EBITDA-based executive compensation misaligns shareholder interests
Corporate compensation structures tied to EBITDA or revenue growth without return-on-capital hurdles often lead to poor capital allocation and value destruction.
The argument
The speaker argued that EBITDA ignores interest expense, taxes, and maintenance capital expenditures, allowing executives to pursue unprofitable growth. In contrast, companies like Cummins, Dollar General, and Olin align better with shareholders by utilizing return on invested capital (ROIC) or return on capital metrics.
The thesis, stress-tested
✓ What validates it
- ✓Proxy statement disclosures showing a shift toward multi-year ROIC metrics in portfolio holdings
- ✓Underperformance or capital-destructive acquisitions by companies utilizing pure EBITDA or revenue-growth targets
▸ Risks discussed
- ▸Investors must tolerate some degree of sub-optimal compensation alignment ('tasting a little vomit') if the underlying business is exceptionally strong
Hear it yourself
"But EBITDA, which is above all the lines, if you're motivated by EBITDA and revenue growth, I mean, you can put a whole bunch of business on the books and not have any of it make any money because if you've got a lot of interest expense and you're a capital intensive business and and you've got big maintenance CapEx, you may throw off a…"
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