December 4, 2021

Reuters BreakingViews: Incentives Play Role in Success of Netflix

The star attractions at Netflix keep winning over new, and sometimes unlikely, fans. But one feature of the movie streaming service’s business model is less well known: the unusual way it offers incentives to its staff. Rivals struggling to compete with the company, which is led by its founder, Reed Hastings, might want to take a peek.

Defying and converting skeptics with innovation has become standard operating practice for Netflix. An additional 3.3 million people subscribed last quarter, bringing the total to 23 million, while operating margins held strong at 14 percent.

A new adversary sounds intimidated. Charlie Ergen, whose Dish Network bought Blockbuster out of bankruptcy, says he does not plan to challenge Netflix on streaming because of its “insurmountable lead.” Even Time Warner’s boss, Jeffrey L. Bewkes, who once likened Netflix to the Albanian Army, changed his tone recently and expressed some admiration for what the $12 billion company had accomplished.

Part of the success may stem from the uncommon way Netflix rewards its people. Employees eligible for stock options can tailor the mix of salary and equity in their compensation packages. The amount of options used to be restricted, but the cap was lifted last year. Mr. Hastings took only about 9 percent of his $5.5 million pay in cash.

Equally unusual is how Netflix doles out options. They are granted monthly instead of annually, as is typical. Given how Netflix shares swing wildly, this makes sense. About a fifth of them are also on loan to short sellers, who think the company is overvalued or the business model is not sustainable.

This can help smooth volatility and reduce some frustration that might discourage managers. To wit, on Nov. 1, the shares were at about $167. A month later they were up to $200. And they opened 2011 at just over $178. Because of the dollar-cost averaging afforded employees, they can worry less about underwater options and more about how to keep Netflix a step ahead of the competition.

Heeding Say on Pay

Companies that ignore say-on-pay votes may pay a hefty price: lawsuits. Shareholders are speaking up on executive compensation with the voice they were given by last year’s financial overhaul legislation. Their advice is not legally binding, but that has not stopped disgruntled investors from calling in lawyers to enforce their views.

The Dodd-Frank Act created say-on-pay to blunt criticism that executives were compensating themselves like rock stars. Beginning on Jan. 21, most public companies had to put pay packages for top officers to an “advisory vote” by shareholders. The law did not change directors’ fiduciary duties, so ignoring a thumbs-down verdict is allowed.

Few boards have faced that option. On Friday, for example, just 27 percent of Goldman Sachs’s shareholders voted against 2010 pay of $18 million for its chief, Lloyd C. Blankfein. At last count, only 12 of more than 350 companies that have held meetings received less than majority support for their executives’ pay. Still, those few could face costly consequences.

A negative vote can lead to bad publicity or the ouster of directors. But for Jacobs Engineering and Beazer Homes, which lost say-on-pay votes this year, it has meant lawsuits against management by major shareholders.

The suits claim the votes were slam-dunk evidence that executive pay was excessive. By not altering pay after the votes, the suits argue, management unjustly enriched itself, breached its duties to shareholders and, in Jacobs’s case, wasted company assets.

These are tough arguments to win. The law generally leaves compensation decisions up to the directors. It is easy to see the reasoning for that. Most shareholders do not pay enough attention to make informed decisions about corporate matters, and some others might have agendas that diverge from the interests of smaller investors.

Still, executive compensation has generally soared, even when profits and share prices have fallen. Many incentives for chief executives are misaligned with shareholder interests. When that perception is wrong, boards should explain why. And when it is not, they are better off heeding shareholder concerns about pay, and adjusting accordingly than squandering more of their owners’ treasure on defending themselves in court.



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Reuters Breakingviews: An Opportunity for Green Energy

In April 2010, an explosion in one of Massey Energy’s coal mines killed 29 workers. Just weeks later, BP’s Macondo well started gushing millions of barrels of oil into the gulf. And more than a month after Japan’s large earthquake, the Fukushima nuclear plant is still leaking radiation.

This week’s blowout and spill in Bradford County, Pa., puts the latest technique to extract natural gas under scrutiny, too. With thousands of wells now being drilled in the United States and big plans unfolding around the world, this is unlikely to be the last time frackers stumble.

And it gives proponents of greener energy a public relations opening. Natural gas has become an unexpected nemesis of wind and solar energy in recent years. Low gas prices have made renewable projects look even more expensive than they seemed before.

In addition to the image-enhancement opportunity, renewable energy firms can also finally showcase projects with enough scale to rival fossil fuel burners and nuclear reactors. The Shepherds Flat wind project under construction in Oregon will create 850 megawatts of capacity, close to the output of a typical atomic reactor. First Solar, a $12 billion energy company, is building a 550-megawatt plant in California.

Renewable energy still has a mountain to climb. In America, for instance, wind and solar power still provide just 1.4 percent of the nation’s total energy diet. And although alternative sources are becoming cheaper, in many cases they still need subsidies. With belt-tightening happening in governments everywhere, that kind of help is under threat. But with the full range of traditional energy sources now on the defensive, wind and solar power producers have a chance to seize an opportunity.

