07-07-2012, 03:16 PM
Boon Wrote:Which scenario is your FAIRER choice, and WHY?
I think this is a great question because it goes back to first principles. My answer to this question is that it depends entirely on who the person answering is. The arguments may be controversial, but hear (read) me out.
From the point of view of the controlling shareholder, the fair answer is to pay almost everything in salary and little or nothing in dividends.
Why? The controlling shareholders, as executives, have put in 100% of the effort, therefore they should get 100% of the rewards. A concession could be made that IPO investors contributed capital and should therefore be entitled to dividends as their reward. But how many shareholders have been there since IPO? For sure, the minority shareholders who bought in the open market did not contribute any capital to the company, so they have done nothing and therefore deserve nothing.
This reasoning is not wrong when we think about our own jobs. After all, we all want to be paid fairly for our work in our jobs, and would fiercely object to credit and rewards being shared with a member of the project team who replaced an existing team member, but then did nothing. Yet, this is precisely the position that minority investors who buy in after IPO find themselves in - as unwelcome new members of the team, who do no work but still claim a share of the spoils.
Indeed, unlike minority shareholders who can easily sell and leave, controlling shareholders are stuck with the business. In that sense they are taking on even greater risks than that implied by their larger shareholdings alone. So they could argue that for taking on disproportionate risks, they should be given disproportionate rewards.
As a controlling shareholder, the only reason to pay dividends would be to maintain a reasonable stock price, so that the company is able to use its stock as currency to raise cash or to buy another company if it so desires. In that regard, it helps greatly to have some sort of consistent dividend record. So most controlling shareholders, their personal views notwithstanding, resign themselves to paying at least a nominal amount of dividends.
From the point of view of the minority shareholder, the fair answer is to pay the equivalent market rate in salary and everything else in dividends.
Why? Ownership and management are independent issues. If the company is paying an outsider $X to do the job, then the controlling shareholder should also be paid $X to do the same job, not a penny more. The fact that the executive is a shareholder is of relevance only when it comes to paying dividends. Nobody forced the owners to take the company public. If they don't like sharing the profits, take the company private. When they own 100% of the company they can have 100% of the profits.
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Market reality usually lies somewhere in between the 2 extremes. I own shares in a few companies where the highest paid executives are not the controlling shareholders. I consider the controlling shareholders of these companies particularly enlightened.
Sadly, it is much more common to see the controlling shareholder being paid way more than senior executives who are non-family, even though these same people are running the company when the controlling shareholder is not around (sometimes by design).
However, since our economy is capitalist (one share one vote) and not cooperative (one member one vote), most controlling shareholders will continue to do as they please. The only real vote that minority shareholders have is: to own the shares, or not. If you are not happy, you are free to sell your shares.
As always, YMMV.
