JustinIdea - Justin Ricaurte's Personal Blog

Making Executive Compensation Reward Long-Term Performance

Now, I'd just like to say I don't know the intricate details of most executive compensation packages, but I'd like to pose this as an idea on how to align pay and the long-term performance of the company. One thing I think people get too hung up on is what the change is in 12 months of pay and stock prices. Why should chief executives have their pay based-on just 12 months of information? If you want a firm to last for the long-term, wouldn't you want to compensate them based-on long-term performance, such as improvement over the last 2, 3, 5, or 10 years? Then there's also the question of how much impact did the chief executive actually have on a firm. If an oil companies profits go up 4x because the price of oil went up 4x, there is no reason a chief executive should receive higher pay. But if profits go up 6x while oil prices go up 4x, then it would make sense for the chief executive to receive higher pay, so long as their competitors and peers saw lower profit growth.

So if you're on a compensation committee and want to create a compensation package that is good for both the chief executive and the shareholders, you should make sure to do a couple things:

1) Benchmark the performance of the firm
2) Reward the executive for long-term performance by staggering their stock options.

Point 1: Benchmarking
With benchmarking, it would be good to benchmark the firm against its competitors. If the company competes against many businesses across multiple products, it might get a little difficult, but would still be a good idea to ensure the benchmarks are done well. Other benchmarks that could be used would be new product offerings and how much growth they have generated, the productivity of the firm, the inputs or outputs of the firm (such as oil prices), and other performance measures that align with the firm's mission.

Point 2: Rewarding for long-term performance
You could also stagger the reward of the chief executive's stock options. For example:
In year 1: The chief executive receives 2 million stock options for performance. 20% of those begin on a vesting schedule starting with the day of compensation, the other options begin vesting after years 2, 3, 4, and 5, if their future performance targets are hit. For the options that begin vesting in the future years, the compensation committee will review the performance target again in each of those years over the entire time period of 2-5 years and will decide then on whether the stock options should begin to vest. If the performance targets are not achieved, the stock options will be destroyed.

In each additional year, the chief executive would also receive additional options that would follow under the same schedule and adjusted for their date of issue. This way the firm's incentives for the chief executive are aligned to create long-term value, instead of just short-term gains.

Inspiration: A Brighter Spotlight, Yet the Pay Rises (NYTimes.com)

Constructive Complaining

It can get pretty frustrating when people complain non-stop. Most of the time it's because they’re whiny and can seem to do anything but look at the negatives. It can also be pretty depressing talking to one of these people. Do they think you really want to hear about how they can’t stand the person down the hall talking all the time, or that they don’t think they’re smart enough to do anything productive? It might be good to ask them sometime.

While these people can be quite a drag on a day, there is a way to take what they do best and turn it into a great opportunity – constructive complaining. During the normal course of a day, I tend to complain a lot, but you’ll also find me doing a lot of writing. Why? Are these two correlated? Yes. Whenever I find something worthy of complaining about, the first thing I ask myself is how could I make it better. From just this simple question, ideas are incredibly easy to generate.

Here’s an example. I tend to focus in on the lyrics of the songs I listen to, so I work on weeding out songs with messages I don’t want to penetrate my subconscious. This process can be a pain when trying to keep track of all of the songs I listen and wanting to generate a playlist for a specific mood. So, I asked how could this be made better? One way I’ve thought of to fix it is to make tagging and labeling of songs much easier for someone. To allow a person to base it on their emotions if need be and then to be able to mix and remix songs that they associate with the emotions into playlists, because a song can be attached to multiple meanings for a person. This would make setting the mood much easier for an occasion or for helping you get pumped up or excited about something. Have a sad day and need to mope for a while? Just play some sad music until you get sick of it and want to be happy again.

Now implementation and execution is the only bottleneck to this method. You’ll generate so many ideas you just won’t have the time to work on them all at once. But in the end, is it better to have too many ideas with a few gems or too few and less of a chance of a gem emerging?

