Saturday, May 2, 2009

WSJ: CEOs Need to Bring Investors Along for the Ride

This is one of my favorite subjects since the perverse short term incentives in public markets have disrupted the apple cart to such a degree - yet for 98% of companies it just continues to be business as usual. The completely broken Board of Directors system is another thorn in the side of any real resolutions and I have little confidence that it will ever change - every time we have a crisis, a lot of hen clucking goes on for a few quarters - then lobbyists begin to pull back on previous legislation that might be passed over the ensuing years... and we end up right where we started. Defenders of the system send out the "sell your stock if you are unhappy" old line, knowing the vast majority of shares are held by institutional accounts who have zero advocacy. Rinse. Wash. Insert Crisis. Repeat. Already you can hear the sharp pencils of compensation consultants trying to find ways around any limitations that might be pursued. I have to write an entry on the latest from Chesapeake's Aubrey McClendon (some awesome new details have come out in SEC filings) [Apr 3, 2009: Chesapeake Energy CEO Aubrey McClendon with New Shady Compensation Deal] but it's systematic - not any 1 company or industry.

I know, I know - if chieftans are not paid 300x (more) what the peasants who work for them, they will leave to go to another country to work for.... 22x the median. And only a select few humans on Earth could run two companies into the ground like Bob Nardelli (Home Depot / Chrysler) - or return on average -5% to -10%+ annually like many other companies have done this decade. I get it, it's a select skill set and it's an outrage my socialist take of rational equitable outcomes even hits the internets. I apologize in advance for the heresy - heads we win, tails we win [Sep 27, 2008: Heads We Win, Tails We Win] is indeed the correct course of action to put shareholders interests in line with the chiefs at the top.

Jeez, even the Wall Street Journal's Jason Zweig is talking heresy now. Don't worry Jason, the CEOs (and their top 3-4 confidants at the top of these reverse Robin Hood organizations) know they just have to keep their mouths zipped, stay low for the next 18 months and then when their stocks rebound to some degree, we can begin the "we are all in this together" chant - i.e. when your Etrade account goes up $8,000 and my compensation goes back to $18 million (with perks) - we all win together. Main Street = Wall Street... say it. Say it. Say it! :) Now where's my $87,000 rug so I can lounge Zenlike with legs crossed as I think this through further? [Jan 22, 2009: Merrill Lynch's John Thain Can Only Work on $87,000 Area Rugs]
  • From 2006 through 2008 (3 years), the 10 largest financial companies in the U.S. awarded their chief executives a cumulative total of more than $560 million in cash, stock and options. Those firms -- some of which are no longer among the 10 biggest -- have lost a total of nearly $1 trillion in market value since the end of 2006. (heads we win, tails we win - the shareholders interests are aligned with those at the top - long term value is being created - if we don't pay our CEOs this level they will leave and destroy other companies: keep repeating the dogma folks)
  • ... But it's hard to argue they deserved it all; something is dangerously wrong with a system that showers riches upon good and bad leaders alike. (not sure how much longer Zweig will be keeping his post at WSJ with talk like this)
Let's see how smaller companies, who still create very nice wealth for their top honchos but at least have some sense to their compensation structure do it...
  • Now consider Alleghany Corp. The small, New York-based insurance holding company hasn't awarded stock options to managers in decades, doesn't measure its performance against a peer group when calculating incentive pay and reserves the right to claw back bonuses if results are later revised downward. (shocking. How do they even keep a CEO with rules like that? Certainly they must have CEO turnover of immense proportion, since these rules are unfair)
  • Alleghany's proxy statement reports that the CEO, Weston Hicks, has earned (although not necessarily received) $28 million since 2005. That hardly puts him in the poorhouse. But his shareholders are unlikely to complain. From 2005 through 2008, Alleghany gained an annual average of 1.7%, while the Dow Jones U.S. Property & Casualty index lost 2.7% per year. (notice the "not necessarily received" part - some is held in reserve until years later when they can see if indeed gains are legitimate and not transitory)
  • What Alleghany and a few other exemplars in the world of corporate compensation do right says a lot about what the rest of corporate America does wrong.
  1. First, too many bosses get unconditional cash bonuses even when they push their firms to the brink of disaster. In 2006, Merrill Lynch's then-CEO, Stanley O'Neal, earned an $18.5 million cash bonus, and Charles Prince, then the CEO of Citigroup, got $13.2 million in cash. (oh yes, Stanley O'Neal - our friend who exited the stage for a cool $160M for his wonderful work at Merrill - even better he does not have to face Congress when they walk up the villians for their showboat hearings; I mean why bring the people who were there when the seeds of destruction were being born? That would make too much sense. Great timing in "being fired" Stanley) [Oct 30, 2007: You're Fired! Now Here is $160M to Help Ease the Pain]
  2. Second, companies measure performance inconsistently, with a grab-bag of metrics that change over time. Lately, two measures have been popular: the stock's total return and the growth in earnings per share. Unfortunately, earnings in the hands of clever managers are like Silly Putty in the hands of an energetic second-grader. (truer words never said - remember, just toss all the bad things you've done to the company under "restructuring"; claim it's a 1x thing even though it happens constantly and then wink at analysts on which set of earnings to use - pro forma - and we can all point to earnings excluding '1x charges' and talk about the money being printed by these companies; we all win here in the Casino) Earnings per share can be stretched upward by stock buybacks, accounting changes, unrepeatable gains and a host of other ephemeral factors. (boo yah, just remember, stocks are "cheap" based on PE multiple - don't you dare use real earnings or how things used to be measured in the 70s or even 80s - notice a pattern here? Government and corporate America both skewing data measurement in an upward fashion to hide dirt? Sort of like a Ponzi scheme eh? If we did not resort to this we'd see the true growth measures across corporate America for the lowly 4-5-6% they are - can't have it; otherwise people would just sit in bonds)
  3. And instead of patiently measuring results, companies have ants in their pants. According to a survey by the National Association of Stock Plan Professionals and Deloitte Consulting LLP, 81% of companies tracked results over three years or less when granting stock incentives; 21% gave out "performance shares" based on a single good year. (yes for example look at all these quite excellent mergers such as AOL Time Warner that massive payouts were thrown about for "excellent synergies" - it would be wrong and unjust to wait 4-5 years to see how those talking points actually worked out over time. Just do something! Anything! And give me a bonus for doing it)
  • Alleghany, by contrast, looks at the long term, using measures that are hard to game. The firm bases incentive pay for its managers on the four-year average growth rate in per-share book value -- simply put, the surplus of what the company owns over what it owes. Book value, as Warren Buffett once wrote, is a "conservative but reasonably accurate proxy for growth in intrinsic business value -- the measurement that really counts."
  • Stock options? Forget it. "We don't want to be in the position of betting against the shareholders," says Mr. Hicks, Alleghany's chief. (Many CEOs who exercise options promptly sell.)
  • Alleghany pays its long-term incentive awards as "performance shares" that go up or down with the market. Last year, when the stock fell 28%, "the value of my total compensation was negative," Mr. Hicks says, "as it should have been, since the shareholders didn't make anything." (send this guy to continental Europe - pure socialist talk)
  • In the 1949 first edition of his book "The Intelligent Investor," after which this column is named, Benjamin Graham said "there are just two basic questions" that investors should care about: "Is the management reasonably efficient?" and "Are the interests of the average outside shareholder receiving proper recognition?" Unless investors pressure more companies to adopt smarter incentive plans, the answer will remain "Probably not."
[Oct 4, 2008: Credit Crisis Sharpens Anger Over CEO Pay]
[Sep 17, 2008: Thain's Aides May Get $200M for Weeks of Work]

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