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Local Restaurateur Steve Hartnett Is Trying To Save Capitalism

Steve Hartnett, the man behind many local restaurants (Cool River, Fox & Hound, Flip’s, Bob’s Steak & Chop House in Grapevine, to name just a few), is also an astute futures trader. He’s a rich man and he is on a rabid campaign to make a difference. Hear him out:

Dear Friends and business associates,
About a month ago we sent out 1000 copies of the below letter to all the Senators, House members, administration folks, relevant government servants, along with hundreds to the media.  My/our goal is to support capitalism and reign in excessive pay packages.  We are receiving encouraging written response from government officials (SEC), senators and house members.  The most treasured hand written response came from billionaire John Bogle–founder of Vanguard.  To address the problems outlined in our letter he volunteered to serve with Warren Buffett in advisory capacity to our government.  He also offered his warm encouragement–advocating we “press on.”

We are noticing much of our terminology and argument has made it’s way into both the media and government.  This of course is rewarding and highly encouraging.  It is a great motivator to see one can make a difference on issues that are important.  What starts with a “butter fly effect” can become a stampede of elephants.

Unless you notify me otherwise, I will include you in our ever growing email contingent of concerned citizens.

Below is a copy of the letter.

Ps: no offense to the CEO’s on my list, as I am not suggesting you are overpaid, but I think you will agree the system is being abused.

March 6, 2009

Dear Dr. Bernanke,

This is a cry for help.  A message in a bottle, corked and set adrift in a sea of people who can make a difference.

As a late stage cancer patient my motivation for writing this letter is selfishly simple; gain favor with our capitalistic maker through a humble effort to help “thy neighbor.”  Our capitalistic system mimics the creator’s brilliant, “tough love,” self improving system of natural selection; reward strength and success and discourage weakness and failure (anyone want to take a shot at improving His plan?).

Parasite Found

Our divinely endorsed free market capitalistic system is under attack from within.  The assault was initiated by executive betrayal of duty regarding their compensation.  This was followed by a misdirected and counter-productive government response; raise marginal tax rates.   As a result, we find ourselves in what might be called, The Great Repression.

Today in corporate board rooms there are parasites, cloaked in Armani suits, gorging themselves on the muscle of wealth creation; they are killing both the working class and risk taking investors.  While costly middlemen — gluttonous carried interests and overpriced investment managers — are extracting the icing off an otherwise mediocre cake, an even more sinister misappropriation is playing out in corporate board rooms where corporate insiders cut themselves bigger pieces of a finite wage cake.  Our great country was built when fortunes of “old money” were created by investors taking great personal risk to grow the economy.  Much of today’s “new money” feeds on the risk and labor of others; they act as leeches, extracting vital economic energy from the system.  In desultory response, searching for equalizing justice, an angered and confused government raises taxes on all the most successful, impeding the natural selection process that is crucial to economic growth.

I am a 60 year old investor, academically trained in finance and entrusted with funds from 150 family members and friends.  This duty I take very seriously.  Also, I am the founder of a restaurant company that was taken public in 1994.  As chairman of our fledgling company I had a front row seat (and was a reluctant beneficiary) to the sleazy, self-fueling dynamics of insider compensation.

Thou Shall Not Tempt

We are all guilty, we are all suckers.  We deserve punishment when we negligently provide insiders the “ATTRACTIVE NUISANCE” of writing their own checks.  The resulting value drainage from savings and retirement accounts is relentless and will eventually be forced on the tax payers.  The trillion dollar problem is hiding in plain sight.

It is no big surprise that the genesis of our current meltdown is rooted firmly in the overreaching behavior of corporate decision makers.  Why do they risk their company with ever increasing no house limit bets? (Subtle hint: their compensation package encouraged recklessness).  Two inequities are prominent with executive pay.  Firstly, the outrageous, ever expanding size of these compensation packages and secondly, their stealth, hard to value structure.  We all want to hire the best and brightest to steward the companies we invest in, but our total disregard for cost when attracting talent is akin to a drunk tearing up the room looking for a bottle.

While scrutiny is currently being applied to executives in the banking system, the problem goes well beyond banking.  Common sense whispers…“something is rotten in Denmark” regarding the compensation programs in all industries across the nation.  Consider that the compensation of the average CEO has grown from about 40 times the average employee–in just 1985–to upwards of 450 times today (not counting personal perks like private jets and sinful golden parachutes).  Executives are not 10 times more valuable today than they were in the past but they have found 10 times more ways to game the system.  The collateral damage from this inequity could destroy capitalism.

