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When a Delaware state judge nullified a $55bn equity pay package awarded by Tesla to Elon Musk in 2024, she asked a good question. Why did Musk need any more incentive to raise the stock price when he already owned around a fifth of a company, worth hundreds of billions of dollars?
Bill Ackman’s Pershing Square Capital Management is giving this topic a new airing. The US hedge fund on Monday bought $900mn of stock in Howard Hughes, a listed conglomerate, taking its stake from 38 per cent to 47 per cent. The company is now set to become an M&A-driven holding company managed by the hedge fund.
That sounds complex enough. But Ackman tried to add an extra dollop of financial innovation. He initially wanted Howard Hughes to pay Pershing Square an annual fee, to reward its “organisational team, resources, and best-in-class advisory and management capabilities”, of 1.5 per cent of Howard Hughes’ market capitalisation — worth over $50mn.
That would have resembled the way asset managers get paid. They receive management fees based on the size of invested capital, as well as a share of the capital gain. But it is highly irregular in public company world, where the reward for managing a company is generally a salary plus bonus, in cash and shares.
It makes sense that Ackman wants to blur these lines. He is both a capital allocator and, he presumably believes, a sharp judge of how to run companies. Besides, a common theme in finance at the moment is the fading distinction between private and public investments. Asking a public company to pay its managers a performance fee seems somehow fitting.
The catch is, it’s not clear any of this complexity is needed. Ackman’s fund has a near-50 per cent stake in Howard Hughes, for which it has paid a generous 48 per cent premium. He has every reason to work hard to make the company’s value go up, and will benefit handsomely if it does.
Warren Buffett, a hero of Ackman’s, managed to keep things simple. His company Berkshire Hathaway pays him a fixed salary, but no special management or performance fee. The Oracle of Omaha’s reward comes from the fact that he owns around 14 per cent of the company, so when it does well, he does too.
After some negotiation, Ackman has emerged with some of what he wanted. Pershing Square will get a sum equivalent to 1.5 per cent of the increase in Howard Hughes’ market value each year. That’s closer to a performance bonus than a management fee.
If Howard Hughes becomes the next Berkshire Hathaway — which, incidentally, would mean its market capitalisation increasing more than 300-fold — investors would be unlikely to begrudge even the most lavish pay arrangements. The same has turned out to be true of Tesla.
But pay should be designed to avoid rewarding failure. Management fees, which get paid even when performance proves elusive, are a poor way to incentivise the boss. Wall Street’s so-called Masters of the Universe have managed to make that the norm in asset management. The less of it there is in the realm of public companies, the better.