will continue as Mr. Mega-Rich takes
advantage of his insider information - and the more trading volume on the
buying end, that he provides, the more choppy the market for that equity will
be. If Mr. Mega-Rich is continuously buying, that choppyness won't go away -
lest other parties take his actions to be information itself, and adjust their
appraisals.

Wall Street I and II aren't the most accurate pictures, but they certainly
aren't fiction. If you aren't the shark, you're getting sharked. But because
of 21st century prosperity, you still might be happy with your returns, even
while paying the tax of giving money to those with better information.

[1] [https://en.wikipedia.org/wiki/Efficient-
market_hypothesis](https://en.wikipedia.org/wiki/Efficient-market_hypothesis)

~~~
chibg10
> If you aren't the shark, you're getting sharked

People say this a lot, but I think it's misleading to most who hear it. This
is certainly true in a trading context (i.e. where the buy/sell time horizon
is short enough where the underlying asset's economic value doesn't change,
though the market price might), but not in an investment context (where it's
expected that the inflow of capital will create economic value and the stock
price will reflect that).

The takeaway is that you should leave daytrading to the pros, and instead bet
on humanity improving the means of production over long time horizons. Unless
you're actually a pro and have good reason to believe you can beat the market.

------
zombieprocesses
Can you blame them? People act in their selfish self-interest.

It's the same thing with cops and firefighters. Their pensions are calculated
based on the earnings of the last few years of employment. So that save
vacation days the last few years to inflate their earnings the last few years.

If there is one thing you can count on, it's human greed. And I'm not
pretending I'm above it myself.

The problem is that the system is set up to be exploited by the CEOs/etc.

~~~
jjoonathan
Can I blame them? Yes, the same way that I can blame a thief for stealing a
car even though society "gave him an incentive to steal it."

One of these is an ongoing source of considerable societal damage. The other
is illegal.

~~~
cjbillington
Making something illegal does create incentives against it, and if stealing
cars weren't illegal I'm sure we'd see much more of it.

~~~
drb91
Generally stealing cars is clear-cut and easy to prosecute. The opposite is
true for insider trading. As a result, things that look an awful lot like
insider trading occur all the time without any interest from the SEC.

I'm not very equipped to judge legally what is or is not a crime, but it does
seem like there's a lot of leeway for people in control of public companies to
effectively take money from their investors.

~~~
jessaustin
Yes but it's important that the "crime" of "insider trading" exist so that
investors might imagine that executive _aren 't_ doing that every single day.
Also it's important that the crime is totally discretionary so that
prosecutors can punish every single non-executive who somehow gets wind of
non-public information while never bothering executives who donate to the
right PACs.

------
batterseapower
Interestingly, it's well known that the stock of firms with high levels of
investment does worse than the stock of firms that do not invest as much --
see
[https://www.sciencedirect.com/science/article/pii/S0304405X1...](https://www.sciencedirect.com/science/article/pii/S0304405X14002323).
One possible reason for this is that managers may channel investment funds
into unproductive empire building.

~~~
fullshark
This is cross-sectional returns over a month so it basically confirms the OP,
don't invest money if you want the stock to up in the next month (or quarterly
report).

------
jimrandomh
Neat fact: the publishing of this article has caused its headline to stop
being true. Since CEO equity vesting schedules are public, all it takes is a
few algorithmic traders acting on this to make the strategy stop working.

~~~
wqnt
Algorithmic traders focus on short-term market movements. The investment
decisions described in the study are about long-term foundamental of
companies. As long as enough investors prefer cash flow to capital
reinvestment on the earning report, the strategy will continue to work.

Cutting costs and investments can easily dress up short-term financial
performance at the cost of long-term productivity. But it will look good for
investors who don't understand the underlying matter and rely on simplistic
metrics to make investment decisions.

------
thisisit
One of the interesting things which has egged on the current bull run has been
the abundance of cash. I need to find the exact link but it seems lot of
companies are buying back stocks which then masks the nonperformance under the
garb of market beating EPS growth.

~~~
sokoloff
What's the under or non-performance? If a company is generating enough cash to
buyback its shares, that's every bit as much a real return to shareholders as
a dividend would be.

If a company retires 10% of its shares from a buyback, each investor now owns
~11% more of the company than they did before.

~~~
adamlett
It’s not so simple. In a perfect market, the market value of the company will
go down when company buys back stock. Why? Because the value of the cash is
now gone. So in your example, each stockholder just owns a slightly larger
piece of a slightly smaller pie.

Of course markets are not perfect, and nobody knows for sure if the market
value of the company is fair or not. When a company engages in stock buybacks,
it’s essentially saying that it believes its stock to be undervalued, which is
why stock buybacks sometimes have the surprising effect of elevating the stock
price, at least in the short run. After all, who has better information about
the company and its prospects than itself?

But as they say, the market is a voting machine in the short run, but a
weighing machine in the long run. If it turns out that the market value of the
company is higher than its intrinsic value, then stock buybacks are actually
destroying shareholder value. The cash would have been better spent buying
shares in an index fund.

~~~
pathseeker
>It’s not so simple. In a perfect market, the market value of the company will
go down when company buys back stock. Why? Because the value of the cash is
now gone. So in your example, each stockholder just owns a slightly larger
piece of a slightly smaller pie.

That's not right. You have a larger piece of a smaller pie, but you have the
same amount of pie.

