caved in to the bad press<\/a> regarding the equity plan they proposed last April–and passed by nearly 90 percent of voted shares–by altering their equity award guidelines.\u00a0 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.\u00a0 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:\u00a0 Is the new Coke policy better than the old Coke policy?<\/p>\nLet’s start with the policy change itself, which has three parts:<\/p>\n
1.\u00a0 Coke will be providing more transparency about the rate at which equity is being awarded (burn rate, dilution, and overhang)<\/p>\n
2.\u00a0 Coke will be using equity more sparingly in “long-term plan” awards, instead favoring cash<\/p>\n
3.\u00a0 Coke will be awarding far fewer options from their equity pool than before relative to performance-based stock<\/p>\n
The effect of the latter two policies will be to significantly reduce the number of shares used to compensate management.\u00a0 What they are NOT changing is just as important as what they are changing.<\/p>\n
–\u00a0 They are not changing the target value of “long-term plan” awards to management.\u00a0 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.<\/p>\n
–\u00a0 They are not changing eligibility for awards.\u00a0 They continue to believe that equity awards should be broad-based within the company.<\/p>\n
So, what have the shareholders gotten out of these changes?\u00a0 Well, management and the board will finally be able to step out of an unwanted limelight over pay.\u00a0 Shareholders benefit from managers and directors being able to focus on business with one less distraction.\u00a0 As for the economic benefits to the shareholders, that’s pretty easy to estimate, too:\u00a0 Nothing.\u00a0 The change in policy yields no economic benefits because, at the end of the day, there were no changes to the expected value of future awards to management.<\/p>\n
To understand how little difference there is between the new and old Coke policies, consider something Warren Buffet, Coke’s largest shareholder, once said.\u00a0 Let’s call it the Original Buffet Rule:\u00a0 The goal of any company should be to get back more than $1 for every dollar it spends.\u00a0 That rule should presumably hold for compensation expense.\u00a0 And it should hold whether they are paying $1 or $1 million.<\/p>\n
So,\u00a0 let’s say that the board decides that they want to pay an executive $1 million.\u00a0 Using the Original Buffet Rule, shareholders can question whether this person is worth $1 million dollars, or whether their achievement is worth $1 million, or whether any agreement or plan that resulted in this $1 million payout was a good one.\u00a0 These are all legitimate economic concerns.\u00a0 If they can’t get past these concerns, and they decide that $1 million is too much, then it doesn’t matter what pay instrument would be used to award that amount, e.g., whether it is awarded in cash or stock or stock options.\u00a0 If it’s too much, it’s too much.\u00a0 Only if it is not<\/em> too much does it make sense to the talk about the award instrument.<\/p>\nNow, some of the plan’s critics, including Mr. Buffet, were in fact concerned about what Coke’s equity plan implied about the future total pay of its management.\u00a0 I think that’s what Buffet meant when he called the plan “excessive.”\u00a0 But, in the end, that is not the issue that the Coke board addressed and, therefore, presumably, not the issue that most concerned the investors that Coke’s board made such point of hearing out.\u00a0 Instead, these investors seemed to be concerned that future equity awards would simply create too much dilution.<\/p>\n
What difference should that make?\u00a0 Suppose that shareholders agree that $1 million is the right amount to pay to an executive.\u00a0 If so, then we can move on to the question of instrument; do we pay it cash, or in equity, or some mix of the two?\u00a0 What would be the relevant considerations in such a decision?\u00a0 They would include:<\/p>\n
–\u00a0 The company’s cash usage situation:\u00a0 Do they have enough cash?\u00a0 If they do, are they better off using cash for a compensation payment than for other purposes?<\/p>\n
