Do perquisites reduce shareholder value

Written by YRK Reddy | Updated: Oct 18 2004, 05:30am hrs
Why does the CEO travel first class air, accompanied by his spouse, gets booked at a luxury hotel and, on return, gets picked up by his chauffeur driven limousine to get to his swanky office for a luncheon meeting in his private dining room Does it help the company and shareholders or is it just corporate splurging

A study by Dr Raghuram Rajan, now the Chief Economist of International Monetary Fund and Dr Julie Wulf of Wharton School for the NBER, USA finds no conclusive evidence that perquisites are inefficient. The study supports perks in the case of mature cash-rich companies, especially if they do not have any major investment proposals. Despite the somewhat ambivalent findings, the study may point to the need for deeper understanding of perquisites, for reasons of corporate governance as well as the exponentially growing inequities which are indeed a worry.

In this context, there are four theoretical propositions that need debate. First, that perquisites are mostly private benefits for managers but of no value to the shareholders. Some may counter this and say if such is the case, managers would have preferred perquisites instead of cash, which is fungible. Managers may indeed prefer perquisites because investors are less likely to discover their hidden value; as there are tax advantages associated with perquisites due to lax taxation regimes; and as they give status and authority both within the organisation and outside.

The second proposition is that perks are necessary for attracting and retaining talent and hence fulfill the function of achieving external equity in the market (this aspect was ignored by Rajan and Wulf). It is, of course, impossible to validate this proposition as compensation surveys are often a minefield of self-serving assumptions.

The jury is out on whether or not perquisites reduce shareholder value
A hard-nosed view must be taken of their impact on corporate performance
The third is that perquisites are necessary to enhance the productivity of managers. First class air travel and chauffeur-driven vehicles are usually justified with this argument. Further, some would also state that the perks give status and power required to transact business productively. After all, who would want to talk to someone coming in an auto-rickshaw for a critical meeting Power being mostly symbolic, perks are the means to exercise such power, they would argue.

The explanations on grounds of productivity may not withstand much scrutiny because the basis for determining perquisites is not the potential for productivity in the first place but the hierarchical level, often unsupported by job-evaluation studies. The argument that perquisites enhance status and power is also questionable as in some such show-off are at a discount say in flatter organisations and societies where there is reverse snobbery. Additionally, one may discover that status and authority can be given with alternative and less expensive methods such as fancy designations and greater delegation of authority.

The fourth proposition arises from the perspective of corporate governance. In the context of the principle-agent theory, lax governance will result in managers padding their own perquisites. Managerial remuneration and perquisites has become a hot subject in market economies because the shareholders are expected to arrest tendencies for managerial excesses. In the absence of such shareholder activism or strict controls by the dominant owner, there is indeed a possibility of a runaway compensation system.

Rajan and Wulf do not find conclusive evidence of managerial excesses at the cost of other shareholders. Contrary to this, there have been several arguments to show that some perks are associated with reduced shareholder value. For instance, a study by David Yermack of Stern School concludes that firms permitting private aircraft under-perform market benchmarks by about 400 basis points per year and that such firms have excess staffing and are less profitable than their counterparts! Further, big companies which are also indulgent employers have under-performed market indices over the decades as brought out by international studies relying on data of S&P and Forbes.

The inconclusive results must not lull employers to continue the exponential growth in perks that aggravate inequities and inefficient investments. It is indeed time to take a hard-nosed view of how exactly they contribute to productivity, corporate performance and eventually the shareholder value.