Those who have followed the Dupont/Trian contest know that the shareholders voted (barely) to retain the incumbent board. But two other, fascinating pieces of information are apparent from the aftermath of that vote regarding the investors’ reaction:
1. The market was surprised
2. The market was disappointed
A seven percent drop in the stock price is huge. Shareholders were clearly invested, so to speak, in seeing Trian win, even as they voted them down. So, while shareholders-as-voters accepted CEO Ellen Kullman’s explanation that Nelson Peltz does not know as well as she what is best for their company, shareholders-as-traders said, “Whoa, that was a terrible decision!” We assume that, being the same people, each making their judgments based on their individual, independent estimation about the future prospects of the company, and with the “wisdom of crowds” sorting out their discordant judgments into a useful, single verdict, we should see less schizoid outcomes.
Alas, this “crowd” effect works via very different mechanisms in proxy voting versus in market pricing. So, which result should management heed? Read more of this article »
The SEC has released proposed rules for disclosing pay for performance, based on the Dodd-Frank law requiring that each company provide “information that shows the relationship between executive compensation actually paid and the financial performance of the issuer, taking into account any change in the value of the shares of stock and dividends of the issuer and any distributions.”
As my regular readers know, “pay for performance” can be usefully evaluated only when we have appropriate definitions of “pay” and “performance.” Appropriate definitions depend on one’s purpose for making the evaluation. Pay-for-performance can be either an exercise in costing, i.e., seeing if shareholders are getting what they are paying for, or for determining alignment, i.e., seeing if management rewards are consistent with shareholder value creation. These can be different analyses, with the same underlying figures yielding very different conclusions.
Read more of this article »
If you are a corporate director, you might not know that executive compensation at your company is now being evaluated, in part, based on your economic profit (EP). The people doing these evaluations are any of the over 300,000 security analysts with access to the new Bloomberg Pay Index, a daily ranking of executive pay for performance (discussed here by Bloomberg’s Laura Marcinek), This index provides a compensation efficiency score based on the ratio of total pay against EP. For instance, Tim Cook—highlighted by Bloomberg as the best CEO bargain—had 2014 pay of $65 million, which was just 0.2 percent of Apple’s three-year average EP.
Two things stand out about this index. First, these data are directly available to the analysts—many of whom are skeptical of the quality of current proxy advisor recommendations—without the intermediation of their governance groups that may be advising them on their proxies. So, this index is likely to have some impact on proxy voting.
Secondly, this index will underlie an increasing number of media reports on compensation governance. It is already behind a stream of articles commenting on pay for specific executives.
What is truly revolutionary about this index is the EP performance metric Bloomberg uses in determining pay for performance. This use of EP represents a breakthrough for three reasons: Read more of this article »
Uh, there are no jelly beans in this jar?
James Surowiecki, author of the bestselling “Wisdom of Crowds,” recently penned an article in the New Yorker called Why CEO Pay Reform Failed, regarding the Dodd-Frank mandated “Say-on-Pay” rule.
He correctly notes that Say-on-Pay has, against the hope of its proponents, done “approximately zero” to stop the rise in CEO pay, and that shareholders have almost universally endorsed these pay levels with overwhelming support. He offers some reasons:
“Why have the reforms been so ineffective? Simply put, they targeted the wrong things. People are justifiably indignant about cronyism and corruption in the executive suite, but these aren’t the main reasons that C.E.O. pay has soared. If they were, leaving salary decisions up to independent directors or shareholders would have made a greater difference. As it is, studies find that when companies hire outside C.E.O.s—people who have no relationship with the board—they get paid more than inside hires and more than their predecessors, too. Four years of say-on-pay have shown us that ordinary shareholders are pretty much as generous as boards are. And even companies with a single controlling shareholder, who ought to be able to dictate terms, don’t seem to pay their C.E.O.s any less than other companies.”
In other words, the very things that people are “justifiably indignant about” appear, in fact, to not be justified. But he is writing in the New Yorker where indignation about CEO pay is a matter of religion, so Surowiecki has to find something, anything, to justify it. He concludes that:
(a) Boards of directors are deluded in thinking they can actually distinguish CEO talent, and are thus irrationally paying more for talent they cannot discern, and
(b) Investors have been hoodwinked by an “ideology” that CEO talent is rare, and that higher rewards can lead to better CEOs. (In other words, maybe certain crowds aren’t that smart.)
If this seems like more than a bit of reaching, consider his sources. Read more of this article »
Regulators are saying that they may want some of that fiduciary attention that boards currently, presumably owe exclusively to their shareholders. Last year, Fed Governor Daniel Tarullo broached the idea that bank boards should perhaps account for regulatory as well as shareholder interests in their governance to address the divergence between firm-level and “macro-prudential” needs. Tarullo suggested that this division of loyalty might supplement, if not somewhat obviate the need for, the other two approaches that the government has tried, i.e., increasingly constrained incentive plan structures and increasingly detailed banking regulations.
The incentive problem has been well covered here and here, as has the downsides of proposed regulatory remedies. Dodd-Frank includes a plethora of direct regulatory constraints to moderate the risk appetite of banks, among other things. Of course, that grand legislation failed to address TBTF or the GSEs with which the big banks competed, and—surprise!—a general feeling persists that regulation may not be enough.