The Endless Loop

Scientists understand the runaway greenhouse effect on Venus is caused by an ever increasing carbon dioxide canopy which traps heat; this releases more carbon dioxide which further thickens the canopy.  As the canopy metastasizes less heat can escape, causing surface temperatures of 700+ degrees (only a convenient analogy and not meant as a position on climate change).    Corporate insider compensation is trapped in this same sort of self destructive ever increasing loop.

As chairman at board meetings, I quickly found an uncomfortable dynamic at work.  WE WERE IN CHARGE OF OUR OWN COMPENSATION (smell that?).  This created an obscene conflict of interest because we represented both the shareholders and ourselves!–Guess who was the favorite in that conflict?

When we discussed compensation for executives – which was the same time we would discuss board compensation – they would roll out reams of facts and statistics supporting how well upper management was being paid at other companies of similar size[i] (we must keep up with the ever increasing wealth of the corporate Jones’s).  Companies of below average compensation were conveniently omitted from the data base — after all, we were better than average.  The CEO, or possibly a board member who was a golfing buddy of the CEO, would present data supporting a large pay increase for our amazingly talented executive.  After a wink and nod, the shamefully biased voting board, in quid pro quo collusion with the incestuous compensation committee (hired and fired by the board), would approve these increases, hiding behind “comparables” from other companies.  Just like Venus, the ever expanding salary loop reinforces itself with no end in sight.

With everyone in the room looking for ways to break new “justifiable” ground for higher pay the problem starts working its way down the high end of the corporate ladder.  After all, it is hard to justify an astronomical CEO package without giving a huge package to other executives.  Soon, the entire upper management team’s compensation becomes bloated–in  2006 CEO’s of America gave themselves a 38% raise at the expense of those doing the heavy lifting!.  How do you like them apples?

Weapons of Wealth Destruction

Ever wonder why executive ‘group think’ loves risky leverage?  THINK OPTIONS.  Here is why options are the number one problem with compensation packages and inappropriate for executives (don’t forget to hold your nose):

(1)     A general lack of understanding of options encourages doling them out like candy, when they are truly “weapons of wealth destruction.”

(2)    Options create risk management vertigo by encouraging executives to take unreasonable business risk.  THE PRINCIPLE DRIVER OF OPTION VALUE IS VOLATILITY.  The more the better.

(3)    Options destroy fiduciary impartiality regarding dividend policy.  Dividend payout always has a negative impact on option value giving executives an incentive to limit appropriate payout.

(4)    Academics have continually proven that most of a company’s change in value is driven by GDP and industry prospects. Options often pay off for a general rise in GDP, not for exceptional CEO performance.

(5)    In bull markets, options pay off like winning lottery tickets.  In bad times, a dark and deadly comedy plays; featuring the threat of abandoning ship by the very executives who set the course.  They scream out the need to re-price their options, blaming the economy for the falling share price (but never giving GDP credit during the expansion phase).  RE-PRICING IS THE ULTIMATE RIP-OFF and we are about to see a wave of option re-pricing the likes of which will defy imagination[ii].

A Possible Solution

As a trader of financial futures, I was stunned to learn that financial institutions levered 50:1 were unwilling to take defensive action when the market started falling.  Their leverage ratio only allowed a 2% fall in value before going underwater; unforgiveable.  Worse still, the instruments to hedge this over exposure were liquid and readily available.  But imagine the $100’s of millions they make on their options if things go just right–with no downside if they don’t.

In 2006, as a small investor I learned that insurance against mortgage default was available and I purchased a large chunk to protect my overall portfolio against economic collapse; we were repaid 7 to 1.  Questions:  Why didn’t the CEO’s of over exposed entities do the same?  Where was the board?  Short answer:  Watching how it all played out on their compensation packages.

Although I am not a fan of big government, I recognize the good and the necessity of intervention on certain issues.  Just like the government must limit highway speed to protect the innocent, so to they must limit runaway executive compensation.  Below is a four part solution:

(1)    The first, though simple, is the most critical… outlaw stock options as compensation.  Substitute restricted stock, eliminating risk management vertigo.

