Expectations‐Based Management

The authors begin by summarizing the results of their recently published study of the relation between stock returns and changes in several annual performance measures, including not only growth in earnings and EVA, but changes during the year in analysts' expectations about future earnings over three different periods: (1) the current year; (2) the following year; and (3) the three‐year period thereafter. The last of these measures—changes in analysts' expectations about three‐ to five‐year earnings—had by far the greatest explanatory “power” of any of the measures tested. Besides being consistent with the stock market's taking a long‐term, DCF approach to the valuation of companies, the authors' finding that investors seem to care most about earnings three to five years down the road has a number of important implications for financial management: First, a business unit doesn't necessarily create shareholder value if its return on capital exceeds the weighted average cost of capital—nor does an operation that fails to earn its WACC necessarily reduce value. To create value, the business's return must exceed what investors are expecting. Second, without forecasting returns on capital, management should attempt to give investors a clear sense of the firm's internal benchmarks, both for existing businesses and new investment. Third, management incentive plans should be based on stock ownership rather than stock options. Precisely because stock prices reflect expectations, the potential for prices to get ahead of realities gives options‐laden managers a strong temptation to manipulate earnings and manage for the short term.     

A Better Way to Measure Operating Performance (or Why the EVA Math Really Matters)

Most companies rely heavily on earnings to measure operating performance, but earnings growth has at least two important weaknesses as a proxy for investor wealth. Current earnings can come at the expense of future earnings through, for example, short‐sighted cutbacks in investment, including spending on R&D. But growth in EPS can also be achieved by investing more capital with projected rates of return that, although well below the cost of capital, are higher than the after‐tax cost of debt. Stock compensation has been the conventional solution to the first problem because it's a discounted cash flow value that is assumed to discourage actions that sacrifice future earnings. Economic profit—in its most popular manifestation, EVA—has been the conventional solution to the second problem with earnings because it includes a capital charge that penalizes low‐return investment. But neither of these conventional solutions appears to work very well in practice. Stock compensation isn't tied to business unit performance—and often fails to provide the intended incentives for the (many) corporate managers who believe that meeting current consensus earnings is more important than investing to maintain future earnings. EVA doesn't work well when new investments take time to become profitable because the higher capital charge comes before the related income. In this article, the author presents two new operating performance measures that are likely to work better than either earnings or EVA because they reflect the value that can be lost either through corporate underinvestment or overinvestment designed to increase current earnings. Both of these new measures are based on the math that ties EVA to discounted cash flow value, particularly its division of current corporate market values into two components: “current operations value” and “future growth value.” The key to the effectiveness of the new measures in explaining changes in company stock prices and market values is a statistical model of changes in future growth value that captures the expected effects of significant increases in current investment in R&D and advertising on future profits and value.     

HOW TO USE EVA IN THE OIL AND GAS INDUSTRY

The use of EVA in the oil industry has lagged behind that in most other industries because the accounting information reported by oil and gas concerns does such a poor job of representing management's effectiveness in adding value for shareholders. The essence of the problem is that the exploration activities of oil companies create assets whose changes in value are recognized by the stock market long before they are reflected on income statements or balance sheets. As a result, all accountingbased performance measures, including generic measures of EVA (which are derived from accounting information), fail to provide meaningful goals, decision tools, or compensation benchmarks.
This article provides a new, EVAbased framework for performance measurement and incentive compensation for oil and gas firms—and for companies in extractive industries in general. The authors show that, when adjusted by a publicly available measure of hydrocarbon reserve value known as "SEC-10," EVA's ability to explain annual stock returns rises from under 10% to almost 50%. Moreover, because SEC-10 has several important limitations as a measure of reserve value, there is considerable additional room for improving EVA's explanatory power. And the actual implementation of an EVA financial management system for an individual oil company can and should be based on more precise estimates of reserve value than those provided by SEC-10.
To this end, the authors provide an approach to hydrocarbon reserve valuation that captures the "real option" value of undeveloped reserves. By incorporating real option values, this new EVA financial management system for oil companies aligns management's incentives with the goal of creating shareholder wealth by rewarding managers for creating real option value as well as current cash flow—and by forcing managers to consider the optimal "exercise" of such strategic options.     

