Posted by Marc Hodak on June 2, 2008 under Executive compensation | 
In the latest issue of Directorship, Amy Borrus of the Council for Institutional Investors says,
Additional sunlight is chasing some perks away at some companies. That’s a good thing–perks are the polar opposite of pay-for-performance.
So is salary. Is CII advocating that CEOs be paid purely on variable compensation? That kind of runs counter to the oft-stated desire to bring down overall CEO pay. Surely, institutional investors can’t expect CEOs going all-variable to forego extra compensation for the extra risk they must bear. Their investment clients certainly would accept such a trade-off. Who would? The “it’s-not-pay-for-performance” critique of perks is too simplistic for an organization like CII.
There is only one good reason to cut perks: They look bad. It looks bad that a CEO who is making millions of dollars per year has the company paying $20,000 for a country club membership, or $15,000 for tax planning. It makes the CEO look grasping, when in fact these perks long preceded their accession from a time when they made perfect sense. It looks bad for the board because it makes them look like a bunch of stooges who can’t say “no” to the smallest thing.
The fact is that most boards can say no. They’re really not all incompetent or corrupt. They have been saying no for years. The fact is that these perks were generally good for the shareholders. They came about, admittedly in a more innocent age, because they represented tax-efficient ways to compensate their executives. If a board takes away $100,000 worth of perks that can legitimately be offered for business reasons, such as country club memberships (for business development), tax planning (to avoid personal financial issues, or fraud), or car and driver (for security), then the executive paying for those items with their own after-tax dollars would have to have their pay increased by about $200,000 to make them whole, especially if the board expected the CEO to retain many of these services.
But, since perks look bad, boards take them away, executives largely replace them at their own expense, and shareholders pick up the tab anyway, except twice over.
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Posted by Marc Hodak on May 15, 2008 under Executive compensation |
Should CEOs make a lot when their workers wages are rising only modestly, if at all?
Let’s say that you’re CEO of an electronics company. You have always gotten those electrical components from a domestic supplier that is a government-protected monopoly. One day, you cleverly figure out how to sidestep that monopoly by sourcing from abroad. Your company saves a lot of money, and profits go up. The shareholders would like to reward, not punish this behavior. That’s how markets work.
Now, as certain compensation critics would have it, you have injured the earnings of the domestic producer. Your pay should be proportionately lower, to reflect their reduced earnings. Make sense? I didn’t think so. But if you replace “government-protected monopoly supplier of materials” with “government-protected monopoly supplier of labor,” then you arrive at the same illogical endpoint; the wages of managers linked with the cost of inputs. That, of course, is a recipe for bleeding the firm with a managerial bias toward uncompetitively high labor costs.
Insisting on a linkage between CEO pay and the wages of their employees is what I’m calling the Wage Link fallacy. It’s based on a primciple that is central to communism: An Individual’s wages should be unconnected to their productivity. Most purveyors of the Wage Link Fallacy, besides outright communists, are unions and their fellow-traveling politicians, most recently including EU officials from yesterday’s FT.
Excessive pay awards for company executives came under fire yesterday from the European Union’s senior economic policymakers, who condemned them as “scandalous” at a time when ordinary employees are under pressure to accept modest wage deals.
Notice how pay is prejudged as “excessive” against the standard of wages of “ordinary employees.”
Those pressing the Wage Link Fallacy invariably are pushing for government to trump the verdict of the market in assigning a small portion of productivity gains to those who create them. They wish, instead, to punish the managers who create those gains, the domestic consumers who benefit from them, and the employees outside of the unions’ sphere of influence who help make them possible.
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Posted by Marc Hodak on under Executive compensation |
David Chun made a great find among an early filer this proxy season.
Many companies are under increasing pressure by the SEC to disclose specific metrics and targets. Issuers (companies) are resisting, claiming that their metrics and targets are confidential information, which disclosure might compromise their competitive position. This is often (but not always) a difficult proposition to defend, especially if your company is allegedly paying bonuses based on EPS targets and is already providing earnings guidance to the investor community.
Well, Equilar, David’s firm, turned up the proxy of AEP, where they provide an explicit EPS guidance range, and disclose how their senior executive bonuses are tied to that very same range. That seems pretty straightforward.
Unfortunately, when the SEC asked for more disclosure, they were thinking that all comp plans would be as simple as AEP’s. But tying senior executive bonuses only to EPS, while simple, is not necessarily optimal. Many companies have more involved bonus plans. Some of this complexity is functional and value-enhancing, some of it is simply obscurantism. Who is going to decide which is which? The SEC’s enforcement division? Developing.
