Is anyone worth millions?

Posted by Marc Hodak on June 2, 2015 under Executive compensation, Governance, Revealed preference | Be the First to Comment

The unanticipated death of a public company top executive can often create an observable market reaction. Sometimes, this reaction is not flattering, as when the stock price jumps five to seven percent when a CEO dies because there was no other way for the shareholders to get rid of him.

On the other hand, you get examples of what happened when the market was hit with news that Ed Gilligan, American Express President and heir apparent to the CEO, passed away suddenly on Friday. Amex stock dropped about ten cents per share (after accounting for changes in the market overall)—a drop of about $100 million dollars. Which answers the question posed in this title: Yes, some people are clearly worth to their shareholders what they are being paid.

Ironically, this financial hit was the result of good governance. Amex did what it was supposed to do in clearly identifying a likely successor in case they should suddenly lose their CEO, as well as pave the way for his retirement. The value of clarity about successorship is supported by empirical evidence. So, in a sense, what Amex has lost in a worthy successor, besides whatever else Gilligan uniquely provided to the company, was simply giving back what they had previously gained from doing the right thing in establishing a clear heir to CEO Kenneth Chenault.

And now Chenault, who just lost a close colleague for whom he clearly had great affection, must once again groom another successor.

SEC proposes new rules on “pay for performance”

Posted by Marc Hodak on May 3, 2015 under Executive compensation, Governance, Pay for performance | Be the First to Comment

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.

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Your EP is now followed by over 300,000 analysts

Posted by Marc Hodak on April 26, 2015 under Executive compensation, Pay for performance | 2 Comments to Read


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 »

Why is Surowiecki now challenging the wisdom of crowds?

Posted by Marc Hodak on April 21, 2015 under Executive compensation, Reporting on pay | 4 Comments to Read

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 »

Squeezing the Balloon Once More, and Expecting a Different Outcome

Posted by Marc Hodak on January 23, 2015 under Executive compensation, Unintended consequences | 2 Comments to Read

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.

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Coca Cola’s Reduced Options

Posted by Marc Hodak on October 2, 2014 under Executive compensation, Governance | Read the First Comment

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 »

ISS vs. Nucor’s Ghost

Posted by Marc Hodak on August 5, 2014 under Executive compensation, Governance | Be the First to Comment

Just published in Directors & Boards.  The summary:

Nucor’s classic incentive plan contained three elements:

1)  A fixed share of profit growth…

2)  …without limit

3)  Annual grant of standard stock options

The company was enormously successful because of this plan.  It looks like everything that shareholders care about is imbedded in this plan.  Empirical evidence strongly supports these plan elements as being good for shareholders.

Yet none of them would pass muster with ISS today.

So, if you’re a director of a public company, and you know what reason and evidence suggest, and you had a choice between adopting a Nucor-style plan or hewing to ISS’s standards, what would you do?

Unfortunately, we know what they are doing, and that it is hurting the value of public companies.

The Last Refuge of Scoundrels

Posted by Marc Hodak on July 7, 2014 under Executive compensation, Politics | Be the First to Comment

It used to be said that patriotism was the last refuge of scoundrels.  Now that patriotism is being viewed with more irony than honor among a certain portion of Americans, I think the “last refuge” has become the bashing of “fat cats.”  My evidence is a recent spate of articles on how President Obama, who is polling rather poorly these days, is once again going after Wall Street bonuses.  There is no surer way to get heads nodding again when you speak.

I nod, too, but for a different reason.  I continue to be astounded by the idea that banks had been managing the well-understood “trader’s option” problem for decades, then suddenly lost the ability to do so in the mid-2000s, and crash goes the financial system.  This explanation simply doesn’t hold water.  Neither does the idea that bankers suddenly became “greedy” in the mid-2000s, and crash went the financial system.  No.  If one wishes to develop a cogent theory about “what went wrong,” one must identify distinguishing characteristics, not common, long-imbedded ones.

I can (and have) provided many reasons why the “bonus culture” of banks has been unfairly blamed for the financial crisis.  Fahlenbrach and Stulz ( provided the best empirical evidence that it didn’t.