Edit: the confusion is you are talking about total market cap while the parent
is talking about share price. Total market cap is irrelevant to stockholders.
Share price is all that's relevant.

~~~
adamlett
_You have a larger piece of a smaller pie, but you have the same amount of
pie._

Yes, this was my point. Stock buybacks are value neutral if the market value
of the company is correct. Ie. the share price stays the same.

------
chibg10
Has anyone read the paper? What is the effect size? I'm assuming the author
means "statistically significant", which is worthless from any decisionmaking
perspective (e.g. policy).

~~~
notahacker
Effect size is ~0.2% of annualised net investment in R&D ($2m for median firm
size) per standard deviation in vesting equity (unvested equity and remaining
vested stock have minimal effect on equation as specified). So not huge but
not trivial.

Paper is pretty thorough, including looking at changes in actual measures of
firm efficiency, forecasts by friendly analysts vs actual earnings growth and
an attempt to defeat the reasonable alternate hypothesis that boards time
vesting decisions according to when they think massive investment is no longer
needed and earnings growth will kick in.

It does however focus on [estimated per quarter based on annual info] vesting
schedules and not actual share sale decisions. Actual share sales are found
not to be statistically significantly related to investment drops (likely due
to a variety of other reasons for offloading and reluctance to offload if the
investment drop is due to short term dips)

------
markhall
Somewhat relevant topic into how many of these CEOs got to where they were:
"New Study Reveals How Many CEOs Fast-Tracked Their Way To The Corner Office"
[https://goo.gl/Bz8fP5](https://goo.gl/Bz8fP5)

~~~
ScottBurson
Actual URL: [https://www.forbes.com/sites/markhall/2018/03/01/new-
study-r...](https://www.forbes.com/sites/markhall/2018/03/01/new-study-
reveals-how-many-ceos-fast-tracked-their-way-to-the-corner-office/)

I think URL shorteners are frowned on here.

~~~
mlinksva
Not to mention, Forbes "articles" are frowned on.

It's a rewrite of [https://hbr.org/2018/01/the-fastest-path-to-the-ceo-job-
acco...](https://hbr.org/2018/01/the-fastest-path-to-the-ceo-job-according-
to-a-10-year-study)

------
valine
>> Could the investment cuts actually be efficient? Perhaps stock price
concerns are motivating, because they induce the CEO to make tough decisions,
such as cutting wasteful investment. If so, we would expect the CEO to improve
efficiency in other ways as well, such as increasing sales growth or cutting
other expenses. And we find no evidence of that.

I imagine looking for ways to increase sales growth and cut costs is something
a good CEO does on a regular basis, so maybe there's not much low hanging
fruit in that respect. I honestly don't see an issue with the explanation that
CEOs are simply more motivated to cut wasteful investment prior to their
equity vesting.

------
purplezooey
This is well known. Mostly what (public) companies spend money on these days
is share buybacks. Especially for retail, they'd be better off in the long
term paying benefits for their hourly employees.

------
fitblipper
Doing this would be foolish since they are taxed as income when they vest but
capital gains after. If their aim was to unfairly take advantage they should
wait until right after vesting not right before.

~~~
Retric
The article address this: "Only once this period is over can they sell — _and
they typically do, to diversify their personal investments. "_

CEO's have a great deal of exposure to the upside of their company doing well,
they want protection from the downside of it doing poorly.

------
LorenPechtel
They missed the real fix for the problem--change how vesting works.

They are talking about changing vesting from 3 years to 5. Instead, how about
take that pile of options and split it into 5 piles. Pile 1 vests in 3 years.
Pile 2 vests in 4 years and so on.

The point is to spread it out over time--they'll do better with a long term
approach.

------
StriverGuy
Relevant to the impact of stock based compensation in real terms for CEO's:

[https://www.bloomberg.com/graphics/2018-blackstone-
schwarzma...](https://www.bloomberg.com/graphics/2018-blackstone-schwarzman-
pay/)

------
gesman
Interesting way to play with stock options for public at large too.

~~~
snarf21
Like most things, you get what you optimize for.

------
ChuckMcM
I think that is a clever way to tease out causality.

------
ggg9990
This is why the public ownership model is bound to fail, and already the most
successful companies are avoiding it as long as possible or entirely.

~~~
imglorp
Alan Greenspan, on his way out, famously said

> he had made a "mistake" in believing that banks in operating in their self-
> interest would be sufficient to protect their shareholders and the equity in
> their institutions. Greenspan said that he had found "a flaw in the model
> that I perceived is the critical functioning structure that defines how the
> world works."

It's not a stretch to apply it to all C-levels at all public companies: they
will absolutely manipulate the company to benefit themselves at the expense of
the shareholder.

[https://www.cbsnews.com/news/greenspan-my-faith-in-banks-
a-m...](https://www.cbsnews.com/news/greenspan-my-faith-in-banks-a-mistake/)

~~~
JoeAltmaier
This is my sister's observation after 20 years in manufacturing. All her
experiences at the executive level were of folks manipulating the company to
get their bonuses regardless of the damage they did. They'd simply move on
when a company failed.

She got sick of it all after 20 years, and now runs a chocolate shop in semi-
retirement.

~~~
rbanffy
> They'd simply move on when a company failed.

And often the failing company would even pay for the outplacement consultants.

~~~
imglorp
That and a ginormous exit package.