One the one hand, we should have expected that conclusion long before Dodd-Frank was even passed. Contrary to the prevailing narrative, banks were working under a heap of government regulations in the run-up to 2008. Those regulations may have been the wrong ones, or they may have been poorly administered, but they undoubtedly contributed to market distortions that made ‘up’ look like ‘down’ in many derivatives transactions.
Rationalizing the regulations, and accounting for the complexity that they create (and their secondary effects), would have been a good start to improving bank governance. Instead we have greater regulatory complexity than ever, which means we have more potential distortions and perverse incentives built into our financial system than ever before. Given this reality, perhaps it makes sense to throw in the towel on trying to contain the externalities of our banking system via sensible regulation, and just tell the board of directors that they must begin to internalize those potential costs by accounting for regulatory interests alongside (or perhaps ahead of) shareholder interests.
Unfortunately, that approach has yet to work well in any other industry in which it has been tried. Instead, history suggests that regulatory cures beget regulation-induced problems, which beget more regulation, etc., until the whole sector becomes in essence, if not in fact, nationalized. This state of affairs continues, often for decades, until the manifest defects of this nationalization become obvious to everyone, and the sector gets substantially deregulated. And everything is better.
Until problems crop up again, and politicians feel compelled to do “something…anything.”
Ethical Systems (ethicalsystems.org) is featuring me, the least distinguished of its collaborators, this month on their site.
Corporate Social Responsibility has become a hot topic. You can hardly talk about corporate governance these days without touching on it. In some areas, you might as well assume that CSR is in the background of every conversation about governance.
Being a history buff, I began to notice that a lot of “what corporations should be doing” sounded a little like reinventing the wheel. Corporations have, in fact, tried many things over the two centuries since they have risen to prominence. Not all of them have been run by greedy, rapacious bastards. Many of them, in fact, have been run by far-sighted, generous spirits intent on doing good while doing well. I thought that it might be worthwhile to review some of the boldest experiments in business history to see if we could learn any lessons from them.
Here are some early conclusions I have come up with.
Americans seemed, at least for now, to have reached their saturation point on direct wealth redistribution. So for those who still feel we have more redistribution to do, they are trying via the tax code. A Democratic congressman has proposed to penalize executive pay if the company “fails [the] test of pay fairness.” Specifically, if a public company fails to raise the average pay of its workers making less than $115,000 by a percentage equal to the overall US growth in productivity plus inflation, the government will eliminate the deductibility of top executive compensation above $1 million. What could go wrong?
Well, let’s look at a brief history of attempts to use the tax code as a vehicle for social engineering.
We begin with the tax on “golden parachute” payments in 1986. Executives being ousted in takeovers got big payouts, while many of the workers left behind got laid off. Very unfair. So the government imposed an excise tax on those “parachute payments” when they became “excessive.” They felt that such a tax would either limit the compensation or limit the deleterious M&A activity. How did that work? Employment agreements began to proliferate for executives stipulating that shareholders pay the excise tax should it be triggered. There were good business reasons for doing this. Given that this tax reimbursement was itself taxable, and the shareholders would be on the hook for that, too, the tax policy basically transferred a chunk of change from corporate treasuries to the U.S. Treasury. It didn’t affect the M&A activity. And it left overall compensation largely untouched.
Read more of this article »
Having been buried in client commitments and research has required me to update our software to enable me to post more efficiently. With that behind us, I am ready to move forward with commentary on governance. I will continue to focus on compensation governance, but will also branch out in what I will be referring as “Level 3 research” and application of mechanism design theory to governance beyond public corporations.
Yesterday, Coca Cola caved in to the bad press regarding the equity plan they proposed last April–and passed by nearly 90 percent of voted shares–by altering their equity award guidelines. It’s fun to speculate about the various forces arrayed for or against the Coke equity plan, and what Warren Buffet thinks, and how the press has reported the issues at stake. But I’ll sidestep all the juicy speculation and bright fireworks and go straight to the only thing that matters, or ought to matter, to shareholders: Is the new Coke policy better than the old Coke policy?
Let’s start with the policy change itself, which has three parts:
1. Coke will be providing more transparency about the rate at which equity is being awarded (burn rate, dilution, and overhang)
2. Coke will be using equity more sparingly in “long-term plan” awards, instead favoring cash
3. Coke will be awarding far fewer options from their equity pool than before relative to performance-based stock
The effect of the latter two policies will be to significantly reduce the number of shares used to compensate management. What they are NOT changing is just as important as what they are changing.
– They are not changing the target value of “long-term plan” awards to management. If an executive had a $1 million target long-term award, they will continue to have a $1 million long-term award; it will simply be paid more in cash than in equity.
– They are not changing eligibility for awards. They continue to believe that equity awards should be broad-based within the company.
So, what have the shareholders gotten out of these changes? Well, management and the board will finally be able to step out of an unwanted limelight over pay. Shareholders benefit from managers and directors being able to focus on business with one less distraction. As for the economic benefits to the shareholders, that’s pretty easy to estimate, too: Nothing. Read more of this article »