Posted by Marc Hodak on April 30, 2008 under Executive compensation |
That was the headline of a WSJ article primarily about holders who don’t want more say. In fact, the three skeptics it cited are surprising to anyone who plays in the corporate governance world.
Charles Elson, chairman of the Weinberg Center for Corporate Governance at the University of Delaware, has rarely seen a governance reform he didn’t like. But in this case, he says that it isn’t the job of shareholders to tweak compensation plans; if you have a problem with the board’s work, go after the board, not their work. This attitude is similar to the attitude held by most people (including Elson) regarding the line of demarcation between the board and management; if the board doesn’t like what management is doing, it should reconsider the management, not get involved in the particulars of management policy.
Edward Durkin is Director of Corporate Affairs United Brotherhood of Carpenters. It’s not often that a union man is against anything that would make management’s job more uncomfortable, but Durkin says:
a simple “yes” or “no” vote on pay plans would lead to a “hollow” dialogue between investors and directors. The union manages 95 pension funds with around $40 billion invested in thousands of companies. Reviews of each of those proxies would necessarily be cursory, he says. In response, he would expect directors to standardize compensation packages, which could lead to less flexible and poorer pay plans.
Durkin prefers to target a smaller group of companies, gain an deeper understanding of what is really going on, and engage management in a discussion about their practices. In other words, he’s already fulfilling the promise of “Say on Pay” without the ham-fisted proxy fights or legislation that impose unnecessary costs on the shareholders. In fact research shows that management engagement by major shareholders is one of the few activist tactics that actually works in altering corporate governance for the better.
Finally, Peter Clapman questions the wisdom of “Say on Pay.” Nobody would accuse Clapman of being a tool of management; he is former governance chief at the giant fund manager TIAA-CREF, and a partner in U.K.-based investors’ group, Governance for Owners LLP.
The quality of a proposal is not, of course, to be judged by who lines up for or against it; it should be judged on the merits. It’s just nice to see some of the corporate governance mavens espousing a more thoughtful approach than the press headlines.
Posted by Marc Hodak on April 19, 2008 under Executive compensation |
That sounds like a silly argument, but it’s basically what the State of New York is telling a couple of HMOs. Here’s the line of argument:
Two of the largest HMOs are seeking approval for a merger, which would make them the largest HMO in the state. Each of CEOs had performance-based incentive plans last year–plans that put a significant amount of their pay at risk. It worked. Their firms performed well, and they doubled what they took home the year before.
“We are very concerned about HIP’s announcement that it has doubled the salaries of its top 10 executives at a time when the company has not been performing well,” a spokesman for the department, David Neustadt, wrote in an e-mail message. “As we consider its pending merger with GHI and conversion to a stock company, we will be asking the executives tough questions about this decision.”
So, in one statement, this state official makes three errors, two of fact and one of logic.
Fact #1, their salaries didn’t budge over the two years; what increased were their bonuses, which was pay they had at risk. Fact #2, against what standard had this HMO not performed well? Apparently against some standard that doesn’t account for revenue and profit, the two metrics upon which the bonus plans were based. In fact, the state offers no argument whatsoever that the incentive plans were not reasonably designed. (I personally don’t like rewarding managers for buying revenue, but I wouldn’t call that unreasonable.) They only object that these plans actually paid out more money to the top executives, and call it a “salary” increase.
Logically what does performance-based pay for the executives have to do with any rationale for approving or disapproving a merger? I’ll admit my eyesight isn’t as good as it used to be, but I don’t remember seeing “CEO pay” as a criterion in the antitrust statutes. In fact, the state offers no logic; they only promise to “ask tough questions,” once the cameras are in place.
It’s a shame that we can’t ask these tough questions of the State Inquisitors…er, state officials.
Posted by Marc Hodak on April 11, 2008 under Executive compensation |
Whenever I’m debating the merits of “Say on Pay” with an earnest advocate, they invariably contend that they are not against CEOs making a lot of money per se, they are only concerned that CEOs make it fairly. They contend that the current system unfairly rewards CEOs due to the laxity or corruption of directors who set their pay, and that giving investors some say over executive compensation will remedy that problem.
One can dispute both of those premises without attacking the motives of those in favor of “Say on Pay,” and I have done so here and here. But I have not been above attacking their true motives, too, here and here. Alas, nothing makes it easier to attack their motives than simply listening to the political supporters of “Say on Pay” on the campaign trail.
