Investors fear use of clever accounting to trip bonuses

Large investors fear FTSE 100 companies are using clever accounting techniques to trigger high executive bonuses and mask poor financial performance.The concerns come as research shows the difference between stated and adjusted operating profits for the UK’s top-100 quoted companies is at 51 per cent — the widest gap in a decade. In 2007 the split was just 15 per cent.

Russ Mould, investment director at AJ Bell, the investment company that carried out the research, said the figures suggested equity markets were nearing “the top of a cycle”.

“As growth gets harder to generate, there is a temptation to employ different financial tactics to generate it, either to appease return-hungry shareholders or hit bonus triggers,” he said.

“If a share price suddenly turns and the economic cycle turns with it, investors [will be left] wondering why something that looked like a sound investment on paper is now a terrible one in reality.”

The growing use of revised profit figures have made shareholders and analysts increasingly wary of these numbers, according to Andrew Millington, head of UK equities at Standard Life Investments, one of Britain’s largest fund companies….

David McCann, an analyst at brokerage Numis, said more companies were reporting adjusted profit figures as “it is becoming harder to deliver growth in a low return environment”.“Companies are looking for ways of showing optical growth so they don’t have to report declining results. Manager pay is increasingly being linked to earnings-based measures, so there is increasing motivation to boost those measures,” he said.

Source: Investors fear use of clever accounting to trip bonuses

Rising Angst Among Defenders of Overpaid CEOs – Inequality.org

Getting rid of the new pay ratio disclosure requirement scheduled to take effect next proxy season may be harder than the Trump administration thought.  I was particularly heartened by this article’s reporting on the number of comments in favor of the proposal (and how that avalanche of comments makes it harder to rescind the rule).  And I was particularly amused by the Chamber of Commerce’s desperation ploy when it’s usual “burdensome” argument failed.  It’s next attempt was claiming that people might actually use those disclosures to make policy.  Uh, that’s the point of information and data, right?

Overpaid CEOs enjoyed a sweet victory in June when the House of Representatives took action to protect them from having to disclose how much more money they make than their workers.But the celebration didn’t last long. The odds of the Senate taking similar action any time soon were always long. Now, given the health care quagmire, these odds are even longer.

Source: Rising Angst Among Defenders of Overpaid CEOs – Inequality.org

CEOs Cut Investment To Sell Their Own Shares At High Prices – Alex Edmans

A new look at “short-termism” examines the link between vesting of the CEO’s shares and reduced growth rate in investment, suggesting an inverse correlation between what’s best for the CEO and what’s best for shareholders.

Rather than studying the shares that the CEO actually sells, we study the amount of shares that are scheduled to vest. For example, if a CEO was given a chunk of shares in Q3 2012, with a 5-year vesting period, they first become saleable in Q3 2017. CEOs typically sell a large portion of their shares when they vest, to diversify their portfolio (we verify this in the data). Thus, if the CEO knows that her shares will be vesting in Q3 2017, and so she’s likely to sell a large portion, she has incentives to cut Q3 2017 investment. Importantly, the driver of Q3 2017 vesting equity is the decision to grant the CEO shares back in Q3 2012. That was five years ago, and so is likely exogenous to (not driven by) Q3 2017 investment opportunities. Thus, any correlation between Q3 vesting equity and Q3 investment cuts is likely to be causal.

We include both shares and options in our measure of vesting equity and estimate this amount at the quarterly level. This is because the highest frequency with which investment is reported is also at the quarterly level. We regressed the change in investment (measured five different ways) on vesting equity and many control variables that may also drive investment cuts (e.g. investment opportunities or financing constraints).

We find a significant negative correlation between vesting equity and the growth rate in investment – using all five investment measures.

Source: CEOs Cut Investment To Sell Their Own Shares At High Prices – Alex Edmans

Rosanna Landis Weaver reviews The CEO Pay Machine 

Our favorite expert on CEO pay, As You Sow’s Rosanna Landis Weaver, likes Steven Clifford’s new book, The CEO Pay Machine: How it Trashes America and How to Stop It.  We recommend the book and Weaver’s review:

Clifford takes apart all the components with a fresh eye. He is skeptical, for example, of the mantra of pay for performance. He notes that bonuses that don’t change behavior are a waste of money, and that many that do change behavior may change it for the worse. “All pay-for-performance systems cause more harm than good,” he writes. “They generate perverse incentives, undeserved and often absurdly high bonuses, and damage the companies that use them.” … He also speaks with great insight about the role of directors. “It’s impractical, if not impossible,” he notes, “for board members committed to being supportive players on the team to transform themselves into hard-nosed negotiators.”

