7/9/12 3:59 PM – Earnings Season Begins, CEO Pay

Alcoa kicked off the earnings reporting season today with a poor report. Earnings season is often somewhat volatile unless earnings have been on a good upward trend.

The last couple years have seen corporate earnings move up to record-breaking territory and with the whole world slowing down right now and with the US dollar moving higher during 2Q/12, dinging multinational profits I suspect that we will have more than the usual number of unpleasant surprises over the next month. Some analyst estimates have come down but I doubt they have come down enough, especially for more cyclical companies.

Traditionally about 70% of corporations exceed their expected earnings, another 20% or so match them and 10% come in low. This is a game that corporate chieftains play with analysts. CEOs and CFOs know their stock will get punished if they miss analyst estimates so the companies consistently give analysts guidance that is too low so that the company can “beat” estimates.

What that does is to punish even more severely the stock prices of companies that miss earnings forecasts. If more companies than usual only meet or even miss their estimates this month that will put pressure on the stock market.

For my part, I hate the earnings reporting game. It encourages deception, puts the corporate emphasis even more on short-term results and enriches senior management as their stock options and stock holdings go up. A lot of this is just so much accounting gimmickry and that is not what I want CEOs focusing on. Like most people, I want management to have a long-term focus. And, I think senior management at most large companies is massively overpaid, mainly by extremely over-generous bonuses of stock shares and options.

Where are the shareholders on this? Well, unfortunately, the largest holders of the vast majority of company shares are mutual funds and pensions whose management are also very highly paid. And of course corporate boards who are supposed to be acting in the best interests of shareholders are populated by other ridiculously overpaid CEOs.

Finally, there is the star factor. Paying senior management is similar to building a pro sports team. One owner can’t decide to reduce compensation for his players or refuse to pay up for star free agents or the team will become uncompetitive and the owner’s income will suffer badly, as will his reputation. In the same way, companies feel like if they don’t keep on pushing executive compensation higher they will become uncompetitive. I think the risk of this is very overstated.

Bottom line – executive compensation will continue to soar, tied to unreasonable stock and option bonuses and executives will continue to find every gimmick to push short-term earnings higher because that affects their pay so much. Companies will continue to manage for the short term rather than long term and the gap between the rich and the middle class will continue to widen.

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