The Joe Sixpack Investing Conundrum

This Angry Bear post got me thinking about executive compensation, and who is at fault for some of the outrageous pay packages we have seen since the mid 90s. Here is AB's take:

I agree that the money should be directed to shareholders, but that's the direct responsibility of the board (in this case the NYSE directors), not the CEO. The CEO's direct responsibility is to maximize the performance of the firm. The board's job is to represent shareholders' interests and exercise oversight over the CEO and topmanagementt.

Simplifying somewhat, if the CEO does his or her job well, then there's a pool of profit created every year ("free cash flow", as it's often called). Some portion of that is paid to top management, including the CEO, and the rest goes to shareholders. The board's job is to ensure that the allocation of those profits serves the interest of shareholders. Certainly, we hope that CEOs will voluntarily decline excessive pay. But when was the last time you turned down a pay raise? If your pay is too high, is it your fault or your manager's fault? I'd say the latter.

Perhaps Grasso should go, but by all accounts he ran the NYSE well, even though he was overpaid for it. The real culprits, the ones who really should go, are the directors of the NYSE. In this case, the directors are particularly culpable because they are primarily CEOs of companies that trade on the Big Board. As such, overpaying Grasso, whose job responsibilities include monitoring member companies, has the appearance if not the actuality of a pay-off for lax oversight.

Now I have no evidence to back this up – it's just a thought – but could it be possible that this is the fault of lower investing costs due to the Internet?

Think about it. Ten years ago only fairly wealthy people invested. Stock ownership was associated with being upper class, and many people probably considered it a travesty that Joe Sixpack couldn't afford to own stock. So now the Internet comes along and lowers the cost of buying stock to $8, and allows you to buy just a few shares, so now Joe Sixpack can get involved in the market (which we applaud as egalitarian). But, wealthy people who own a lot of stock have an incentive to act more like owners than Joe Sixpack. Wealthy people read their annual reports, while Joe doesn't. Wealthy investors know who the CEO is and what his compensaton rate is, but Joe doesn't. If a significant portion of stock becomes owned by Joe and his friends, and short-term stock funds that don't really worry about the business fundamentals, then it is entirely possible that no one was really watching the board and making sure they look out for the shareholder's best interest.

I know a lot more went into this, like the speculative bubble that drove stock valuations to outrageous prices, but I can't help but wonder if a big part of the problem is that there is a disconnect between owning stock and acting like an owner of the company.