Source: Book Review: The CEO Pay Machine – CEO Pay Updates: 2017 Proxy Season

Opioid Controversy: McKesson CEO’s Bonus Draws Shareholder Ire | Fortune.com

The Teamsters pension fund has written to shareholders about excessive compensation at McKesson: “It is staggering that Hammergren received a $1.1 million boost to his bonus just months after the company announced it had reached a record $150 million settlement with the DEA in a year the company faces mounting litigation, negative press and Congressional scrutiny.”

[John] Hammergren is consistently one of America’s highest-paid executives, and as such, his compensation has been scrutinized and pilloried over the years—in 2013, shareholders overwhelmingly said no to his pay package (something shareholders rarely ever do). But this year, a considerable amount of outrage over the CEO’s compensation is focused on a $1.1 million slice of his $97.6 million compensation pie—and that outrage is closely related to the country’s spiraling opioid crisis.The $1.1 million is the amount the McKesson board’s compensation committee boosted Hammergren’s annual bonus pay this year—a cherry on top of all that other cash—through the use of an “individual performance modifier,” an assessment that incorporates a range of non-financial metrics including alignment with the company’s much touted “ICARE” principles—Integrity, Customer first, Accountability, Respect, and Excellence. Good behavior, in essence.

The thing is, as Fortune reported in a feature story in June, the company’s behavior hasn’t been so good. McKesson (MCK, +0.98%) is currently embroiled in controversy around its role in the opioid epidemic; in January, the company settled, for a record $150 million, claims that it had failed to report large numbers of suspicious orders of prescription opioids to the DEA. As a result, McKesson, which accepted some responsibility in the federal settlement, will operate under an independent monitor for the next five years. Meanwhile, in West Virginia—where it shipped more than 100 million doses of highly addictive prescription pain pills in a period of six years—the state Attorney General has sued the company for violating the state’s controlled substances and consumer protection laws, and McKesson faces litigation brought by towns and counties across the state. Along with the nation’s other two major drug distributors, the company is also subject of a Congressional investigation.McKesson’s testimonials to its purported guiding principles, all the while, is what has really gotten under the skin of some investors who view them as mere lip service.

Source: Opioid Controversy: McKesson CEO’s Bonus Draws Shareholder Ire | Fortune.com

Renault Shareholders Narrowly Pass CEO Pay Over Government Opposition

Renault SA shareholders approved Carlos Ghosn’s 7 million-euro ($7.8 million) compensation for last year over the objections of the French government, which argued that the automaker’s chief executive officer is overpaid.

Shareholders voted 53 percent in favor of the CEO’s 2016 pay in an advisory decision at the company’s annual meeting on Thursday in Paris. The French state, which owns 19.7 percent of Renault, opposed Ghosn’s remuneration for the fourth time, a spokeswoman for the state’s participation agency said. In July last year, Renault’s board cut the variable component of Ghosn’s pay package by 20 percent, which wasn’t enough to satisfy the French government.

Source: Renault Shareholders Narrowly Pass CEO Pay Amid Controversy – Bloomberg

How Badly Must a C.E.O. Behave Before His Pay Is Clawed Back? – The New York Times

Gretchen Morgenson writes in the New York Times:

[There is] a lawsuit unfolding in Delaware Chancery Court…that involves the former chief executive of United and a prime figure in the Bridgegate scandal that has dogged Gov. Chris Christie of New Jersey. The facts of the case reflect a similar disdain for United’s shareholders by the corporate board members who are supposed to serve them.

At the heart of the lawsuit is the refusal by United’s directors to retrieve any of the $28.6 million received by Jeffery A. Smisek, United’s former chief executive, when he was defenestrated in 2015 amid a federal corruption investigation….In a litigation demand, [The City of Tamarac, Fla., Firefighters Pension Trust Fund] requested that the company’s board claw back the severance pay given to the executives who took part in the bribery scandal. By doing so, United’s board would correct its breach of fiduciary duty and prevent “the unjust enrichment” of company executives.

Seems fair enough. But United’s board has refused. Its justification for not recouping the pay is, well, pretty rich.

In a letter to the pension fund, a lawyer for United explained that it would harm the company to give the board “unfettered discretion to recoup compensation” in cases involving wrongdoing. “Where such discretion is out of step with industry norms,” the letter said, it would “make it difficult for United to recruit and retain top talent, particularly at the senior management level.”

In other words, clawing back severance awarded to executives amid a bribery investigation is not industry practice. And if United pursued such a recovery, the airline would be an outlier and unable to hire good people.