–\u00a0 The company’s equity situation:\u00a0 Do they have enough shares in their account to make the award?\u00a0 If they don’t, would it be prudent (or possible) to buy back some shares in order to make that award?<\/p>\n
–\u00a0 Retention and alignment:\u00a0 Would the company prefer that the executive have some or all of that amount in restricted stock?\u00a0 Or in vested stock with holding restrictions?<\/p>\n
Note that if the company has plenty of cash and plenty of shares and no particular concern about the executive’s existing exposure to the stock price, then whether they pay in cash or equity makes not one bit of difference <\/em>from the shareholder’s perspective.<\/p>\nBut isn’t awarding shares all dilutive<\/strong>!<\/em>?\u00a0 Yes, it is.\u00a0 But so is paying out cash.\u00a0 Both types of awards dilute equity exactly the same; they just dilute it from different parts of the balance sheet.\u00a0 In other words, if you’re fine with the overall level<\/em> of the award, and the company is not strapped for cash or stock, then the instrument of compensation is of no economic consequence.\u00a0 Furthermore, if the company is not strapped for cash or stock, and you are not<\/em> fine with the level of the award, then the instrument of compensation is irrelevant.<\/p>\nIn other words, the net effect of Coke’s new equity policy is to provide more transparency about something that does not make any difference to the shareholders as long as Coke is a solvent company.\u00a0 The net effect of Coke’s commitment to reduce the number of shares being awarded, and especially options on those shares, is to artificially constrain the instruments available to the board in making awards and, potentially, to reduce the amount of alignment between Coke’s managers and shareholders.\u00a0 So, I have to take back the statement that this policy would have no economic effect.\u00a0 It may have a slightly negative economic effect.\u00a0 New Coke might be subtly worse than old Coke.\u00a0 Who knows how much a subtle difference can make?<\/p>\n
If one recognizes that, for a company as solvent as Coke, dilution per se<\/em> is an irrelevant conversation, then one might reasonably ask what all of the standards around dilution and burn rate and overhang have to do with shareholder value in your typical Fortune 500 company.\u00a0 That is a good question with a surprisingly easy answer, but I will leave that to another day.<\/p>\n","protected":false},"excerpt":{"rendered":"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.\u00a0 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 […]<\/p>\n","protected":false},"author":1,"featured_media":0,"comment_status":"open","ping_status":"open","sticky":false,"template":"","format":"standard","meta":{"footnotes":""},"categories":[5,27],"tags":[],"class_list":["post-3385","post","type-post","status-publish","format-standard","hentry","category-executive-compensation","category-governance"],"_links":{"self":[{"href":"http:\/\/hodakvalue.com\/blog\/wp-json\/wp\/v2\/posts\/3385","targetHints":{"allow":["GET"]}}],"collection":[{"href":"http:\/\/hodakvalue.com\/blog\/wp-json\/wp\/v2\/posts"}],"about":[{"href":"http:\/\/hodakvalue.com\/blog\/wp-json\/wp\/v2\/types\/post"}],"author":[{"embeddable":true,"href":"http:\/\/hodakvalue.com\/blog\/wp-json\/wp\/v2\/users\/1"}],"replies":[{"embeddable":true,"href":"http:\/\/hodakvalue.com\/blog\/wp-json\/wp\/v2\/comments?post=3385"}],"version-history":[{"count":6,"href":"http:\/\/hodakvalue.com\/blog\/wp-json\/wp\/v2\/posts\/3385\/revisions"}],"predecessor-version":[{"id":3387,"href":"http:\/\/hodakvalue.com\/blog\/wp-json\/wp\/v2\/posts\/3385\/revisions\/3387"}],"wp:attachment":[{"href":"http:\/\/hodakvalue.com\/blog\/wp-json\/wp\/v2\/media?parent=3385"}],"wp:term":[{"taxonomy":"category","embeddable":true,"href":"http:\/\/hodakvalue.com\/blog\/wp-json\/wp\/v2\/categories?post=3385"},{"taxonomy":"post_tag","embeddable":true,"href":"http:\/\/hodakvalue.com\/blog\/wp-json\/wp\/v2\/tags?post=3385"}],"curies":[{"name":"wp","href":"https:\/\/api.w.org\/{rel}","templated":true}]}}
![\"\"](\"http:\/\/dbr.ge\/wp-content\/uploads\/2013\/07\/Coke-Coca-Cola.jpg\" "\\"coke\\"")
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