What stops management from just "compensating" themselves by taking all the stock in a company?

Question

One of the odd things about a lot of modern companies is that the management, meaning the senior officers (CEO, CFO, CTO, etc) can pay themselves in stock.

For example, Square's Jack Dorsey pays himself 500,000 shares of stock or something like that every month and then promptly sells it. In other words, he creates 105,000 shares of stock every week and then sells it, currently for about $7 million each week. That comes to about $350 million over the course of a year. If you consider that Square has a declared earnings of around $30-40 million, the $350 million Dorsey is getting by diluting the stock is pretty significant. The whole revenue of the company is only about $2 billion annually.

To a shareholder this might seem like he is looting the company. I mean why stop at just generating 105,000 shares per week for himself? Why not just create a million shares a week and pay himself $70 million per week instead of just a measly $7 million? If you are going to pound the company into the ground, why not just go whole hog and dilute the pesky shareholders to nothing?

What stops management from doing this, essentially "paying" themselves so many shares they dilute the non-management shareholders to nothing, get a stock majority and then just delist the company and take the company private. Just take the whole pie. What stops them from doing it?

If the answer is "the shareholders could sue them", well, why aren't the shareholders suing Dorsey NOW for looting the company? Where is the dividing line between dilution being merely greedy and being malfeasance?

Answer 1

Answer: the board. The board oversees the operations of the company and essentially supervises the CEO. The amount of actual supervision that takes place varies by company. While I cannot comment on Square, there other recent examples that are instructive.

Darden is the parent company of brands like Olive Garden, and several others. It's a solid dividend paying stock that is/was owned by many institutional investors. In October of 2014, activist investors took over the board and ousted the CEO. Several C-Suite positions were replaced with those that supported their position.

The previous CEO made some decisions that were not supported by the board or the investors at large. In that case, no raiding was going on. It was more of an approach to business that they did not like. It only took about a year, but one day things were being run by the old guy, and less than a year later half the board was new, and new C-Suite.

So, if the Square CEO essentially controls the board, there is nothing much to be done. If he does grant himself excessively, he will dilute the company into oblivion, which also makes his ownership worthless. So there is a bit of a vested interest in not doing this. Plus if he does do this, who would want to work with him again?

So, prudence should be practiced anytime a business owner sets his own compensation. Failure to do so could lead to the failure of the business and in the end the owner could really hurt themselves.

Answer 2

This may vary according to the jurisdiction the company is incorporated in, but in the one I'm somewhat familiar with (Denmark), neither the CEO nor the entire board can validly issue an unlimited number of new shares.

The creation of new shares must be decided by a shareholder meeting and written into the corporation's bylaws. The shareholders can delegate to the board the detailed decisions of when and how to issue new shares, but they must set a concrete maximum number of new shares that can be issued, or the decision will not be legal.

Answer 3

You might enjoy reading the book "Pay without Performance: The Unfulfilled Promise of Executive Compensation"

The theoretical limit on what executives are paid comes from "arm's length bargaining" between the CEO and the board. That's the idea that there's a tough, hard-nosed negotiation between the CEO and the board, with the board representing shareholders' interests, unwilling to pay a penny more than they had to.

The book presents many examples showing that CEO's pay does not match what you'd expect if arm's length bargaining was being used. Instead, the book says, CEOs pay themselves as much as they can without shareholders being 'outraged', i.e. deciding to do something about it. It's very difficult for shareholders to do much, as each shareholder has so little power, so this is a very high bar, explaining why CEOs are so well paid.

Answer 4

The first line of defense against the CEO doing this is other board members; the CEo can't actually do anything without approval from the board of directors. But you ask "What stops management from doing this", so if the entire board colludes to give themselves stock, obviously they aren't a check on themselves. The next line of defense is shareholder votes. The board of directors is chosen by shareholders, and have to periodically win re-election from the shareholders. However, those elections can be years apart, and corporations vary as to what sort of options the shareholders have for emergency elections, so that's not much of a defense against directors who are willingly to act shamelessly.

However, there's a third line of defense of the courts. Shareholders can sue executives that don't act in the interests of shareholders, and the government can criminally prosecute them. The more shameless the directors are, the easier it is to make a case.

Why not just create a million shares a week and pay himself $70 million per week instead of just a measly $7 million?

