ESOPs - a case of wrong incentives.

The front page of leading newspapers reported the sudden resignation of a top business executive. The reason behind his resignation was not clear and only occupied a couple of lines. More emphasis was on this person's high compensation, from present and past employers. I was stumped !
Curios to find why this person was paid so much, I searched specifically for achievements, skills, talent and omitted words and phrases related to compensation, salary, bonus. I could not find anything exceptional to justify that kind of compensation.

The law of distribution is one of the ancient. After a successful hunt, people would gather around the dead animal and only one person, usually the oldest, would be given the task to distribute. The person responsible for distribution could not set aside anything beforehand and would claim only what was left-over. Such laws are the foundations of human society.

The hefty compensation paid to a handful people in any corporate is mostly in the form of stock options (ESOP) or common stocks those can be redeemed after a certain period. Generally, ESOP is as follows - e.g. the executive gets the right to buy, say 100k shares at a future date at a pre-determined price. Suppose that price is 100; if the price goes up to 120 on that date, the person can still buy at 100 and immediately sell it in open market at 120 netting a profit. Or they can wait for the price to rise further.

This is a good arrangement as long as people are honest. If otherwise, it becomes a dangerous one.

These handful people are the ones who are directly responsible for the financial management of the company. One can increase revenue via aggressive sales though it may actually not generate enough profit for sustenance, or another company can be acquired and merged to increase the revenue which may turn out to be a bad acquisition, or they can evade tax liability, or simply lie. There are several ways to create a sense of optimism whereas the underlying reality may be different. Also, the promoter group wants to limit the financial information only to a selected few for vested interest. Most promoters and their close ally are the ones to flee the scene at the first hint of trouble. And they run away being richer at the cost of the hard earned public money.

ESOPs should be distributed entirely to employees except for those handful ones.

Employees who are more closely involved in building the products & services of the company and directly serving the customer and far away from the financial management of the company. This will improve their loyalty to the company and hence they will work for the long term. It will also improve the quality of work as their work directly affects the future compensation. I also think it will improve the financial discipline of the company and curb the indifferent attitudes employees have towards company facility like going for business class in a one hour flight or binge drinking on 5-star accommodation or using the photo-copier for personal use :-)

This simple change of incentives can go a long way in improving corporate efficiency and lead to more ethically managed business. Insider trading will be a lost phrase because no one will hold those obscene number of options and be in a vantage to manipulate the stock price. People can engage in more meaningful work than fixing the broken system left by dishonest ones.

Improper use of sentiment analysis

Sentiment analysis has been a tech buzzword which entailed the popularity of social media. 

Just as the child bites at almost everything as soon as its milk teeth grow, everyone with a social media account seemed to have an opinion about everything. And companies were trying to exploit this tremendous amount of data by analyzing public opinion. 
I have also been involved in such an effort though I now admit that our sentiment engine was not good enough. 

But what worries me is another buzzword predictive analytics. And its dangerous application in stock markets. 

Several startup companies are trying to predict stock price based on public sentiment. The practice of predicting stock prices itself is a questionable business model; seems they are trying to justify the prediction using this new methodology.

Information that triggers price movement is private to only a few who take advantage as early movers. Hence the price trend already starts way before the news is published in mainstream media. 

Look at TATA STEEL. 

The general sentiment in beginning of Mar 16 on Indian steel industry was extremely negative. China had produced more steel in one year than the Brits had done in last 80. However, we see a 30% increase in TATA STEEL price in the same month. Only at the end of the month, the company made public of its decision to sell Chorus. Under the circumstances it would reduce debt, hence the optimism about the company. Selected few knew that their CFO was making several trips to London and had taken advantage of this fact. 

Another example of a debt ridden company - GMR infrastructure. 

Look at the sharp price rise on 13 Jun 2016. It was after four days the general public learnt about its progress to sell off stake in a profit making project. 

(as of writing this article, the company had already denied it as rumors !! ) People interested may track the story further to see how such things wipe off hard earned money of retail investors. 

Hence we can conclude the following. 

One can look at the currently emerging price trends and predict the future sentiment but not the other way around.