Andrew Smithers is a leading expert in financial economics and global asset allocation. His 45 years’ experience in investment includes 25 years at S. G. Warburg & Co., where, among other roles, he ran the investment management division, and 20 years as head of his own investment consultancy, Smithers & Co., based in London. He is the coauthor of three books on international finance. His latest, Wall Street Revalued: Imperfect Markets and Inept Central Bankers, was published by Wiley in July, 2009. Earlier books areValuing Wall Street (2000), cowritten with Stephen Wright, and Japan’s Key Challenges for the 21st Century (1999), cowritten with David Asher.
As head of Smithers & Co., Andrew has helped to pioneer the application of academic analysis of financial economics to investment management. Best known for its application of Tobin’s qto market valuation, Smithers & Co.’s work on valuing employee stock options led directly to changes in the way these are accounted, while its work on Japan has revolutionized the role given to demographics in investment analysis.
Does the use of stock options for a significant part of executive pay, and the use of stock price performance as the criterion by which executives’ success or failure is judged, create inappropriate incentives for management?
The idea that you can provide good incentives to management based on stock prices was always flawed and is based on a misunderstanding. The declared aim was to align the interests of management with those of stockholders. In reality it did the reverse: it tore them apart. This all started with the development of option incentives, whereby management was given the option to subscribe for shares at a given price, in the 1980s. It became more pronounced in the 1990s and was particularly prevalent in the United States.
Did the granting of stock options lead to false accounting?
Yes. The cost of these options was not shown in companies’ accounts, even though it was shown in the national accounts. If you look at the national accounts and not the P&L figures of individual companies, the income of employees was the income they received both through normal management payments and the profit they made from realizing their options. That was therefore a deductible expense for corporations; however, it was not shown in the companies’ accounts, which attributed no value to the option when it was first granted.
Had companies found a surreptitious means of creating free money for their staff?
Yes, it was a way of doing just that, which meant that company profits were being overstated.
What are the key negatives from the companies’ perspective?
It leads to perverse incentives, encouraging management to boost the volatility of the share price. That is not in the best interests of stockholders!
Were you were one of the few people who questioned the practice at the time?
Yes, indeed. The report we wrote—“The impact of employee stock options”—was published in April 1998. I cowrote it with my colleague Daniel Murray of Smithers & Co. and with John Emerson of accountants Robson Rhodes.
Did the corporate world close ranks on you?
The biggest deniers were the investment bankers, the Wall Street Journal, and others who had little interest in doing anything that might deflate biggest stock market bubble in history.
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