(2)    Roll back CEO pay, and require shareholder approval beyond a “reasonable” number.  If insiders want to make a democratic run at shareholder generosity, fine, but shareholder approval must be requested on a separate instrument from the dense legal information sent out by companies.  It should be requested in bold print with emphasis on the importance of insider conflicts, golden parachutes, and include warnings about runaway compensation.

(3)    Incorporate this new legislation all at once to prevent brain drain between industries.

(4)    Appoint the venerable John C. Bogle and Warren Buffet – who are proven risk takers and guardians of shareholder value – to review these suggestions and edit/add their own.

In conclusion, executive pay is inequitable and destructive due to both size and structure.  Executives will continue to take excessive risk in a quest to justify excessive pay.  Eventually the outrage mayl be remediated but the hour glass of capitalism is low on sand.  There is no democracy in our current methodology.   It is a hidden dictatorship riddled with quid pro quo[iii] .  The quiet majority does not like it one bit, but we only have ourselves to blame.  We allow the foxes to guard the shareholder hen house.

Most sincerely,
Steve Hartnett
United States citizen

32 comments on “Local Restaurateur Steve Hartnett Is Trying To Save Capitalism

  1. The Creator discourage[s] weakness and failure?

    Oh for heaven’s sake, that ended it all right there.

  2. Please provide Steve’s email address…I want to join his worthwhile cause.

  3. Thank you for that truly informative and spot on evaluation of our current corporate epidemic. I couldn’t agree with you more on the points you made in your letter. To those of you who don’t understand the points that Steve Hartnett was referring to, I would advise you to research the problem with the hope of understanding it better. While it would be nice if we could legilate ourselves out of this current fiscal crisis, there is a simpler solution at hand: (albeit just as difficult to enact) To get shareholders to understand the problem at hand and use your considerable collective power to eliminate board members who take part in this never ending, slow motion train wreck. That will never be able to happen until the true operators (shareholders) take a moment to understand the problems and more importantly, understand the solution.

    Kudos, Mr. Hartnett and good luck in your efforts.

  4. “Consider that the compensation of the average CEO has grown from about 40 times the average employee–in just 1985–to upwards of 450 times today (not counting personal perks like private jets and sinful golden parachutes). Executives are not 10 times more valuable today than they were in the past but they have found 10 times more ways to game the system.”

    I think the CEO/founder of Costco set his salary at 60 times the lowest paid employee wage. I think he gets it. I think that is a pretty fair business model for any large corporation. I don’t think it should be government mandated though.

  5. Then what would you do Trey? Shoot them all. You can’t just say garbage.

  6. One simple question for Trey.

    Could you please explain why executive compensation has grown from 40 to 450 times the average employee’s compensation, and why this is necessary for a healthy market?

    If so, I’ll accept your well thought out reply.

  7. This is a slippery slope the Democrats are playing on. Too many are hinting that they (politicians) should be able to determine or set the salary for business executives — and NOT JUST those who work for businesses being bailed out by the government. Soon, they will want to determine the salaries of more than just high-paid executives instead of letting the private sector handle it. That also will mean middle class jobs too. Just plain scary.

    I do find it interesting that the same politicians who complain about the over-priced executives still manage to vote themselves a pay increase every single year for their PART-TIME job.

  8. I for one am against any government intervention in determining a ‘fair’ wage. I worked on a Defense Contract in 1995 that specified we were to pay everyone according to the Department of Labor Area Wage Determination (AWD). The problem was evident when our skilled Airframe Repairers were stuck in the same category as Auto Bodyshop repairers. Aircraft Electronics Technicians and Jet Engine Mechanics were also classified as Auto Mechanics. Needless to say, the new, extremely LOWER wage drove many skilled workers away. It was a two year contract where we got screwed by some US Gov’t employee who did not understand the value of highly trained people. I would never want any of you guys to go through that. Socialised Capitalism is an oxymoron.

  9. What about the parasites in DC? They are more corrupt than the fat cats. Term limits I say.

  10. As the letters author, I too hate the idea of government involvement. It’s just been difficult to figure a solution. It’s been like a snowball running down a hill–hard to stop. Shareholders are such a diverse group it’s hard to get their unified attention. Outlawing stock options as exec. pay will be a big step forward. These stealth buggers fly under peoples radar and are like acid on shareholder value.

  11. or limit their income to some number, say, 200% of the average income of their constituency? or maybe somewhere around the 90% percentile assuming some sort of bell curve?