Pension Funds Vote “No” on Mylan Directors

Frank Glassner’s Compensation in Context newsletter reports:

Four large pension funds have asked shareholders of the drug company Mylan NV to vote against six directors, including the company’s chairman, who have been nominated for re-election at the company’s annual meeting June 22.
“We believe the time has come to hold Mylan’s board accountable for its costly record of compensation, risk and compliance failures,” said the letter to shareholders, a copy of which was filed recently with the Securities and Exchange Commission.


The letter was signed by Scott Stringer, the New York City comptroller, on behalf of the $170.6 billion New York City Retirement Systems for which he is fiduciary to the five funds within the system; Thomas DiNapoli, the New York state comptroller and sole trustee of the $192 billion New York State Common Retirement Fund, Albany; Anne Sheehan, director of corporate governance for the $206.5 billion California State Teachers’ Retirement System, West Sacramento; and Margriet Stavast-Groothuis, adviser, responsible investment, for the €205.8 billion ($230 billion) Dutch pension provider PGGM, which manages the assets of the €185 billion Pensioenfonds Zorg en Welzijn, Zeist, Netherlands.


Collectively, the pension funds own approximately 4.3 million shares of Mylan stock, worth about $170 million, said the letter to shareholders.

Perk Disclosures: Reminders for Executives and Directors

The lesson from this: If you’re going to have your corporation underwrite your cosmetic surgery, remember to declare it as a perk and part of your executive compensation.

The investigation into the perks, personal expense reimbursements and other items of value received by Mr. [Miles] Nadal [of MDC Partners, Inc.] or his management company from 2009-2014 ultimately revealed that Mr. Nadal received far more benefits than were disclosed in MDC’s proxy statements—ranging from sports car and yacht expenses to cosmetic surgery to charitable donations in his name—totaling nearly $11.285 million, which Mr. Nadal also repaid to MDC. On May 11, 2017, without admitting or denying the SEC’s findings of securities law violations, Mr. Nadal consented to an SEC cease-and-desist order and he agreed to pay $1.85 million in disgorgement, $150,000 in interest and a $3.5 million penalty. Mr. Nadal also agreed to be barred from serving as an officer or director of a public company for five years.

Source: Perk Disclosures: Reminders for Executives and Directors

Paper: An Activist View of CEO Compensation

A new paper from Stanford University’s Rock Center presents a formula that improves on the “static” disclosures about CEO pay on proxies because it reveals a more important metric: variability with performance. The factors:

1. Calculate the “minimum” payout that a CEO is expected to receive in a given year. One might expect that the minimum payment a CEO receives is equal to his or her salary. Typically, however, this is not the case. A CEO will retain time-vested restricted stock without regard to performance. Furthermore, CEOs almost always receive some portion of their annual bonus. Targets are set low enough to be achievable, and a zero payout almost never occurs in practice. Most plans set a lower threshold (hurdle amount) equal to 50% of the target, and we include this figure in the minimum payout. Taking this all together, we assume the “minimum” payout to a CEO as equal to the CEO’s salary, plus restricted stock, plus 50% of the target value of the annual bonus.
2. Calculate how much incremental pay the CEO will receive if he or she achieves target-level performance. This amount equals the incremental compensation assuming the annual bonus and long-term incentive plans are paid out at the target level. (We assume no change in stock price, so that all of this incremental compensation comes from additional payments and not change in value of equity awards due to stock price change).
3. Calculate incremental pay if maximum bonuses are paid. This amount equals the incremental compensation for achieving the high end of the annual bonus and the high end of the long-term incentive plan. (Again, we assume no change in stock price).
Steps 2 and 3 highlight how much upside potential is available to the CEO for achieving performance milestones, even if shareholders see no appreciable return. They also illustrate the potential disconnect that can occur between the financial outcomes of shareholders and the CEO.
4. Add the incremental compensation the CEO will receive assuming some reasonable stock-price appreciation. We assume a 50 percent increase, although higher or lower return scenarios are equally valid. This calculation adds the incremental payout from stock options and the appreciation of restricted stock and performance shares. Treating stock-price appreciation as an independent analytical variable allows us to see how equity awards add leverage to the pay package and the degree to which CEO pay outcomes and shareholder interests are aligned.
Taken together, this framework provides a foundation for analyzing the scale and structure of CEO pay. It provides a rigorous and systematic method for evaluating critical issues, such as:
  • The degree to which pay is “guaranteed” or “at-risk”;
  • The degree to which payouts are driven by operating versus stock-price performance;
  • The sensitivity of CEO compensation to stock-price returns;
  • The importance and rigor of performance metrics;
  • The potential risk embedded in the CEO pay package.

The paper can be downloaded here.