Holding true to constructive complaining, here’s something to keep in mind. When you hear one person complain, think business opportunity. When you hear many people complaining, think BIG business opportunity! Happy complaining! :D

A Sustainable Policy

Last week it was great to see Al Gore acknowledged for his efforts in promoting the building of a more sustainable society.  With a decrease in pollution and energy consumption, we will have fewer incidences of illnesses such as asthma and thereby decreasing the amount we spend on health care, more money to spend on things aside from energy, greater domestic and international economic growth, and a more peaceful world because money will not flow en mass to dictatorships built off of fossil fuels, especially ones that finance international terrorism. 

One big problem with proposed policy measures is that they do not allow for both parties to get what they want from the table.  The Democrats want to help the environment, public health, etc., and the Republicans want to promote growth by lowering taxes.  To increases its chances of success, a policy should take into account these agendas.  One such as this:

1. A cap-and-trade pollution system where the government sells credits that companies can buy for their needs.  The cap would need to be lowered each year to promote further decreases in energy used. 
2. Requiring all business that produce goods in the United States or that sell goods to American consumers to participate in the system and to take into account a life-cycle analysis of their products.
3. Requiring companies listed in the United States and those that want to have government pensions buy their stock to disclose their carbon footprint.
4. Eliminating the corporate income tax in exchange for participation.

A policy such as this will promote business to adopt more energy efficient measures and reward the most energy efficient companies by allowing them to sell their credits and then not have to pay a corporate income tax.  The elimination of the corporate income tax would further spur innovation and accelerate the development of a more sustainable environment.

This acceleration of innovation will create millions of jobs in research, development, production, marketing, financing, and servicing these new products and make American-made products more competitive in the global economy.  These new employment opportunities along with the money the government makes by selling the credits will also offset the revenue lost by the elimination of the corporate income tax, keeping our national debt from increasing due to the program.

Using Songs to Segment?

If you think about it, the music you listen to can say a lot about your inner thoughts and desires, personality, and what you relate to.  Its the emotional outlet that people tend to share a lot, especially when younger.  Could this provide a worthwhile way to do customer segmentation?

Pandora and Last.fm have a huge store of songs that people have favorited/bookmarked/etc. and what music they listen to at different points in time.  If you look me up, you'll probably find I like to listen to a lot of club music now.  You could throw me in the segment of a person that likes to go out, dance, and socialize a lot.  With a little more demographic information (maybe age, education, and location), the company could then tailor ads to product categories of interest to me.  Ads that might target me could be networking events going on in the area, nice clothing, or sports cars.

These ads wouldn't be able to pick-up whether I like to trade stocks or if I read business news ever day, but it might provide a nice way to find out what people want to spend discretionary money on.  Who knows, with a large enough user base it might say more.

The Ultimate Convergence in Computing

I won't deny that I became extremely excited when I saw Microsoft announce the Surface computer.  But my mind couldn't help but wander and see if there was a way to improve upon the concept and the entire idea of how humans should be able to interact with computers.  Is playing around on walls, floors, and tables the best way to interact with computers, or is there an even better way?  I personally don't think it will be the end all, even with an OLED covered house with walls that are as dynamic as those in Disney's Smart House movie.

Why limit yourself to a surface to do computing at all?  Even better, why make the internet a separate space where things are done?  The internet in the end, as my friend Anders says, is merely another way for humans to communicate.  So what could the ultimate convergence become?  In science fiction movies like The Matrix, humans have to plug into a machine to be able to connect to a "virtual reality".  Why should virtual reality be any different from reality?

Device convergence is great and everything, but I believe the ultimate convergence in computing will be when virtual reality and the internet are completely integrated into reality.  When you are walking down the street, you won't pull out your cell phone to find a place to go.  You will see the possibilities appear before you.  You won't even need a cell phone to carry on a conversation.  Instead of having a character in SecondLife as an avatar to interact with others, you will see other people, who are not physically there, walking around and will be able to interact with them.  You might not even be "there".  (Of course, teleportation would make getting there a lot easier. :-) ) 

With virtual reality and the internet completely integrated into reality, the possibilities are truly infinite.

