Every public company splits into two groups with different stakes: shareholders own the company; executives run it day-to-day. Those two groups want similar things in theory. In practice, a CEO who gets paid a flat salary has almost no financial reason to care whether the stock goes up or down. So starting in the 1980s, boards started asking: what if we paid executives in stock? Give them a stake in the outcome. Make their interests and shareholders' interests the same. It was a clean, elegant idea. It also had consequences nobody fully anticipated.

Stock-based compensation comes in a few flavors — actual shares, stock options (the right to buy shares at a fixed price), and restricted stock units that vest over time. The logic is identical in each case: the executive only gets rich if the stock goes up. So they'll work to make the stock go up. Alignment achieved. The problem is that 'make the stock go up' and 'build a great company' are not the same instruction. They overlap a lot of the time. But not always.

This is the core side effect: stock-based pay aligns executives with the stock price, not with the company. Those are different things. A share buyback uses cash the company already has to purchase its own shares from the open market, reducing the number of shares outstanding. Fewer shares means each remaining share represents a bigger slice of the same pie — so the price rises. The company isn't more valuable. It just looks more valuable per share. For an executive with options vesting this quarter, that distinction barely registers. For a long-term investor, or an employee, or a supplier depending on the company's health in ten years, it matters enormously.

There's a second side effect that gets less attention: volatility. When a large portion of an executive's net worth is tied to one stock, they have a powerful incentive to manage how that stock is perceived — not just how the company performs. That means careful timing of announcements, aggressive earnings guidance, occasionally aggressive accounting. Enron's executives were heavily compensated in stock. So were the executives at several banks that collapsed in 2008. The structure didn't cause the fraud directly. But it created a situation where a rising stock price was worth more to the people in charge than the underlying reality the stock was supposed to represent. That gap, when it closes, tends to close fast and badly. The CEO scenario from the opening — cutting R&D, laying off workers, buying back stock, pocketing $40 million — is legal. It happens regularly. Whether it's good management depends entirely on your time horizon and whose interests you think the company should serve.