From Stock Selection to Portfolio Alpha Generation: The Role of Fundamental Analysis

In this roundtable sponsored by Columbia Business School's Center for Excellence in Accounting Research and Security Analysis, a group of successful investors discuss their approaches and methods. A common saying among financial economists is that stock prices are set not by the average investor, but “at the margin” by the most sophisticated and influential investors. The intent of this roundtable is to furnish a portrait of such “marginal” investors, one that turns out to be quite different from the quarterly earnings‐driven, momentum traders often depicted by the media and deplored by corporate executives. In response to the common charge of short termism leveled by corporate managers, most of the investors at the table claimed to take large, multi‐year positions in companies they believed to be well‐managed, but temporarily undervalued. Instead of being attracted to earnings momentum, and rather than simply capitalizing current earnings at industry‐wide multiples to arrive at price targets, the analysis of these investors begins with a “deep dive” into a company's financials, which is often reinforced by primary research—visits with management, customers, suppliers. The aim of such research is to identify, well before the broad market does, companies that promise to earn consistently high and sustainable returns on invested capital.     

Why EVA Bonus Plans Failed—and How to Revive Them

Most companies rely heavily on earnings to measure their financial performance, but earnings growth has at least two important weaknesses as a proxy for investor wealth. Current earnings growth may come at the expense of future earnings through, say, shortsighted cutbacks in corporate investment, including R&D or advertising. But growth in earnings per share can also be achieved by “overinvesting”—that is, committing ever more capital to projects with expected rates of return that, although well below the cost of capital, exceed the after‐tax cost of debt. Stock compensation has been the conventional solution to the first problem because it's a discounted cash flow value that is assumed to discourage actions that sacrifice future earnings. Economic profit—in its most popular manifestation, EVA—has been the conventional solution to the second problem because it includes a capital charge that penalizes low‐return investment. But neither of these conventional solutions appears to work very well in practice. Stock compensation isn't tied to business unit performance, and often fails to motivate corporate managers who believe that meeting consensus earnings is more important than investing to maintain future earnings. EVA often doesn't work well because increases in current EVA often come with reduced expectations of future EVA improvement—and reductions in current EVA are often accompanied by increases in future growth values. Since EVA bonus plans reward current EVA increases without taking account of changes in expected future growth values, they have the potential to encourage margin improvement that comes at the expense of business growth and discourage positive‐NPV investments that, because of longer‐run payoffs, reduce current EVA. In this article, the author demonstrates the possibility of overcoming such short‐termism by developing an operating model of changes in future growth value that can be used to calibrate “dynamic” EVA improvement targets that more closely align EVA bonus plan payouts with investors’ excess returns. With the use of “dynamic” targets, margin improvements that come at the expense of business growth can be discouraged by raising EVA performance targets, while growth investments can be encouraged by the use of lower EVA targets.     

Top Management Incentives and Corporate Performance

There is little agreement about either the effect of executive compensation on corporate performance or the best way to measure the strength of executive incentives. With little guidance from academic research, managers and directors continue to rely heavily on the percentage of pay "at risk" as a proxy for incentive strength.
Starting with the premise that managers, like investors, are motivated by prospective changes in their wealth, this article presents a measure of incentive strength called "wealth leverage" that reflects the sensitivity of an executive's company-related wealth—total stock and option holdings plus the present value of expected future compensation, including future salary, bonus and stock compensation—to changes in shareholder wealth. After estimating top management's wealth leverage at 702 companies, the authors conclude that: 1) the median company has significant wealth leverage; 2) almost all corporate wealth leverage comes from their accumulated stock and option holdings, not from current compensation; and 3) companies with higher wealth leverage significantly outperform their industry competitors.     

EVIDENCE ON EVA

EVA has attracted considerable attention as an alternative to traditional accounting earnings for use in both valuation and incentive compensation. With a host of consultants now marketing related metrics, numerous claims have been made—most based on anecdotal evidence or in-house studies. This paper summarizes the authors' independent evidence regarding EVA's alleged advantages.
The authors begin by reviewing the theory that links the underlying concept of residual income to shareholder value. Second, they discuss how Stern Stewart modifies residual income to produce its proprietary EVA metric and show how median EVA compares with residual income, net income, and operating cash flows over the period 1988–97. Third, they examine the claim that EVA is more closely associated with stock returns and firm value than is net income. Their evidence indicates that EVA does not dominate net income in associations with stock returns and firm values. Fourth, they examine a second claim that compensation plans based on residual income motivate managers to take actions consistent with increasing shareholder value. Here the evidence (from a study by Wallace) suggests that managers do respond to residual income-based incentives by, for example, increasing asset sales, cutting capital expenditures, repurchasing stock, and producing higher levels of residual income. The authors conclude by arguing that a metric such as EVA can be effective for internal incentive purposes even if it conveys little news to market participants regarding the firm's valuation.     

