The always entertaining and often insightful Mark Cuban has a 2009 post on layoffs and executive compensation that might be of interest. Cuban begins his post by lamenting the fact that profitable firms often shed workers, and he attributes this at least in part to the fact that executives have a strong incentive to maximize shareholder value.

Executives are not stupid. Usually. They recognize that killing off employees can juice a stock price. Even in this market. Which in turn can juice the value of their options and compensation. At the companies I run, we have cut raises, put a freeze on hiring, done what we need to do, but we have done all we can to avoid layoffs. Why? Because its the right thing to do. It’s the patriotic thing to do. I’m selfish enough and arrogant enough to think that maybe if I pay attention to the big picture that I can impact the big picture.

Appeals to patriotism raise alarm bells for me, but I think that this stance will resonate with many readers.

I own stock in some firms whose backs are up against the wall because of debt. Unfortunately, they don’t have a choice but to cut jobs in order to save jobs. I understand this reality. It’s unfortunate, but a fact of life.

I find this interesting: there is no question that the tax treatment of capital income encourages firms to rely on debt rather than equity, and one wonders if tax reform might lead to a healthier corporate sector.

I also own stock in firms that are profitable. Put a freeze on hiring. Put a freeze on all raises to employees of all levels, including yours. You don’t have to try to squeeze every nickel to the bottom line. I realize these are extrodinary times. I’m happy to accept a P/E ratio that is 20pct or 50pct higher (lower earnings vs the current price) . I want you to manage for the long term benefit of the company rather than manage to the stock price.

Cuban goes on to argue that the problem is that employees are in “the cash zone” while executives are in what he calls “the equity/lottery ticket zone,”

There is a big difference between not making Wall Street happy and not making money.
The pressure from Wall Street is to grow earnings forever. Not matter what it takes. This isn’t a problem when a company is doing well. Everyone is happy. But when the economy hits a bump like it has now, when the market is hitting a bump and stock prices are declining, like it is now, the pressure comes. Everyone owning the stock reacts and whats to know what the CEO will do to get the price back up. This, as they say “is where the CEO earns their pay” Unfortunately, what this really means is that everyone who works for that company is at risk. At risk of losing their jobs, benefits, raises, you name it. It’s at risk.

Cuban proposes a solution:

As long as CEOs live in the equity/lottery ticket zone and employees in the cash zone, CEO pay is going to be outrageous relative to everyone else.
The only possible way to change this is to put CEOs in the cash zone. Make companies generate 100pct of their compensation in cash that is 100pct expensable in the quarter paid. That’s not to say they can’t own stock. Hell yes they can own stock. But make them buy it either on the open market, or as part of the programs that make stock available to every company employee, on the same terms. They are getting paid enough in cash and if they believe in their ability to run the company, they can put their money where their mouth is. Eliminate all the free lottery tickets. Make them buy stock, options, warrants, whatever, on the same terms as everyone else can.
Shareholders tend to ignore how much stock is given to management, they don’t ignore cash. Companies will always be a lot more stringent with their cash, whether it’s paid to the CEO or anyone else. CEO cash compensation will go way up, but total compensation will come way down. More importantly , CEOs getting paid huge sums incash will stand out like a sore thumb when things aren’t going so well. They will be treated like everyone else in the cash zone and held far more accountable for their work.
Of course this is all just my opinion, but to me it’s a good thing for all involved. The rich can still get richer, but everyone shares in the risk.

I’d love to hear from entrepreneurs of scholars of corporate finance on whether or not Cuban’s approach is sound. Are there closely-held firms that embrace a compensation strategy of this kind, and do those firms tend to flourish?

(Thanks to a twitter.com/lewismd13 for the tip.)

Cuban’s discussion reminded me of Arnold Kling’s essay “When Labor is Capital,” which includes a discussion of “roundabout production”:

The idea of roundabout production is to use intermediate activities to increase final output. For example, a plow cannot be eaten, but it can be used by a farmer to produce more food. Using a plow is an example of roundabout production, in that first you produce the plow and then you use the plow to grow more crops.
Whatever it means to do social-media marketing, if it is part of a sustainable pattern of specialization and trade, then somehow it must help the economy increase output, just as a plow helps a farmer increase crops. Jobs like website development and social-media marketing are very far removed from the final stage of production. They illustrate the emergence of increasingly indirect and roundaboutpatterns of specialization and trade.
The trend is for the proportion of people employed in final-stage production to get smaller and smaller. Two or three generations ago in the United States, agricultural workers and manufacturing production workers made up half of the labor force. Today, that figure is less than 10 percent. However, thanks to roundabout production, we can produce more manufactured goods and more food than ever.

Kling goes on to apply this concept to the U.S. labor market:

If labor is capital, then we have lost the automatic tight connection between spending and employment. Firms can vary their output with little or no variation in employment. This explains how we can have a “jobless recovery,” meaning a large percentage increase in output without a comparable percentage increase in employment. For firms in today’s economy, labor represents an investment. Firms hire workers in order to develop capabilities that will eventually produce output more efficiently. The return on an investment in workers may take as long or longer to realize as the return on investment in a machine. The return on investing in workers may be at least as uncertain as the return on investing in equipment.

Kling suggests that the U.S. economy is in the midst of a great recalculation. This view is quite controversial and that is hard to discern through the use of conventional statistics, a fact that Kling wouldn’t find remotely surprising:

The suddenly unsustainable housing and mortgage boom comes atop the ongoing obsolescence of various patterns of specialization, as the Internet and globalization continue to foster new forms of organization and competition. The result of the boom-bust cycle superimposed on the ongoing obsolescence is to overload the market’s ability to reconfigure production patterns so that workers are fully employed.
The market needs to undertake a recalculation in order to deploy workers in a new, sustainable pattern of specialization and trade. The process involves gradual, decentralized trial and error. Firms need to be launched by entrepreneurs, who will make risky investments in employees. The failure rate will be high, but eventually the successes will have a cumulative effect that brings about more economic activity.
The challenge is made difficult by the increasing specialization of labor-capital. The problem of matching skills with needs in roundaboutproduction is much more complex than the problem of adding or subtracting workers in final-stage production.

Cuban and Kling aren’t talking about the same thing, of course, but I think it’s useful to juxtapose these different ways of thinking about layoffs.