Publicly-traded corporations compensate their chief executives mostly through stock option grants. Some or all of these options may be tied to performance but performance is measured in the market valuation of the company’s stock price. But what can the typical CEO do year-by-year that actually affects the company’s stock price?
Sam Pizzigati recently highlighted one of the problems with CEO compensation, where they create a vicious cycle of fake success. A company may issue 1,000,000 stock options to an executive as part of his annual compensation. The options grant him the right to buy shares at a discount anywhere from 15% to 50% of the market price (the strike price is determined in advance).
So how does a good, successful executive ensure that he’ll sell his shares at a profit? One way to do that is to engineer corporate buybacks of outstanding shares of stock. Stock purchases are a way of rewarding investors for buying company stock. They reduce the supply of shares on the market and stimulate buying. Some critics of corporate stock buybacks argue that these plans are just mechanisms to artificially drive up the price of a stock by creating the illusion of demand for it.
A CEO can thus influence how much his stock options will net him by guiding the corporate stock buyback process. He may not be able to set the price directly but he certainly knows what the company buyback price will be. He can time his own purchase/sell trades accordingly.
An old investor’s adage holds that you should buy stocks that are closely held by their chief officers because that is a signal that the insiders believe in the company’s future success. If CEOs and other high-level officers are immediately cashing in their stock options and selling shares on the open market, that is a sign they don’t believe in the long-term success of their strategies. It’s not necessarily an accurate signal but you should be watching what the insiders do with their options. They either want to own a piece of success or they want to hedge their bets.
Corporate CEOs who manipulate stock prices historically don’t believe in the stock market. So where do they invest the money they make off their option trades? Many of them put their money into bonds and other income-producing equities. Of course, not every CEO is a money-grubbing cad who lays off workers just to drive up share prices. Many hard-working CEOs also invest in income-producing equities.
In other words, the guys making the most money off the stock market don’t count on stock trading cycles. They don’t invest in stocks that they can buy and sell, they want income-earning equities that they can count on year-after-year. If a stock doesn’t pay dividends on a regular basis these guys are less likely to invest in it.
Investing in income properties may not seem like a stellar way to make millions of dollars overnight but these people are investing layer upon layer of capital into dependable wealth-generating value. They look for interest and dividends, not trading value. Trading value represents a business model, not an investment in income. Learn to distinguish between the two models and you’ll be in a much better position to build your wealth over time. And you won’t have to manipulate stock prices to do that.