Narrower Margin

Chalk one up for Morgan Stanley’s chief executive, James P. Gorman. Persuading Mitsubishi UFJ to convert $7.8 billion of preferred stock into common shares early will save his bank almost $800 million a year in dividend payments and lift its common equity. It’s a smart and opportunistic move to offload the expensive capital that saved the Wall Street firm during in the 2008 crisis.

Of course, Morgan Stanley’s deal with its Japanese partner isn’t all good. Increasing the capital base makes it harder to reach a mid-teens return on equity, the bank’s target, especially after managing only about a 6 percent return in the first quarter. Not having to pay Mitsubishi dividends will make up only about half the extra earnings needed to post a 16.5 percent return with the extra capital — and to sustain it across the cycle.

That’s a distant prospect either way, even if Morgan Stanley is making progress. Its advisory and underwriting units are performing well and its trading operation posted its best quarter since the crisis. But there’s a long way to go. The pretax margin in wealth management, 10 percent, is slightly better than what it was for all of 2010, but it’s still half of Mr. Gorman’s target.

Even the beleaguered fixed-income trading unit looks better. Revenue more than doubled from the fourth quarter, after stripping out the effect of accounting rules on its own liabilities. But there’s still no tangible evidence that Morgan Stanley is making enough headway to improve its market share from 6.5 percent among the top nine players to the 8 percent the management wants to achieve within a year.

Mr. Gorman, who will be under growing pressure to improve the bank’s performance in his second year on the job, could decide to put some of the additional equity into trading in hopes of increasing returns. Or he could lobby the Federal Reserve to allow his firm to buy back some of the extra capital. Neither step is a sure thing. For now, the Mitsubishi deal leaves the chief executive’s recovery plan with less margin for error.


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Reuters Breakingviews: A Warner Merger With Potential

The less glamorous music publishing side still sets the pace for any deal. This income stream from songs played on the radio or performed live has been steady for Warner, with the division’s operating profit before depreciation and amortization declining a mere 6 percent in the fiscal year that ended in September 2010, compared with the fiscal year in 2008. The recording side, which includes the Atlantic and Warner labels, has suffered far worse over the same span, with those earnings tumbling nearly a third.

Potential buyers like Ron Burkle and Len Blavatnik may have reason for optimism about the business of discovering and developing rock stars. The increasing use of smartphones and the development of cloud-based song libraries are creating fresh hopes of reinvigorating the legal distribution of music.

But everyone is mainly eager for a merger of Warner and EMI. The first attempt at a deal was in 2000, when European watchdogs shot down the idea. But the business has changed substantially and Warner’s next owner is likely to try uniting the company with the industry’s overleveraged No. 4 player seized earlier this year from Guy Hands, the buyout baron, by its lender, Citigroup.

Not only could the best executives and musical acts be cherry-picked from the two firms, but nearly the whole merged recording unit could be run with just one side’s cost base.

The last time these two tried a merger in 2006, annual savings were estimated at some $300 million. Assuming that still holds true, the estimated $2.3 billion present value of these savings would go a long way toward paying for any deal.

Warner and EMI are each worth roughly $3 billion. Selling one of the two publishing businesses to sidestep regulatory questions would probably fetch at least $2 billion. Despite the industry’s troubles, new investors could still enjoy a good return.

An Untapped Mine


Facebook’s success may seem sui generis. But the social network’s disputed paternity and escalating value — $85 billion at last estimate — is creating a familiar commotion. People are claiming a share of Mark Zuckerberg’s creation. The story bears striking parallels with past bonanzas, especially Nevada’s silver rush 150 years ago.

The Comstock Lode was the Silicon Valley of its day. The market value of companies excavating its wealth was about $40 million by 1865, about half the value of the real estate and personal property in San Francisco at the time. That would equate to about $60 billion in today’s economy. The system that sprang up around the mines included engineers developing new technologies to extract silver from stone. Hundreds of companies were formed. A few captured nearly all the spoils.

Just as today, the combination of uncertain ownership and tremendous lucre invited controversy. The mining company Gould Curry, for example, attracted 15 lawsuits in one year. Such legal claims consumed an estimated 20 percent of the revenue generated by the Comstock Lode in its early years of operation.

The outcomes resemble Facebook’s travails. Early and important figures — Eduardo Saverin at Facebook or James Finney at Comstock — were celebrated as genial figures, but pushed out for a fraction of the eventual riches. And like the Winklevoss twins suing Facebook today, others who claimed to own Comstock Lode land but who didn’t do any heavy lifting were given a chunk of cash and told to go away.

Outsiders can’t tell whether today’s claimants are victims or opportunists. The latest is Paul Ceglia, a wood-pellet salesman charged with fraud last year, who says he bought half of Facebook in 2003. Some mine owners of yore took money from investors before telling them a rich shaft was worthless. Other plaintiffs submitted fabricated evidence against wealthy miners.

The parallels do have their limits. Mr. Zuckerberg isn’t like Henry Comstock, for whom the lode was named. Mr. Comstock finagled his way in, using $50 and a blind horse. Mr. Zuckerberg actually built Facebook. That’s significant. An untapped mine with rich silver deposits is worth a fortune. An undeveloped social network is just a good idea. — JEFFREY GOLDFARB and ROBERT CYRAN

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