Obama, gunning for blue collar votes in Pennsylvania, has been highlighting his support for this regulation, saying that “CEOs make more in one day than their workers make in one year.” Politically speaking, it certainly makes more sense to attack the rich with a subtle conspiracy theory than to expect voters in middle America to digest the subtle governance issues actually being debated in this bill. Obama can conclude that if well-regarded Harvard academics are in favor of it, it’s safe to exploit his support for the bill by any means necessary.
“Say on Pay” proponents may contend that just because most of its supporters are appealing to envy, out of more concern with social issues than governance issues, it doesn’t mean that advocacy on the governance issues is inappropriate or insincere. True enough. But these same advocates generally hold the trump card of politics over rationality: even if there is no evidence that “Say on Pay” will actually help the shareholders, they will tell you, “If we don’t pass this, Congress will come up with something worse”–a veiled threat of substantive regulation of pay. Which is just saying that one should accept a poisoned slice instead of a poisoned loaf.
Thanks.
Posted by Marc Hodak on April 7, 2008 under Executive compensation |
Many CEOs over the years have reportedly turned down bonuses or otherwise requested that they get less cash than the Board approved in their pay packages. This act generally invites praise or cynicism of the CEO. As far as I’m concerned, once the board has awarded the money to the CEO, he or she can do whatever they want with it, including return it to the company, pass it along to their colleagues, or donate it to my kid’s education. However, I’m always left wondering about the governance of companies that have somehow accidentally paid their CEO too much.
Generally, the refusal to accept the full board-approved pay is associated with poor company performance. Foregoing pay is generally intended to be a sign that the CEO wishes to “share the pain” of cutbacks being felt by the workforce or declines suffered by the shareholders. This sacrifice is generally well received by the employees when it’s donated to a pool to be divided by employees. It’s often well-received by the shareholders when the CEO simply allows his bonus to revert to the corporate coffers. Sometimes, the CEO gives back cash, but gets more in equity, something the unions refer to as “bait and switch,” and what we at the HV Mechanism Design Center refer to as a poorly implemented incentive plan.
In fact, my problem with CEOs turning down pay has nothing to do with their motivations around what they or others feel they deserve. My reservations are about their boards’ competence in incentive design. A well designed bonus plan should never result in a situation where the CEO doesn’t feel his or her pay is undeserved. A well-functioning board should not find itself in a position to have its incentives ignored and returned. What impact did the incentives have if the CEO didn’t even take it?
A CEO dictating to the board to give them less than the board approved does not inspire confidence in me that the board is in control over one of the few things they should totally control. Whether the CEO does this out of a sense of guilt or showmanship or political correctness does little to salve that concern.
Posted by Marc Hodak on March 8, 2008 under Executive compensation |
Henry Waxman, Chairman of the House Oversight and Government Reform Committee, held hearings yesterday on executive compensation. The Wall Street Journal predicted:
It should make for good political theater. For added effect, Mr. Waxman has invited testimony from corporate-governance experts and Brenda Lawrence, the mayor of Southfield, Mich., a middle-class community that has been affected by the housing crisis.
(HT: Larry Ribstein)
Here are my qualms about Congress trying to substitute their judgment for that of directors on this issue:
1) Their analysis is post-hoc. The competition for talent in the executive suite is fierce–something Henry Waxman doesn’t really believe. The competition for returns in the corporate market is extremely fierce, something Henry Waxman doesn’t have a clue about. About ten percent of executives that were thought highly competent when they were hired will end up in the bottom ten percent of corporate returns, even on a sector-by-sector basis. “Why did the board pay these people so much money when they plainly were such poor CEOs?”
2) Even post-hoc, Congress is incapable of distinguishing perverse incentives from decent ones. It’s not that they’re stupid. I have quizzed institutional shareholders, securities analysts, corporate officers, even other compensation consultants on the incentive effects of certain compensation structures, and they often come to the wrong conclusion. “You mean that regular grants of restricted stock actually create an incentive to tank the stock price?” Could happen. I’m skeptical that our national Chamber of Unintended Consequences will come to the right conclusions.