What Determines TSR

Researchers have long wrestled with the question of what determines a company's total shareholder return, or TSR, and their results have been decidedly mixed. Some empirical studies come down in favor of dividends or earnings per share, while others favor return on capital or other profitability measures. In this article, the author takes a “first principles” approach that begins by demonstrating that TSR should be a function of a company's economic profit, or its Economic Value Added (or EVA). He shows that, from a theoretical standpoint, the sum of dividends and share price appreciation—which is the definition of TSR—is ultimately a function of increasing EVA and, along with it, a company's “aggregate NPV.” He further shows that if stock prices are determined by discounting expected cash flows, corporate NPV will equal the discounted value of EVA, and increasing NPV will come down to increasing EVA. In developing his argument, the author demonstrates that TSR is actually a leveraged version of a measure he calls “TIR,” or total investor return, which is the blended return that an investor would earn from owning the entire capital structure of a company, bonds as well as stock. He then presents the findings of regression analysis showing that a company's TIR and TSR are both strongly positively correlated with its EVA performance plus the change in its aggregate NPV (with R²s equal to 1.0 and 0.94, respectively). In a final step, the author shows that the change in EVA provides a better statistical explanation than other financial measures for changes in aggregate NPV and, hence, actual TSR     

Does Risk Management Add Value? A Survey of the Evidence

The fact that 92% of the world's 500 largest companies recently reported using derivatives suggests that corporate managers believe financial risk management can increase shareholder value. Surveys of finance academics indicate that they too believe that corporate risk management is, on the whole, a valueadding activity. This article provides an overview of almost 30 years of broadbased, stock‐market‐oriented academic studies that address one or more of the following questions:

• ? Are interest rate, exchange rate, and commodity price risks reflected in stock price movements?
• ? Is volatility in corporate earnings and cash flows related in a systematic way to corporate market values?
• ? Is the corporate use of derivatives associated with reduced risk and higher market values?

The answer to the first question, at least in the case of financial institutions and interest rate risk, is a definite yes; all studies with this focus find that the stock returns of financial firms are clearly sensitive to interest rate changes. The stock returns of industrial companies exhibit no pronounced interest rate exposure (at least as a group), but industrial firms with significant cross‐border revenues and costs show considerable sensitivity to exchange rates (although such sensitivity actually appears to be reduced by the size and geographical diversity of the largest multinationals). What's more, the corporate use of derivatives to hedge interest rate and currency exposures appears to be associated with lower sensitivity of stock returns to interest rate and FX changes. But does the resulting reduction in price sensitivity affect value—and, if so, how? Consistent with a widely cited theory that risk management increases value by limiting the corporate “underinvestment problem,” a number of studies show a correlation between lower cash flow volatility and higher corporate investment and market values. The article also cites a small but growing group of studies that show a strong positive association between derivatives use and stock price performance (typically measured using price‐to‐book ratios). But perhaps the nearest the research comes to establishing causality are two studies—one of companies that hedge FX exposures and another of airlines' hedging of fuel costs—that show that, in industries where hedging with derivatives is common, companies that hedge outperform companies that don't.     

PERHAPS EVA DOES BEAT EARNINGS—REVISITING PREVIOUS EVIDENCE

In two articles, the first published in 1997 in the Journal of Accounting and Economics and the second in 1999 in this journal, Gary Biddle, Robert Bowen, and James Wallace presented evidence that reported earnings are more closely related than EVA to marketadjusted stock returns– in other words, that earnings are more “value relevant” than EVA. These papers, which are among the most widely cited in finance and accounting, fundamentally affected perceptions about the importance of EVA as a measure of corporate performance. The current article addresses a simple question: Do the Biddle, Bowen, and Wallace results continue to hold for a different set of companies, a different time period, and a different market? The authors first examined updated EVA information for different companies in the same time period examined in the Biddle, Bowen, and Wallace study. They then looked at a more recent time period (1995–1999) and a different market (the Canadian stock market), and found in all cases that “EVA has greater power than earnings in explaining marketadjusted stock returns.” Their findings validate the widespread corporate acceptance of EVA as a management tool.     

