Ownership and Compensation Conflated: The Case of Bill Gates and Paul Allen at Microsoft

Paul Allen claims in his memoir that Bill Gates tried on more than one occasion to reduce Allen’s relative ownership interest in Microsoft. Of course, the veracity of Allen’s explanation can be questioned even if the ownership changes in percentage terms are a matter of public record. Whereas The Wall Street Journal focused on Allen's credibility in making his claim, I see a case study on the difference between ownership and compensation for labor.

Allen claims in his book that in the mid-1970's, when he and Bill Gates were two college dropouts based in New Mexico, Gates asked for 60% of their partnership because of his greater contributions to the creation of software for running the BASIC programming language on an early PC, the MITS Altair 8800. Allen insists he had assumed that the partnership was evenly split, but he agreed Gates' request anyway. Several years later when the two men established Microsoft as a formal partnership, Gates asked to change their respective shares in the business to a 64-36 split, a demand to which Allen again agreed. However, in the early 1980s, Gates rebuffed Allen after he asked for an increase in his own Microsoft shares because of his work on a successful Microsoft product called SoftCard. Allen writes that he was deeply disappointed in Gates’ response; after all, the two men had known each other since they were students at a prestigious private school in Seattle. "In that moment, something died for me," Allen writes in his memoir. "I'd thought that our partnership was based on fairness, but now I saw that Bill's self-interest overrode all other considerations. My partner was out to grab as much of the pie as possible and hold on to it, and that was something I could not accept." Allen recounts that he sucked it up and thought, "OK…but one day I'm out of here."[1]  Gates had put money above not only friendship, but also a stable, enduring partnership. 

In 1982, Allen eavesdropped on a discussion between Bill Gates and Steve Ballmer, who would go on to become the company's CEO, in the Microsoft offices in Bellevue, Washington. Allen claims in his memoir that he heard the two men talking about his recent lack of productivity and how they might dilute his equity in the company by issuing options to themselves and other shareholders. Allen said he burst into the room and confronted the two men, both of whom later apologized to him and backed down from their plan. "I had helped start the company and was still an active member of management, though limited by my illness, and now my partner and my colleague were scheming to rip me off. . . . It was mercenary opportunism, plain and simple."[2] To be sure, Allen admits that his work was limited by an illness. Gates's attempts to lower Allen's stake in the company reflected Gates' concerns that Allen wasn't working hard enough and wasn't committed to the company, say people familiar with the relationship.[3] That was one reason, those people say, why Gates had put a provision in the first partnership agreement that would allow him to buy out Allen if Gates thought there were irreconcilable differences. In his memoir, Allen refers to the provision but does not include a reason for it, or why it was not mutual. 

The link between productivity or work accomplished and ownership stake may, however, not sufficiently distinguish between compensation and ownership. To be sure, additional ownership shares can be part of a compensation package, but Gates sought to change the founding ownership agreement by reducing his partner's share of ownership, which attends to founding the company. In other words, Gates should arguably have gone after Allen's salary and additional stock options, for those are more oriented to the quality of work and productivity. If a person owns a business, he still owns it if he performs badly for a year; of course, what he could take out as salary might be less than the prior year. 

1. Nick Wingfield and Robert Guth, "Microsoft Co-founder Hits Out at Gates," The Wall Street Journal, March 30, 2011.
2. Ibid.
3. Ibid.

Weening Businesses off Debt: A Difficult Recovery?

We might view the recovery from the financial crisis of 2008 as a systemic correction in which managers were weened off their reliance (i.e., addition) on debt. Of course, the key lies in holding to the correction rather than falling off the wagon. Perhaps there should be an AA for debt-ridden businesses.

The near credit-freeze that came to a head in September of 2008 meant that even in the ensuing recovery, managers at American companies would be hesitant to spend their companies’ cash reserves. $838 billion for S & P’s 500 Index in March, 2010, was up 26% from March, 2009. Accordingly, managers have been hesitant to hire. From late 2007 to late 2009, payroll employment dropped by nearly 8.4 million by July, 2010; only 11% of the lost jobs were regained.[1] 

Robert Gordon, an economist at Northwestern University, points to the shift in executive compensation more in the direction of stock options. This arrangement gives managers more incentive to cut costs more in recessions and hold off in hiring in recoveries so that profits might surge first. However, one could point to the mandatory delay stipulated in some executive’s options to buy stock as giving them an incentive to look to the longer term.  Lynn Reaser, another economist, points to the lack of available external credit even more than a year after the financial crisis of 2008. She argues that managers conserved cash because they couldn’t rely on outside financing. 

However, firms like Apple, Yahoo, and Google are debtless and doing very well, so I would question the premise that outside credit is something to be desired.  Managers betting on leverage typically allow their irrational exuberance to distort their debt-to-assets and debt-to-profit benchmarks. If managers have become more averse to debt, maintaining higher cash reserves is not a bad thing, even when little interest is made on the cash. Once the new level is achieved, then only replenishments would be needed, so the diminishment of a firm’s investing in equipment or new hires would be temporary—to build the reserves and then to keep them stocked.  Drawing on their firm’s cash reserves rather than asking a bank for a loan or selling bonds proffers more freedom and self-reliance—qualities that are valuable even though they are difficult to quantify.  

1. Robert J. Samuelson, “The Big Hiring-Freeze,” Newsweek (August 2, 2010), p. 26.