Extreme Corporate Risk Taking

October 12, 2007
The New York Times: Maybe It’s Time to Restructure Executive Stock Options

The reasons for the poor performance of option-laden bosses seem obvious. An option holder will get rich if the stock soars, but he is no worse off if it falls a lot rather than a little. So a project with a huge possible profit may seem attractive even if a big loss is also possible, or even probable.

Kudos to the New York Times for publishing this article just before the Great Recession hit. Well done I say! Seriously, the timing was impeccable.

So let's try and imagine what an option-laden boss might be thinking now. We've seen the dotcom bust. Times have changed. Investors want dividends (especially during ZIRP). Well, fine. If that's what they want then that's what they'll get. The incentive to boost them would seem irresistible, at almost any cost. Hell, burn the seed corn if necessary! Right?

The following chart shows the 1-year moving average of corporate net dividends divided by corporate net cash flow.


Click to enlarge.

Other than another return to the median, what's the worst that could possibly happen? I'm speaking on behalf of option-laden bosses looking to cash out before it happens, of course.

Let's zoom in for a closer look.


Click to enlarge.

To infinity and beyond! Well, once we get these stupid dividend (chart) and net cash flow (chart) spigots oiled up. Both seem to be getting sticky again. The temporary prosperity must flow!

Lever up! If you engage in extreme risk taking by borrowing money to invest in extreme corporate risk taking then just think of all the money you could make! That's what makes parabolas (y = x²)! And if/when it all comes crashing down again, don't go blaming the option-laden bosses. Unlike you, the bosses stand to lose nothing if the risk doesn't pay off. That's what makes it such a sound business decision for them. Woohoo!

This is definitely not investment advice. There may be the tiniest hint of sarcasm though. But what's new?

Source Data:
St. Louis Fed: Custom Chart