The Case for Maximizing Long‐Run Shareholder Value

Criticism of the shareholder model of corporate governance stems in part from misunderstanding about what shareholder wealth maximization means for the other stakeholders of public companies. The corporate goal of shareholder wealth maximization does not imply that such stakeholders “do not matter.” Managers maximize shareholder value by maximizing the total expected cash flows available to distribute to all of their stakeholders. To maximize such cash flows, managers must provide their customers with desirable goods and services at attractive prices—which in turn requires that managers attract the employees, suppliers, and financial capital needed to conduct their businesses by providing each of these groups with market‐determined returns on their contributions to firm value. In this way, successful corporations benefit all of their stakeholders, and what is good for the corporation is generally good for society. External forces such as the media and government exert considerable influence on corporate actions and, in so doing, they play a role in helping to limit negative corporate “externalities” such as pollution and climate change. But direct regulation of productive activities should be used sparingly, and subjected to ongoing cost‐benefit analysis. Government regulation replaces the collective decisions of a broad marketplace of stakeholders using their own resources to act in their own interests with decisions made by government officials with complicated incentives and using resources generated by others. More generally, government should seek to regulate corporate actions only in the limited situations in which there are no market solutions for reducing the effects of externalities. For example, government plays a critically important role in identifying and deterring corporate fraud, and in ensuring competition and a level playing field for companies and all their stakeholders.     

EVA AND DIVISIONAL PERFORMANCE MEASUREMENT: CAPTURING SYNERGIES AND OTHER ISSUES

This article makes three basic points about divisional performance measurement that managers should keep in mind when attempting to choose between EVA and more conventional, accounting-based measures. First, no divisional performance measure, whether it be EVA, divisional net income, or ROA, is capable of capturing synergies among divisions—those shared benefits or costs that make the sum of the parts worth more than the whole. And EVA is neither more nor less effective than more conventional financial measures in deterring divisional managers from taking actions that increase divisional profits at the expense of corporate value. Thus, there is a fundamental contradiction in the very attempt to evaluate the divisions of a multi—divisional firm as if they were independent companies. If there are synergies, divisional performance measures—even those employing transfer prices—are likely to prove inadequate in some respects (and this article recommends some methods for encouraging synergies that might be used to supplement if not replace divisional measures). But if there are no synergies, then top managers should re-examine their business strategy and consider selling or spinning off divisions. Second, a given performance measure's degree of correlation with stock returns should not be management's sole, or even its most important, criterion in choosing to adopt a given performance measure. A better method for evaluating performance measures is to weigh the behavioral or incentive benefits of a given measure against all direct and indirect costs associated with its implementation. In making such a costbenefit analysis, the incentive benefits from the tighter linkage of rewards to share prices provided by more market-based measures should be traded off against the greater market risk and exposure to other uncontrollables imposed by such measures as well as the costs involved in changing the firm's internal accounting and reporting systems. Third, the EVA practice of “decoupling” performance measures from GAAP accounting, while having have potentially significant incentive benefits, also has potential costs in the form of increased auditing requirements and the possibility of litigation.     

Beyond EVA

A former partner of Stern Stewart begins by noting that the recent acquisition of EVA Dimensions by the well‐known proxy advisory firm Institutional Shareholder Services (ISS) may be signaling a resurgence of EVA as a widely followed corporate performance measure. In announcing the acquisition, ISS said that it's considering incorporating the measure into its recommendations and pay‐for‐performance model. While applauding this decision, the author also reflects on some of the shortcomings of EVA that ultimately prevented broader adoption of the measure after it was developed and popularized in the early 1990s. Chief among these obstacles to broader use is the measure's complexity, arising mainly from the array of adjustments to GAAP accounting. But even more important is EVA's potential for encouraging “short‐termism”—a potential the author attributes to EVA's front‐loading of the costs of owning assets, which causes EVA to be negative when assets are “new” and can discourage managers from investing in the business. These shortcomings led the author and his colleagues to design an improved economic profit‐based performance measure when founding Fortuna Advisors in 2009. The measure, which is called “residual cash earnings,” or RCE, is like EVA in charging managers for the use of capital; but unlike EVA, it adds back depreciation and so the capital charge is “flat” (since now based on gross, or undepreciated, assets). And according to the author's latest research, RCE does a better job than EVA of relating to changes in TSR in all of the 20 (non‐financial) industries studied during the period 1999 through 2018. The article closes by providing two other testaments to RCE's potential uses: (1) a demonstration that RCE does a far better job than EVA of explaining Amazon's remarkable share price appreciation over the last ten years; and (2) a brief case study of Varian Medical Systems that illustrates the benefits of designing and implementing a customized version of RCE as the centerpiece for business management. Perhaps the most visible change at Varian, after 18 months of using a measure the company calls “VVA” (for Varian Value Added), has been a sharp increase in the company's longer‐run investment (not to mention its share price) while holding management accountable for earning an adequate return on investors’ capital.     