  12. Please people, or as Gordon Ramsey would say, “Oh, come on!” Comments from folks posting on a blog about business ideas, acumen, proposed solutions to the ancient have/have-not woe should really be correctly spelled (legilate?), thoughtful, and absent of the cover/filler or all-too-handy euphemisms and analogies (doling them out like candy…fly under people[']s radar). PLEASE!!! If your design in writing something is to be taken seriously, as it appears was the intent here, then pepper in less rhetoric and everyman-isms and show more lucid historical support. Try less dancing and more dot-connecting. Cite things. Persuade me with authority, not emotion. Show that you have the scholarly backdrop. Lend credence to your argument. Steve, your letter, regardless of your intent, reads like an amateurish plea, instead of a top-tier attempt to persuade a national financial markets figure on a macro-economic point. I really hope you did not send that. Perhaps that, inter alia, is why it’s “garbage.”

  13. wja et al,

    Looks like my writing style, not surprisingly, does not sit well with all. Your accusation of amateurism is in fact true because I am far from a professional writer. Just doing my best to communicate thought and influence corporate direction. But,I will take your comments under advisement.

    However, I do believe we can all make a difference even if we are not as rhetorically gifted as wja. Citizens should not be discouraged if they lack the polish and talent of professionals. Communication of thought rather than hubris of style is primary.

  14. Also, Steve, could you provide a list of all the restaurants you’re actively involved in?

    I’d like to have a handy guide to where I won’t be spending my money.

  15. As a business owner, I agree with most of what Hartnett says. I risked everything I owned in betting that I would be successful in my venture. My gamble paid off handsomely and thus I deserve all of the spoils……Chief Executives of firms on the other hand, what have they truly risked? If their decisions fail, they lose their job. Big. Deal. Let’s have them sign a personal guarantee risking everything they own and then I could better agree with the money they make…………

  16. Steve, I’d like that list too. I’ll do my best to stop by and spend my money.
    And as I said previously, I’m interested in your email address to inquire more about this. If you would rather not make it public, you can reach me with a comment at my blog, which is in the link in my name.

  17. I don’t believe we will ever get to the point of legislating exec compensation but this letter at its very least serves as an awareness campaign to shareholders and potential shareholders. If I don’t like the exec pay structure of a company then maybe I won’t buy the stock. If more people do the same then the stock price drops and the situation self-corrects. Go Steve!

  18. Trey–I usually sympathize with your libertarian rants, but you’re wrong to dismiss Scott’s ideas out of hand.

    You say that executive compensation should only be the business of investors in the company, but the problem is that investors (i.e., sahreholders) actually have little to no say over executive compensation. Board members and compensation committees at public companies are typically comprised of CEOs and high-paid executives at other companies who have a vested interest in awarding outrageous pay packages because they know it’s a quid pro quo game. Shareholder attempts to limit such practices and actually have a say in executive compensation are ignored by the Board and prohibited by the SEC.

    I’m surprised that such an undemocratic process doesn’t offend your populist sensibilities. There are currently many legislative proposals to empower shareholders to have a say in the companies that they own, which I would hope you would support–since they are all democratic in nature and designed to wrest control of companies from the self-interested directors and return it to the owners.

    These proposals include things like allowing allowing shareholders to use corporate proxy material to nominate directors, shareholder access, broker voting of uninstructed shares, independent board chairmen, independent executive compensation advisors, shareholder advisory voting on pay, severance pay limits, and clawback provisions (i.e., requiring return of merit-based bonuses when the company later restates its earnings).

  19. I agree, options are one of the most deadly forms of executive compensation. Steve made the point very well: the value of options is driven by volatility and one way to increase this is to take on more risk. That definitely looks like what is happening to me. I’d like a list of those restaurants too.

  20. Steve nailed it right on the head. The current level of executive compensation is way out of whack. Our government seems to have been listening to people like Mr. Hartnett lately. Let’s just hope they do something about it.

  21. Hi all,

    Regarding a list of restaurants; I have sold most through the years including Fox and Hound and Cool River amongst others. Currently, we own and operate Bob’s Steak and Chop House Grapevine, Flip’s Grapevine, and the brand new Flip’s in north Fort Worth.

    Thanks to all for weighing in,
    Steve

  22. Forgive my mid-spelling earlier. I was responding on my iPhone just the same as I am now and I’m sure most people can understand the difficulties associated with typing a response on a cell phone. Stop focusing on trivial matters and look to the crux of the argument. His points are valid, even if I mid-type on my phone while agreeing with them.