That would work out to be about 10% of the market capitalization after a year. And the board of directors would have to get their own slice of the pie to go along with that. It's a lot easier to win a court case after taking 1% of the company for yourself rather than 20%. Furthermore, at that point it's pretty much all or nothing. Once the market sees that you're diluting shares, people aren't going to want to buy the shares, so giving yourself shares and selling them isn't going to work; you'll have to get enough shares to take it private.

Answer 5

There are two different issues here¹:

• Creation of new shares: the company uses them to raise capital. Theoretically they do not affect the value of current stockholders assets. If you have a $1,000,000 company with 1,000 stocks, if you raise 1,000 new stocks you should value them at $1,000 so you get a $2,000,000 company with 2,000 stocks.

  The issue here is that if you previously owned 501 stocks and controlled the company, with the creation of new shares if you want to keep your control you need to buy 500 shares, and maybe you do not have the money at hand. So your 50% of the "old" company is "diluted" into the 25% of the "new" (bigger) company.

• Paying your executives: the compensation of the executives is established in their contracts with the board, it is not something that they decide for themselves². So it is not that executives are "paying themselves so many shares", it is the company that pays them.

  The pay of executives is linked to their success, and one of the prefered metrics of success is the value of the company stock. So, paying the executives in stocks effectively links their salary to how well the company is doing, giving them an incentive to improve the value of the company (and thus the stocks) as much as they can³. There may be also, in some jurisdictions, some tax benefits by paying them this way.

In the end, if the company issues new shares and uses them to pay their executives, for the stockholders it is not different if the company issues the new shares, sells them (to the existing stockholders or to the public) and uses that money to pay the executive⁴.

Apart from that remains the question if the board is paying too much for their executives and the profit the company gets from them, but that question may appear no matter how the executives are paid: money, stocks, stock options, lollipops...

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¹I do not have a lot of information about the specifics of Square & Jack Dorsey's case, I am addressing the general idea.

²Of course, another issue are the relationships between the executives and the board, and if those relationships can lead to some kind of deal that benefits the executives and the board at the expense of other stockholders. But those are very complicated issues that must be studied in detail for every case; that may amount to fraud and other nasty crimes and that in general are not dependent on how the executives are paid.

³And of course, it also gives the executives an additional incentive (the primary one would be to keep their position) to cook the books and get the stock price to rise artificially. Again, we are talking about activities that are most probably illegal, and it is not an unavoidable and direct consequence of paying with stocks.

⁴And from an accounting POV, it would be no different that issuing no shares and paying the executives out of the company assets; as the loss of those assets would mean that the value of the company is lower and due to that the value of each action is also lower.

Answer 6

The company is giving the guy part of the stock they still own. When a company creates stock, they sell off as much as they care to to raise more money, but they retain as much as they care to in order to maintain control of themselves. (EG: if they created 100 stock, and sold all 100.. then 100 different people could own it, and the company would have to do whatever those 100 people said. Most companies retain a lot of stock for themselves in order to keep public stock owners from making a take-over of the company).

Companies also buy-back stock all the time. They could be buying back LOTS of stock over time, and simply handing it out as a reward.

150k shares sounds like a lot, but maybe the company has done tons of stock splits in the past and has tons of shares. They most likely own more then 50% (in order to keep control of themselves). But, they buy back other shares and can pass those shares on to anyone they want, including gifting them to an exec as a performance reward.

So, I don't see anything wrong with this. They're not magically creating new stock. A company, once they have gone public with initial offering, can only create stock by doing a stock split.. which they have to file to do and impacts all investors. This could take their current stock and split it and give them more to hand out. But, most companies want LESS stock that is worth MORE.. not MORE stock that is worth LESS.

I think the biggest issue I'd be concnered with (as both an employee and investor) would be the exec immediately selling off the stock they get awarded. That is a red flag that the exec doesnt' have faith in the company.

Either the exec is riding the fence and constantly looking for a new job (so they want to stay liquid to make that easiler). Or, they don't have faith in the company they run, and are selling stock as fast as they can get it because they anticipate a fall any time soon.

A good leader will take the stock and hold it. Look at Warren Buffet. He holds onto his company's stock. He is in for the long haul. And, his company's stock is in short supply and worth a lot of money. That is the sign of a good leader that is sticking around.

A company with tons of stock, and execs selling it as soon as they get it are basically giving out red flags that they don't care about the company's long-term viability, and are cashing out their chips to beat a hasty retreat from the casino because they expect the "winning streak" to end soon. Very disconcerting.