Incentives and Investor Expectations

This article argues that the Expectations‐Based Management (EBM) measure proposed by Copeland and Dolgoff (in the previous article) is essentially the same measure that EVA companies have used for years as the basis for performance evaluation and incentive compensation. After pointing out that the analyst‐based measures cited by Copeland and Dolgoff do not provide a basis for a workable compensation plan, the authors present the outline of a widely used expectations‐based EVA bonus plan. In so doing, they demonstrate the two key steps in designing such a plan: (1) using a company's “Future Growth Value”—the part of its current market value that cannot be accounted for by its current earnings— to calibrate the series of annual EVA “improvements” expected by the market; and (2) determining the executive's share of those improvements and thus of the company's expected “excess” return. One of the major objections to the use of EVA, or any single‐period measure, as the basis for a performance evaluation and incentive comp plan is its inability to reflect the longer‐run consequences of current investment and operating decisions. The authors close by presenting a solution to this “delayed productivity of capital” problem in the form of an internal accounting approach for dealing with acquisitions and other large strategic investments.     

The Market Reaction to Discontinuing Regular Stock Dividends

This paper investigates the behavior of returns to share-holders of NYSE and AMEX firms that publicly announce the discontinuance of regular stock dividends. Using event-type methodology, the results show that the average abnormal return for NYSE and AMEX firms is negative but not statistically significant on the event date. Partitioning the sample by stock-related characteristics shows that for small firms with low stock prices and low institutional ownership, management's decision to drop regular stock dividends conveys a significantly negative signal, which, in turn, causes stock prices to decline. Firms that drop a stock payment and simultaneously initiate or increase cash dividends experience a significant increase in shareholder wealth. However, firms that drop the stock dividend policy and do not begin a cash dividend policy experience a sharp decline in shareholder wealth.     

Drivers of Shareholder Returns in Tech Industries (or How to Make Sense of Amazon's Market Value)

Earnings according to GAAP do a notoriously poor job of explaining the current values of the most successful high‐tech companies, which in recent years have experienced remarkable growth in revenues and market capitalizations. But if GAAP earnings fail to account for the values of such companies, are there other measures that do better? The authors address this question in two main ways. They begin by summarizing the findings of their recent study of both the operating and the stock‐market performance of 169 publicly traded tech companies (with market caps of at least $1 billion). The aim of the study was to identify which of the many indicators of corporate operating performance—including growth in revenues, EBITDA margins, and returns on equity—have had the strongest correlation with shareholder returns over a relatively long period of time. The study's main conclusion is that investors appear to be looking for signs of neither growth nor efficiency in using capital alone, but for an optimal mix or balancing of those goals. And that mix, as the study also suggests, is captured in a cash‐flow‐based variant of “residual income” the authors call “residual cash earnings,” or RCE. In the second part of their article, the authors show how and why RCE does a much better job than reported net income or EPS of explaining the current market value of Amazon.com , one of the best‐performing tech companies in the world. Mainly by treating R&D spending as an investment of capital rather than an expense, RCE reveals the value of a company that is distinguished by both the amount and the productivity of its ongoing investment—both of which have been obscured by GAAP.     

CEO Overconfidence and Earnings Management During Shifting Regulatory Regimes

This study examines the relationship of CEO overconfidence with accrual‐based earnings management, real activities‐based earnings management, and targeting to meet or just beat analyst forecasts. Following, we measure “overconfidence” based on the CEO's tendency to hold in‐the‐money stock options, as rational expected utility maximizers should exercise early to avoid overexposure to company idiosyncratic risks. The results show that before the Sarbanes Oxley Act of 2002 (SOX), companies of overconfident CEOs were more likely than other CEOs to engage in managing earnings through accelerating the timing of cash flow from operations and achieving analyst forecast benchmarks. After SOX, we find that overconfident CEOs are more likely to have income‐increasing discretionary accruals. They remain more likely to engage in real activities management through abnormally high cash flows, and also have abnormally low discretionary expenses. These results are consistent with overconfident CEOs feeling less constrained by SOX, and suggest that this individual characteristic works against regulators’ attempts to constrain earnings management by corporate executives. In contrast, we find that the tendency of overconfident CEOs to manage to targets decreases after SOX, perhaps due to changes in investor behavior in the new regulatory environment.     

