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It’s been a bumpy week for Nintendo. On July 28th, after experiencing lackluster sales of their latest system–the 3DS, a portable gaming device with a 3D screen–Nintendo announced the company’s first ever quarterly loss and a unit price cut for the 3DS from $250 to $170. While the price cut comes as welcome news to gamers and Nintendo fans, the markets didn’t take it quite so well. After this announcement, Nintendo’s stock opened down 4.4% in the US (the stock had closed at 22.17 on July 27th and opened on the 28th at 21.20). Moreover, where the S&P stayed fairly level throughout the day, Nintendo’s stock continued to drop, eventually closing at 19.45 on July 28th, down more than 12% from the prior day’s close.

On July 29th, Nintendo’s CEO, Satoru Iwata, announced a series of management pay cuts, including a 50% cut to his own salary. The move seems to have been an attempt to halt the stock’s decline. And it worked. While the S&P opened down on July 29th, Nintendo opened up about 1.5% at 19.75.

Source: Yahoo Finance Interactive Charts

In many ways, the voluntary salary cuts are a form of bonding, a way to demonstrate the management’s commitment to the shareholders. Nintendo’s management, by decreasing their guaranteed salary, have increased their incentive to boost the company’s performance and thus their own bonus potential. That being said, it seems the Nintendo executive salaries weren’t exactly overblown by today’s standards; Iwata himself earned only an estimated $770k in base salary in 2010 (the average base salary of a S&P500 CEO in 2011 is approximately $1.1 million).

The stock’s decline might also have been arrested in part by Iwata’s more complete explanation around the decision to reduce the price of the 3DS. A price cut may spur sales of the portable gaming device. Increases in sales would help the company achieve scale efficiencies. In other words, the more Nintendo sells, the cheaper it will be to make each 3DS. But it’s anyone’s guess whether the 3DS will sell at this lower price point. The device has increasing competition from the substitute market of high-end smart phones, which are relatively cheap for consumers due to subsidies from wireless phone companies. Nintendo also talked about the need to increase 3D games available for the system, which would certainly increase the appeal of the system.

For me, the real surprise in all this is that Iwata and the rest of the Nintendo management bothered to reduce their salaries. The move makes a good show and does seem to demonstrate a commitment to the shareholders. But if the management were really committed to the shareholders, they should find a good way to use their huge cash reserves. The company currently holds over $13 billion in cash, which is more than half the company’s total market cap. As it is, the cash reserves give Nintendo management a lot of “breathing room” to make mistakes, like with the 3DS. The excess cash also depresses the stock’s rate of return. If management wanted to demonstrate their commitment to the shareholders, they could have kept their salary and either paid out their free cashflow (the cash they don’t need to fund operations and planned future investments) in a large one time dividend or announced sound future investments for the cash reserves.

Don’t get me wrong. I think the voluntary salary cuts are a good bonding device. It sends a powerful message to the shareholders. The message just isn’t as powerful as figuring out what to do with the cash reserves.

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