Crikey

Telstra chairman, Donald McGauchie announced last week that the company had re-signed CEO Sol Trujillo and COO, Greg Winn. McGauchie stated that the “announcements will build on the success so far in transforming Australia’s most successful telco into a global media-comms company, because they align the financial interests of senior managers with long-term wealth of shareholders.”

While Telstra has set relatively high performance hurdles regarding the exercise of options, the poor Telstra board (like most other public company boards) just don’t get it. That is, options don’t truly align the interests of senior management with shareholders.

That is because options provide the holder with all the upside of shareholders, but none of the downside. If Telstra were to go belly-up, shareholders would lose their shirts  — option holders would only lose the ability to buy a new Bentley.

If Telstra wanted to truly align management with shareholders, they would do what private equity owners require of their management  — put their own skin in the game. In Merchants of Debt – KKR and the mortgaging of American Business, George Anders noted that, with regard to managers of KKR owned-companies:

The buyout would jack up top managers’ stake in the company by three to ten times. Managers would pay hard cash for a sizeable part of their stock  — exposing themselves to financial loss if the company did poorly, a risk that option-holding executives seldom faced at a public company. “When a manager has his own money invested and it’s his company [noted KKR boss, Henry Kravis] he’s going to come in a little earlier in the morning. He’s going to think harder about that capital expenditure. Does he need that limousine and he corporate jet?”

Telstra’s 2007 Annual Report stated that Trujillo owns 250,000 Telstra shares, worth around $1.2 million. For a man worth upwards of $100 million, that’s not a lot of skin in the game. Barely a pinky toe.

While Telstra (and many other public companies) claim that performance hurdles attached to options align the manager’s interests with shareholders, in reality, they don’t. Instead of fearing private equity, public companies should learn from PE.

To align executive interests with shareholders interests, boards need to ensure that the executive can lose if the company performed poorly, not merely win if the company performs well.