Optimal Incentive Contracts for Loss‐Averse Managers: Stock Options versus Restricted Stock Grants

This paper provides an explanation for the widespread use of stock option grants in executive compensation. It shows that the optimal incentive contract for loss‐averse managers must contain a substantial portion of stock options even when it should consist exclusively of stock grants for “classical” risk‐averse managers. The paper also provides an explanation for the drastic increase in the risk‐adjusted level of CEO compensations over the past two decades and argues that more option‐based compensation should be used in firms with higher cash flow volatility and in industries with a higher degree of heterogeneity among firms.     

EVA AND TOTAL QUALITY MANAGEMENT

Both TQM and EVA can be viewed as organizational innovations designed to reduce “agency costs”—that is, reductions in firm value that stem from conflicts of interest between various corporate constituencies. This article views TQM programs as corporate investments designed to increase value by reducing potential conflicts among non-investor stakeholders such as managers, employees, customers, and suppliers. EVA, by contrast, focuses on reducing conflicts between managers and shareholders by aligning the incentives of the two groups. Besides encouraging managers to make the most efficient possible use of investor capital, EVA reinforces the goal of shareholder value maximization in two other ways: (1) by eliminating the incentive for corporate overinvestment provided by more conventional accounting measures such as EPS and earnings growth; and (2) by reducing the incentive for corporate underinvestment provided by ROE and other rate-of-return measures. At a superficial level, EVA and TQM seem to be in direct conflict with each other. Because of its focus on multiple, non-investor stakeholders, TQM does not address the issue of how to make value-maximizing trade-offs among different stakeholder groups. It fails to provide answers to questions such as: What is the value to shareholders of the increase in employees' human capital created by corporate investments in quality-training programs? And, given that a higherquality product generally costs more to produce, what is the value-maximizing quality-cost combination for the company? The failure of TQM to address such questions may be one of the main reasons why the adoption of TQM does not necessarily lead to improvements in EVA. Because a financial management tool like EVA has the ability to guide managers in making trade-offs among different corporate stakeholders, it can be used to complement and reinforce a TQM program. By subjecting TQM to the discipline of EVA, management is in a better position to ensure that its investment in TQM is translating into increased shareholder value. At the same time, a TQM program tempered by EVA can help managers ensure that they are not under investing in their non-shareholder stakeholders.     

The Evolution of Executive Pay Policy at General Motors, 1918–2008

This article documents the gradual movement of General Motors away from the partnership concept that dominated U.S. corporate pay policy in the first half of the 20th century and toward the “competitive pay” concepts that have prevailed since then. The partnership concept was achieved by paying managers bonuses in the form of GM shares, with the amounts paid out of a single company‐wide bonus pool and based on a fixed share of profit (after subtracting a charge for the cost of capital). Thanks to this “EVA‐like” bonus scheme, GM's managers effectively became “partners” with the company's shareholders, sharing the wealth in good times but also the pain in troubled times. What's more, the authors also show that, from the establishment of the program in 1918 through the 1950s, the directors went to great lengths—including several bouts of innovative (and often complex) problem‐solving—to achieve their compensation objectives while maintaining such fixed‐share bonuses. But the sharing philosophy and associated compensation practices were gradually supplanted by competitive pay practices from the 1960s onward. The authors show that by the late 1970s, GM had a board of directors with modest shareholdings, in contrast to the board in the early post‐war period, whose directors had large stakes. As a consequence, directors began acting less like stewards of capital and more like employees whose financial rewards came not from returns on GM's stock but from the fees they received for their services. This fundamental change in board compensation almost certainly contributed to the gradual abandonment of fixed‐profit sharing for GM's managers. In its place, the board implemented competitive pay policies that, while coming to dominate executive pay policy in the U.S. and abroad, have largely divorced executive pay from changes in shareholder wealth. In the case of GM, this growing separation of pay from performance was accompanied by a significant decline in corporate returns on operating capital as well as stock returns over time.