Much of the issues surrounding executive compensation is a concern that the manager’s interests should be aligned with the shareholders’. We have seen large cash salaries giving way to stock and options grants, and now the concern is that CEOs will do whatever they can to juice the price of the stock when their options vest or their sale restrictions end, and then let the price of the stock collapse as they retire or move on. In fact, the latest round of the shareholder arms race is a proposal to extend the restriction period for several years after the executive leaves the company.
Management pay packages are certanily the most public face of this issue, and it does lead to interesting bits of trivia, such as Jeff Bezos’ ownership of approximately 20% of Amazon, given the company’s P/E ratio of 70, means that he would actually lose money by paying himself more. However, this is only part of the issue, and the great Benjamin Graham himself noted that practically speaking, it is almost impossible to overpay good management, although it is trivially easy to overpay bad management, although the solution is not to cut to pay, but to fire them. A bigger issue is empire-building to feed the corporate ego, engaging in questionable mergers to make the company bigger but not better, and uneasonably witholding dividends to keep more assets under management.
But all this business of making managers “think like owners” might run into difficulties when they actually are. I have already talked about CCA Industries, run by the two old men who will not cough up their excessive cash holdings, and now I will point out Hallwood Group, a nifty little holding company that is 66% owned by Anthony Gumbiner. Hallwood Group’s only current subsidiary is a textile manufacturer that produces a line of breathable waterproof nylon fabric that is currently very popular with the US military. The Berry Amendment, which requires military procurement to give preference to domestic firms, is definitely an advantage in their business. The firm has previously been in the commercial property business and owned an oil and natural gas company that went bankrupt last year. The firm faces some lingering liability from a funding commitment to the energy company, but I don’t see that their liability is enough to explain the company’s P/E ratio which is an inconceivable 4.34, and that level of earnings is in theory sustainable, although when we do finally put out of Iraq and Afghanistan the military can be expected to go through a lot less cloth.
However, in the depths of despair in March and April of 2009, the company was selling for less than $10 a share, which is a forward P/E ratio of less than 1. Mr. Gumbiner saw an exciting opportunity to steal the company, offering a $12 buyout. He was forced to abandon this offer in June after the price moved to well above $14. He also proposed in 2007 to liquidate the company. But, even though the tender offer in 2009 would have been stealing the company, it was Gumbiner thinking like an owner, and an owner who wanted to own more. United States law protects majority shareholders from taking unfair advantage of minority shareholders, which presumably prevented him from just voting for the company to sell itself, but it is a perfectly natural instinct on his part that could be prevented only by the actual value of the company being perceived by the other shareholders. But these tricks do lead us to consider the nefarious possibility that he is intentionally trying to not maximize shareholder value because he has another tender offer up his sleeve. So, curiously, most managers should be made to think like owners, but people who are actually owners should be made to think like managers.
And if the P/E ratio has led you to run out and buy this company, be careful. Daily volume is on average 4500 shares, so purchases will have to be especially small and careful or the stock will shoot up. The share price is volatile enough as it is, thank you.
And don’t turn your back on Anthony Gumbiner.