Why did Charlie Munger support performance-based bonuses but oppose stock option incentives?

Why Does Munger Support "Performance-Based Bonuses" but Oppose "Stock Options"?

Hey, I've always been fascinated by investing and corporate governance, especially Charlie Munger's insights. As Warren Buffett's right-hand man, he's incredibly sharp and always views things through the lens of human nature. Today, let's discuss why he favors "performance-based bonuses" (bonuses tied to a company's actual results for executives) but isn't a fan of "stock options" (giving executives the right to buy company stock at a low price). I'll keep it simple and conversational, avoiding academic jargon.

First, Why Munger Likes Performance-Based Bonuses

Munger believes performance-based bonuses are great because they're directly linked to the company's real achievements. For instance, executives only get paid when the company genuinely makes money and profits grow. It's like running a small shop: you only give yourself a bonus when the shop actually turns a profit. This pushes executives to focus on real results—improving products, controlling costs, and long-term planning—instead of superficial tactics.

From his often-cited behavioral psychology perspective, this incentive avoids "decision-making biases." People tend to be lazy or short-sighted, but performance bonuses act like a constant reminder, nudging them toward the right decisions. Munger himself said a good incentive system should reward real value creation, not shortcuts. At Berkshire Hathaway, he implemented similar principles, resulting in executives acting like true owners, driving the company's long-term value to soar.

Why Munger Opposes Stock Options?

Stock options sound fancy—giving executives a chance to buy company stock cheaply and cash in big if the price rises. But Munger sees major flaws, primarily due to asymmetric risk: if the stock surges, executives win big; if it crashes, they lose nothing. It's like buying a lottery ticket—hit the jackpot and celebrate, lose and you're no worse off. This encourages short-term tricks, like manipulating earnings, massive stock buybacks, or hyping news to artificially inflate the stock price temporarily, allowing executives to cash out quickly. The result? The company's long-term health suffers, and shareholders (especially small investors) are left holding the bag.

Munger digs deeper with behavioral psychology: options amplify "cognitive biases." For example, "overconfidence"—executives think they're smart enough to control everything, often underestimating risks; and "anchoring effect"—they fixate on stock prices, ignoring the company's true intrinsic value. Munger cites cases like Enron, where option-based incentives led to disaster and the company's collapse. He sees options not as incentives but as "poison," turning executives into gamblers rather than responsible stewards.

To Sum It Up Simply

Munger's logic is pretty down-to-earth: incentives should be like fishing—use the right bait. Performance bonuses are solid bait, encouraging executives to "catch big fish" (long-term value); stock options are more like slot machines, addictive but unreliable. Ultimately, he aims to use good corporate governance to avoid pitfalls caused by human weaknesses. If you're an ordinary investor, next time you look at executive pay, think about Munger's view—don't just skim the surface; ask if it truly makes the company better.

I use these ideas in my own investing, and Munger's approach has helped me dodge many pitfalls. Do you have any specific examples you'd like to discuss?