Transparency as a Competitive Advantage

I believe it was in my entrepreneurship class that our instructor said 70% of a company's market value was derived from its intellectual property.  If you were to open up all of your intellectual property and allow the world to scrutinize it, would 70% of your value suddenly deteriorate?  Or could you make your business more valuable by showing the world the "crown jewels"?

It seems that logically if you show all of your competitors everything that you're doing, your company will be left in the dust as they keep their trade secrets and integrate yours to boot.  You've lost your entire competitive advantage right?  Could any positive consequences come from this?

I can see a couple potential positives from it: increasing the quality of one's products and services, increasing employee retention, having a faster rate of innovation, and decreasing consumer cynicism.  Having a policy of transparency can potentially increase the quality of the company's products.  Viewing what has taken place in the open source community, if you open up the source code of a piece of software, suddenly tens of thousands of eye balls are able to scrutinize the code, test it, and find more bugs than would be found by the company's own bug testers.  For the pharmaceutical industry, opening up all of their clinical trials to more scrutiny by the scientific community would allow the companies to potentially increase the quality of their drugs and the targeting of it.  It would also allow the company's to avoid negative publicity, such as happened with Merck a few years ago.

The policy of transparency would also create a greater incentive for the brightest minds to want to work for the company, because they would be able to share ideas and innovations with their peers at other institutions, which would spur further innovation.  An anecdote from the book I just read, Science Goes to War, talked about how the warring city-states of ancient Greece adopted a policy that their scientists could freely talk amongst themselves.  Scientists were less likely to defect from their city-state, because they would be able to discuss their discoveries with the brightest mines regardless of which city-state they were a part of.  Seeing as the quality of a company's employees are an incredible source of competitive advantage (they are the ones that develop the innovations), it would help to both recruit and retain the brightest people, potentially decreasing the costs associated with recruiting and retention.  The increased rate of innovation would occur from the dialogues the employees would hold with others not at the company, but that we're extremely knowledgeable in the field of interest.

The policy could also help to decrease consumer cynicism.  To pick on the pharmaceutical industry again, consumers complain a lot about high drug prices and don't always see the correlation between drug cost and care received (the same can go with the health care industry in general).  A policy of greater transparency could help to decrease consumer cynicism toward the industry by not only informing consumers as to what drugs are on the market, but which ones did not make it and why.  If the company also broke-down it's expenditures on the various failed drugs it would allow it to show consumers why they need to pay the higher prices for the successful drugs, compensating for all the failed R&D. 

Also, with the transparency of the failed trials, the companies could allow academic researchers to continue to run tests on the drugs in different settings and see if any of them allow for the drug to be successful.  if it ends up being successful, the company can then sell the drug to the designated market, leasing the intellectual property if need be.

With all of these taken into consideration, it might be worthwhile for companies to test a policy of transparency with respect to their company and the market and/or field of study.

Real Estate 2.0 (and beyond?)

Last week while pondering about my finance class, this article on Zillow came to mind.  It brought up a lot of great points about how Zillow is and could dramatically change the way we think of real estate transactions. 

If Zillow were to completely revolutionize the real estate market by making realtors unnecessary, would the lower cost of real estate transaction decrease the time the average person lived in a residence?  Would the amount of time a home is on the market decrease as well?  Especially with the "Make Me Move" feature where you can list what price you are willing to sell for.

Would this introduce more investors into the real estate market regardless of boom or bust?  We might see investors pop-up with sophisticated algorithms and day trade real estate to take advantage of small swings in the market. Albeit moving would still be a pain (for those who wished to live in the home) and knowing about the kinks in a house would take a lot of analysis (and honesty), but anything is possible when you don’t need a property to appreciate by more than 6% to break even.

If Zillow could completely automate real estate transactions and investors controlled the majority of housing, real estate might look a lot more like stocks do. Real estate exchanges and everything. How long for this scenario?  Optimistically probably 20-200 years. :-)