Why management pay matters to investors just like you

Focusing on how managers are paid could be a worthwhile pursuit for Foolish investors.

The content of this article was relevant at the time of publishing. Circumstances change continuously and caution should therefore be exercised when relying upon any content contained within this article.

When investing, your capital is at risk. The value of your investments can go down as well as up and you may get back less than you put in.

Read More

The content of this article is provided for information purposes only and is not intended to be, nor does it constitute, any form of personal advice. Investments in a currency other than sterling are exposed to currency exchange risk. Currency exchange rates are constantly changing, which may affect the value of the investment in sterling terms. You could lose money in sterling even if the stock price rises in the currency of origin. Stocks listed on overseas exchanges may be subject to additional dealing and exchange rate charges, and may have other tax implications, and may not provide the same, or any, regulatory protection as in the UK.

You’re reading a free article with opinions that may differ from The Motley Fool’s Premium Investing Services. Become a Motley Fool member today to get instant access to our top analyst recommendations, in-depth research, investing resources, and more. Learn More.

The issue of management pay has become more popular in recent years. However, the focus has not normally been on how CEOs and CFOs are paid, but rather how much they are paid. In some cases and in some regions it is many multiples of an average salary, which is generally viewed as being unfair by many individuals.

The amount, though, should not matter all that much to investors. The reality is that most investors are happy for the management team of their successful business to be handsomely rewarded. The real focus, therefore, should be on ensuring that the right incentives are in place to encourage sustainable growth and share price rises over a long period of time.

Cash

Practically all senior managers receive total pay which includes a bonus for reaching specific targets. This incentive is crucial in order for them to invest their capital in the areas which are most beneficial to the long-term performance of the business. In some cases, this can simply be a cash bonus for meeting certain goals. While this may increase motivation, it may also lead to short-termism and a failure to act in the best interests of the long-term future of the business.

Shares

A better alternative to cash bonuses is where management incentives take the form of shares in the company. This is a sound idea, since it means that they could develop a substantial holding in the company and their financial interests may eventually be closely aligned with those of the company’s shareholders. This should mean that they pursue the growth opportunities which could have the biggest impact on the company’s share price. As a result, they will work towards a higher share price and, ultimately, higher capital growth for the company’s investors.

Stock Options

However, simply issuing shares to company management does not guarantee they will act in the best long-term interests of the business. Some managers who have a substantial shareholding may seek to generate high short-term capital growth on their shares. This may lead to them prioritising short-term decisions over long-term ones, with a focus on acquisitions, increasing earnings through measures such as share buybacks and increasing debt levels in order to expand more rapidly.

A better idea than issuing shares could be stock options. This is where an employee has the right to purchase shares in the company at a predetermined price. Stock options take a specified number of years to vest (vesting refers to an employee gaining ownership over the stock options), and this encourages them to make decisions that will bear fruit over the long run, rather than the short run. In this sense, their interests will be very closely aligned with those of long-term investors.

Takeaway

Finding out how senior management is incentivised is relatively straightforward. Details of director pay are included in a company’s annual report. Ensuring that the interests of the CEO and CFO in particular are closely aligned with those of shareholders could help to ensure that the company delivers high and sustainable returns over an extended period of time.

Should you invest, the value of your investment may rise or fall and your capital is at risk. Before investing, your individual circumstances should be assessed. Consider taking independent financial advice.

More on Investing Articles

Petrochemical engineer working at night with digital tablet inside oil and gas refinery plant
Investing Articles

Can the Centrica dividend keep on growing?

Christopher Ruane considers some positive factors that might see continued growth in the Centrica dividend -- as well as some…

Read more »

Smiling family of four enjoying breakfast at sunrise while camping
Investing Articles

How I’d turn my £12,000 of savings into passive income of £1,275 a month

This Fool is considering a strategy that he believes can help him achieve a stable passive income stream with a…

Read more »

Person holding magnifying glass over important document, reading the small print
Investing Articles

2 top FTSE 250 investment trusts trading at attractive discounts!

This pair of discounted FTSE 250 trusts appear to be on sale right now. Here's why I'd scoop up their…

Read more »

Smiling young man sitting in cafe and checking messages, with his laptop in front of him.
Investing Articles

3 things that could push the Lloyds share price to 60p and beyond

The Lloyds share price has broken through 50p. Next step 60p? And then what? Here are some thoughts on what…

Read more »

Young female business analyst looking at a graph chart while working from home
Investing Articles

£1,000 in Rolls-Royce shares a year ago would be worth this much now

Rolls-Royce shares have posted one of the best stock market gains of the past 12 months. But what might the…

Read more »

Investing Articles

Are HSBC shares a FTSE bargain? Here’s what the charts say!

There are plenty of dirt-cheap FTSE 100 banking stocks for investors to choose from today. Our writer Royston Wild believes…

Read more »

Three signposts pointing in different directions, with 'Buy' 'Sell' and 'Hold' on
Investing Articles

Just released: Share Advisor’s latest ‘Hold’ recommendation [PREMIUM PICKS]

In our Share Advisor newsletter service, we provide buy, sell, and hold guidance for our universe of recommendations.

Read more »

Investing Articles

Investing £5 a day could help me build a second income of £329 a month!

This Fool explains how £5 a day, or one less takeaway coffee, could help her build a monthly second income…

Read more »