Executive Compensation Systems Are Bad For Shareholders

This study by researchers at Michigan State University raises questions about the accounting methods used by US auto companies. The managements in these companies did exactly what their incentive systems told them to do. They kept production higher than demand to keep the production cost per car down. This inflated profits and had a positive impact on executive compensation. Inventories, of course, increased, but they were on the balance sheet and not on the income statement. Prices had to be cut in order to move the inventory and this had a negative affect on the brand image of US automobiles. The decline in brand image has a long term affect on the firms but the managers are paid for meeting short-term profit goals. The average tenure of a CEO is 7 years. They have an incentive to maximize short term gains at the expense of the long term. This kind of thinking produced terrible results for shareholders. They are not well served by the incentive systems in most firms that are based upon short term financial performance.