‘Say on Pay’ vote destroys $500MM+ in shareholder value

Posted by Marc Hodak on May 9, 2012 under Executive compensation, Reporting on pay | 3 Comments to Read

It had to happen.  At some point, the CEO pay critics second-guessing the board of directors would lead a CEO to say “Screw it,” and leave the shareholders to deal with the aftermath.

Yesterday, Aviva’s shareholders, saw the departure of Andrew Moss, their CEO, after his pay package was voted down.  While it’s difficult to interpret any given Say on Pay vote, it’s a fair assumption that these votes respond to headline news about a company.  In the case of Aviva, the headline appeared to be “Insurer performing badly; CEO pay goes up.”  So, here is what the shareholders have wrought:

1.  While the stock price jumped on news of Moss’s departure, it quickly came back down to earth, then continued sinking as the realization set in of who they might get to succeed him.  The stock price is now six percent below where it started just before Moss’s announcement.

You can assume that the board didn’t know what Moss’s value was relative to their next best choice for leader, but my dealings with boards indicates that the opposite is more likely the case.  Aviva’s board was as disappointed as their investors with the company’s performance since July 2007, when Moss took over, but so is the board of every other insurer with a Europe-centric business.  Their choice wasn’t between Mr. Moss and the person who would make the company perform like those that didn’t have Aviva’s imbedded assets and market positioning.  Their choice was between Mr. Moss leading the company or someone else leading exactly the same company.  The fact that the board paid Mr. Moss his bonuses instead of sacking him indicates that they though he was the best leader they could get at this time.  The drop suffered by the stock as the market surveys the landscape for his potential successor indicates that the board may have been right.

2.  By the way, the stock drop has cost Aviva’s shareholders over $500 million, even accounting for the general slump in the market over the last couple of days.  The shareholder’s putative complaint was that the board had agreed to pay Mr. Moss a $1.86 million bonus, on top of his $1.55 million salary.  So, it appears that the shareholders, in their trading capacity, have penalized the company with a half billion dollar CEO changeover cost because they believed, in their proxy voting capacity, that two million dollars was too much to pay their CEO in a bonus.

3.  Part of the shareholder’s concerns, again based on an inference from headlines, is that they didn’t like the fact that Moss’s bonus was based on financial and operations metrics that didn’t include the stock price.  These metrics were presumably chosen on the basis that they should lead to a higher stock price, but might not if there is a secular decline in the industry, as happened with Euro-centric insurers.

Boards can never win on this one.  They must choose whether they will pay their managers for being in the same boat as shareholders, or for being good managers of what they’ve got (with some allowance for the fact that they can alter the composition of the assets they manage).  Paying them to be in the same boat as shareholders, i.e., by accounting for the stock price, means risking paying them well just because their sector takes off, regardless of how well they actually managed the company.  Paying them for being good managers, i.e., by focusing on financial and operational metrics particular to the company, risks paying them for doing as well as any managers in their position could do, given what they had, even if the stock price goes down due to a sector decline.

There is no perfect answer to this dilemma.  Boards deal with this all the time, some admittedly better than others.  But if shareholders think they can make these decisions better than their boards, then we are in for more stock price disappointments, not less.

4.  By the way, it’s not as if Mr. Moss was well-shielded from Aviva’s shareholder value.  Much of his personal wealth was likely tied up in the company’s stock price, given his respectable stock grants since July 2007, some of which he will forfeit as a result of his departure.  In other words, the nominal, governance concern that Mr. Moss was not properly aligned with the shareholders is almost certainly, egregiously wrong.  Few individuals on this earth probably had a greater interest in Aviva’s stock market success than Mr. Moss.

In a perfect world, the stock price would reflect management’s actual, comparative performance.  In a perfect world the pay of the executive would reflect this marginal contribution to the firm’s value.  In a perfect world, the metrics that a board uses to try to gauge this marginal contribution would actually do so.  (Most boards are, unfortunately, rather poor at this task, but it’s not clear that non-board members are any better at it.)

But in this world, economic considerations about pay and performance have barely begun to be understood by the public, the governance critics, and even by institutional shareholders.  I would dare say that even some boards are still a bit confused by it.  But today, the public appears to be buying the media narrative of a “shareholder spring,” calling the best efforts of seriously awakened boards a pay racket, with breathless prose that “greater shareholder activism will be good for stocks and the wider economy.”

Look me up in a few years, and I will be able to explain why stocks and the wider economy are no better off, and why public company CEO pay has continued its climb, anyway.