Windfall Profits
Alex Zakson
November 14, 2005
We’ve been reading a lot about the record earnings of oil companies, and listened to the executives justify them, and to consumer groups condemn their greed. Market forces brought about conditions that resulted in these huge profits. If the oil companies did anything illegal to accumulate these profits they should be prosecuted. No one has said that they had. Consumer groups that expect the companies to forgo huge profits and be good Samaritans miss the point. Profits are important; they allow companies to prosper and to GROW.
In an interview the president of ExxonMobil stated that they are in the oil business. But are they really? No, the company managers use oil to earn big salaries and bonuses and to raise the stock price.
Top management incentives include salary, bonus and stock options. The salary is tied to performance, the bonus to profits and the stock options to stock price. When a company meets its financial objectives, top management can negotiate better salaries; when the company meets or beats profits goals the bonuses are paid in full, or enhanced; and when earnings per share increase, stock prices rise, making stock options more profitable for the recipients.
Negotiating easily achievable objectives is a major management undertaking, meeting them an unwavering commitment. Making profit objectives is so critical that it has recently led to several well-publicized large-scale cases of corporate fraud (remember Enron?). Interestingly, when corporations fail to grow their earnings per share by increasing business fast enough, they resort to stock buy backs. They plow back company profits NOT into expanding the business, but into shrinking the supply of company stock, through stock buy backs, thus increasing earnings per share.
When a company makes huge profits it ought to put the earnings back into the business, not pilfer it away by paying astronomical bonuses and stock buy backs. If ExxonMobil and the other oil companies that have benefited greatly from our appetite for large SUVs and hot cars plow back the earnings into new refineries, new exploration, and search for other sources of fuel, then the profits they make are not objectionable, but if they waste it away to benefit management then they are violating their responsibility to both the stock holders and consumers and should be condemned, and their profits should be taxed more heavily.
(While my focus here is on oil companies, one could make a similar argument for any company in any business that uses stock buy backs to increase earnings per share.)
In an interview the president of ExxonMobil stated that they are in the oil business. But are they really? No, the company managers use oil to earn big salaries and bonuses and to raise the stock price.
Top management incentives include salary, bonus and stock options. The salary is tied to performance, the bonus to profits and the stock options to stock price. When a company meets its financial objectives, top management can negotiate better salaries; when the company meets or beats profits goals the bonuses are paid in full, or enhanced; and when earnings per share increase, stock prices rise, making stock options more profitable for the recipients.
Negotiating easily achievable objectives is a major management undertaking, meeting them an unwavering commitment. Making profit objectives is so critical that it has recently led to several well-publicized large-scale cases of corporate fraud (remember Enron?). Interestingly, when corporations fail to grow their earnings per share by increasing business fast enough, they resort to stock buy backs. They plow back company profits NOT into expanding the business, but into shrinking the supply of company stock, through stock buy backs, thus increasing earnings per share.
When a company makes huge profits it ought to put the earnings back into the business, not pilfer it away by paying astronomical bonuses and stock buy backs. If ExxonMobil and the other oil companies that have benefited greatly from our appetite for large SUVs and hot cars plow back the earnings into new refineries, new exploration, and search for other sources of fuel, then the profits they make are not objectionable, but if they waste it away to benefit management then they are violating their responsibility to both the stock holders and consumers and should be condemned, and their profits should be taxed more heavily.
(While my focus here is on oil companies, one could make a similar argument for any company in any business that uses stock buy backs to increase earnings per share.)
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