3) I pity Compensation Committee members. Yea, there are a few who are careless, maybe even negligent. I’ve read about them, and can jump to conclusions as fast as any reader. And Nell is right that most compensation committee members don’t quite know what they’re doing in structuring packages, but that’s not their fault. We don’t generally hire incentive experts to the board, and their fiduciary responsibility demands that they apply incentive mechanisms to their packages, and incentives are tricky (see 2). Nevertheless, the directors I’ve personally worked with, to a man (or woman), have been highly conscientious and, if anything, wary of overpaying their CEO to the point of occasionally hurting their chances of retaining a very good person.
Personally, I believe that the answers to the ‘problem’ to exec comp are far more subtle than a congress-critter can manage.
Link here on “where does this committee the authority to investigate stuff like this?”
Posted by Marc Hodak on March 7, 2008 under Executive compensation |
Toll Brothers has somehow flushed a perfectly good bonus plan down the toilet.
Their old bonus plan gave the CEO a fixed 2.9 share of his company’s profit gains. There was no cap on the bonus, which presumably meant no cap on their performance. And their performance was good. In the good years, their CEO made big bucks. So did the shareholders, including the largest shareholder, the CEO.
The new bonus plan is based on undisclosed “varied” criteria. In my experience, this is pretty close to saying “discretionary.” Mr. Toll also continues to get 2 percent of the profit, so there is now marginally less emphasis on profitability, and more on other “varied” stuff. And his new plan is capped at $25 million. Two things puzzle me about this cap: it’s arbitrarily high, so it won’t likely be a practical limit, and it still manages to convey that we will cap performance when the wind is really to our back. This is almost the perfect way to convey the message that we will provide a token sop to our investors that doesn’t really help them.
What I don’t get is why Mr. Toll would go to the trouble of undermining a perfectly good bonus system for a few million more dollars. The man owns 29 million shares. It’s not like this extra $6 million he would have earned under the new plan would make up for the nearly $300 million he lost as a shareholder from the decline in his stock price. He can make this bonus amount with a one percent increase in his stock price.
Then, KB Homes, with the same, nearly flawless bonus plan, objective and profit-based, decides to override the market’s short-term verdict with a “discretionary” bonus of $6 million (coincidence?). Their explanation?
Otherwise he wouldn’t have received KB’s standard “annual incentive” for the top job, which is tied to profits under the builder’s current plan.
“Standard annual incentive?” What the hell is that? The bonus amount you get paid for not earning your bonus?
“This is the kind of stuff that makes us crazy,” says Richard Metcalf, director of public affairs at the Laborers International Union of North America, whose pension funds own stakes in both Toll and KB. “What kind of board of directors gives a $6 million bonus when the company’s stock falls 60%?”
It drives me crazy too. And it’s the kind of thing that invites Henry Waxman to pull CEOs into his Star Chamber, and the IRS to do stuff like this.
Posted by Marc Hodak on February 14, 2008 under Executive compensation |
The Comcast board has decided to cut founder Ralph Roberts’s salary to $1 per year, make him ineligible for bonuses, annual equity grants, as well as certain death benefits that would have accrued to his wife or estate. These changes follow a loss of about a third of the value of the company’s shares in the last year. As a result of that slide, Comcast has been under severe criticism from major shareholders. Besides concern about the founder’s pay, certain large shareholders have generally been critical of management’s apparent lack of focus on value creation, and have asked for more of the cash being returned to shareholders. So, along with the cuts in pay, the company responded yesterday with 25 cent per share dividend, and a commitment to buy back $7 billion of shares by 2009.
All this is evidence that, while the happiness of shareholders is proportional to a rise in share price, the power of outside shareholders increases with a decline in value. In other words, major shareholders seem to live with a balance of happiness or power, depending on the company’s fortunes. When performance falters, just about any board can put enough pressure on a controlling family to make significant strategic changes, and even rein in their compensation. Unfortunately, when things are going well, it’s easy for a controlling family to layer on additional compensation, and the Roberts family took advantage of that. No one I know has found a way around this dynamic.
So, when the company was riding high in prior years, the Roberts family accumulated beneficial ownership of millions of additional shares, including those that were part of about $50 million in compensation for 2006. The family now owns or controls nearly 40 million shares, not counting a couple million more unvested, underwater options. What that means now, however, is that the $1.50 increase that followed yesterday’s changes were worth about $60 million to them. So, in 24 hours the Roberts were able to increase their wealth with some shareholder-friendly moves by more than their total compensation from the firm for all of last year. Now, if they can recover what they had lost from their peak last year, they could make an additional half billion dollars.
For now, this family is completely on the shareholder’s side. The time to watch them again will be when the company makes a spectacular recovery, and management again becomes untouchable.
