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A Booming Stock Market Should Not Be a CEO’s Best Friend

February 2, 2017, 8:38 PM UTC
Photograph by Rob Friedman — Getty Images

U.S. stocks have been hitting new highs since Donald Trump’s election last November. While investors are poised to benefit from the exuberant market, CEOs stand to gain the most, since their compensation is primarily composed of stock and stock options.

In recent weeks, however, members of Congress, investors and companies have moved to tilt the emphasis of CEO pay away from stock price. This is welcome news, as current compensation practices encourage economic boom and bust cycles, which leave workers vulnerable.

Company boards have often felt compelled to pay CEOs in stock options and in other specific ways to gain a tax deduction, but in January, U.S. Sen. Jack Reed of Rhode Island and others reintroduced a measure in Congress to limit pay deductibility to $1 million. If passed, it would level the playing field between cash and stock payments, giving boards more freedom to design effective incentive programs and one less reason to pay CEOs as they have.

Just this week, a coalition of large institutional investors, the Investor Stewardship Group, issued a guide to stewardship and governance for investors and boards that encouraged boards to step away from stock performance as the basis of CEO pay. In its 12 principles, the group urged that boards establish goals and incentive structures that demonstrate “a clear link to the company’s long-term strategy and sustainable economic value creation.”

And starting in February, research firm Institutional Shareholder Services, which provides information to institutional investors to help them decide how to vote their shares, will be including metrics such as return on equity and revenue growth in investors’ information on CEO performance. These are baby steps forward when it comes to performance measurement, but represent a big step away from a focus on stock price and shareholder returns, as was the case in ISS’ prior analyses. Such a move could open broader dialogues between shareholders and boards and could encourage boards to expand their horizons on what constitutes performance as well.

Both institutional investors and companies favor the ISS changes. When ISS surveyed institutional investors and companies late last year to ask if they would find it helpful for ISS to add other measures, nearly 80% of shareholders and 70% of companies supported or strongly supported the use of additional measures.

These latest developments have long been needed, as a myopic concentration on stock price has negative impacts. Research has found that CEOs motivated to boost stock price create economic boom and bust cycles as they attempt to push stock prices higher by taking excessive risk in good times and making deep, repetitive cuts during bad times. This destabilizes the economy, creating risk and uncertainty for workers.

What’s more, CEOs who drive their company based on stock price can cause great harm. Recall the accounting scandal at Enron in 2001; excessive risk taking that eventually brought down Lehman Brothers in 2008 or Wells Fargo’s fake accounts scandal last year. Building great companies requires CEOs to take actions that add value to a wide group of stakeholders (customers, employees, suppliers, and the community, as some examples).

One of the highest public priorities President Donald Trump and Congress should be working on is the economy and jobs, according to a January Pew Research survey of 1,502 adults. Given the negative impacts of CEO pay tied to stock price on both the economy and jobs, everyone on both sides of the aisle should welcome these latest changes.

Eleanor Bloxham is CEO of The Value Alliance, an independent board education and advisory firm. She is the author of two books on corporate governance and valuation.