Executive Bonuses tied to long-term performance

Economist William Baumol warned us what happens when the company managers are not the company owners. For over twenty years we have witnessed corporate management use short-term profits to justify outrageous bonuses. By the time the shareholders realize that the profits were contrived, it is too late and the company's share price, profitability, and competitiveness have diminished. Securities analysts argued that cash flow measured a firm's value. This encouraged managers to minimize research and development of new product. In the short-term, profits and free cash flow were higher but in the longer term the company fell behind the competition in innovation, quality, and competitiveness. This happened to virtually every industrial sector of our economy most notibly seen in the auto industry the past twenty years.
Investment banks allowed traders to take 8 and 9-figure bonuses for "profits" from trades in securitized mortgages. the profits were based on invalid calculation of likely default rates (see my blog entry on this conspiracy). Now that we know the profits do not exist in securitized mortgages, it is too late. Brokers have hundred million dollar windfalls and the taxpayers are looking at trillion dollar bailouts.
Company boards of directors have obediantly followed the recommendations made by the executive management to offer bonuses for short-term results. fiduciary responsibility has no consequence.
Shareholders today are not a well-organized small group of rich investors that have only one degree of separation between themselves and the corporate decision making. Today, shareholders are middle class employees with 401ks managed by mutual funds that are paid regardless of the investment performance. Worse, the individual investor may have an investment advisor who is also compensated on a percentage of the amount invested, not the performacne of the investment. this places at least three levels between the shareholding member of the middle class and the performance of the company: the investment advisor, the mutual fund manager, the public company manager. None are compensated based on long-term performance of the investment.
Going forward, management bonuses should be tied to five-year company performance. bonuses should be paid in stock that in turn has to be held for five years. this ensures that managers own actions have an eye on the longer term and that the manager has a commitment to succession planning: future managers are trained and selected based on their commitment to long term success because their predecessors are still dependent upon future success to realize their full bonus.