Now, a new paper by legal scholars Whitehead and Sepe basically blames competition for talent as undermining proper incentives.  I salute them for at least acknowledging the competition for talent in banking.  Most critics of the banking system were feverishly trying to outdo each other in how firmly they would cap banker pay in arbitrary ways at arbitrary levels without regard to the competitive issues that such rules would create in order to “solve the problem” that they claimed was at the heart of the financial crisis.  The ensuing exodus of talent at large, public U.S. banks has been unbelievable.  (Literally–people outside of the industry don’t believe me when I tell them how bad it has been.  The more polemical critics simply roll their eyes and smugly say, “Yeah, the talent to blow up the economy. Good riddance.”)  Whitehead and Sepe acknowledge the competitiveness issue, but then go on to recommend arbitrary limits on how bankers may move from one firm to another.

If you believe that you have to compete for talent in financial services, including traders, and if you understand that different forms of pay offer different expected value to potential employees, then one can readily see that the only way to increase the risk and constraints of banker pay while acknowledging the need to compete for their talents would be to increase the expected value of that constrained, riskier pay package.  Partnerships do this all the time.  They create very risky, very constrained pay packages, and manage to lure incredible talent.  Hedge funds didn’t contribute to the financial crisis, and didn’t need to get bailed out.  And no one is suggesting that we need to limit how hedge fund employees move from one firm to another in order to moderate or contain risky behavior.  What makes this work is that hedge funds don’t have to disclose how much their successful people earn.

How little President Obama and his staff know about these issues may or may not shock you.   But he doesn’t have to know anything about the economics and dynamics of incentive compensation in the financial sector, or any sector.  He just has to know the math:  “Bashing Wall Street” = “Higher poll numbers.”

The hidden risk of “at-risk” pay

Posted by Marc Hodak on May 30, 2014 under Executive compensation, Governance | Read the First Comment

On Monday, Staples, Inc will try to win its “Say-on-Pay” vote with ISS recommending against approval the executive compensation plan.  ISS made its recommendation based on its usual arbitrary, micro-managing concerns which are not the subject of this post.  Here, I want to highlight the problem Staples created for itself, without anyone’s help, and unintentionally revealed in this pair of sentences:

The [Compensation] Committee … recognized the need to address retention of key talent and to continue to motivate associates in light of the fact that we did not pay any bonus under the Executive Officer Incentive Plan or Key Management Bonus Plan in 2013 and 2012.

As a result of the changes to the compensation program in 2013, an average of 84% of total target compensation (excluding the Reinvention Cash Award) for the NEOs was “at risk” based on performance results, and 100% of long term incentive compensation was contingent on results.

Anyone reading Staple’s proxy could be forgiven for thinking that these two sentences have nothing to do with each other, notwithstanding that they appear consecutively in this proxy.  It’s clear that neither the authors of this disclosure nor the board that approved it saw the connection, either.  But look carefully at what they are saying.

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The Growing Executive Compensation Advantage of Private Versus Public Companies

Posted by Marc Hodak on April 14, 2014 under Executive compensation, Governance | Be the First to Comment

Private companies have a natural governance advantage over public companies – one that stems mainly from the presence on their boards of their largest owners. This governance advantage is reflected in the greater effectiveness of private company executive pay plans in balancing the goals of management retention and incentive alignment against cost.

Private company investor‐directors are more likely to make these tradeoffs efficiently because they have both a much stronger interest in outcomes than public company directors and more company‐specific knowledge than public company investors. Furthermore, private company boards do not have to contend with the external scrutiny of CEO pay and the growing number of constraints on compensation that are now faced by the directors of public companies.

Such constraints focus almost entirely on one dimension of compensation governance – cost – in the belief that such constraints are required to limit the ability of directors to overpay their CEOs. In practice, any element of compensation can serve to improve retention or alignment, as well as being potentially costly to shareholders. Furthermore, any proscribed compensation element can be “worked around” by plan designers, provided the company is willing to deal with the complexity. For this reason, rules intended to deter excessive CEO pay are now effectively forcing even well‐intentioned public company boards to adopt suboptimal or overly complex compensation plans, while doing little to prevent “captured” boards from overpaying CEOs.

As a result, it is increasingly difficult for public companies to put in place the kinds of simple, powerful, and efficient incentive plans that are typically seen at private companies – plans that often feature bonuses funded by an uncapped share of profit growth, or upfront “mega‐grants” of stock options with service‐based vesting.

All of this is detailed in my newest article published in the Journal of Applied Corporate Finance.