About kmassie

I am a Canadian lawyer currently living in London. After practicing labour and employment law in Canada, I moved to South Africa to obtain a Master's Degree in Labour Law. I recently had a book published entitled "Executive Salaries in South Africa: Who Should Have a Say on Pay," which was co-written by my colleague Debbie Collier with input from journalist Ann Crotty. In addition to working as an associate at the Institute of Development and Labour Law at the University of Cape Town, I offer consulting services for companies looking to adopt or modify all forms of employment policies, including remuneration policies.

Linking overpaid CEOs to overpaid directors

FindTheCompany recently released a story on the 25 worst performing CEOs in the United States, naming Mark Ellis, CEO of Linn Energy, as the worst of the worst. The author looked at US companies whose CEOs took home over $10 million in 2014 despite the company’s stock price dropping by more than 20%. Topping the list, Mark Ellis took home just over $10 million while Linn Energy’s stock price dropped by 67%.

Recently, the Boston Globe wrote an article that questioned whether skyrocketing director pay can be linked to skyrocketing executive pay, stating that “escalating compensation could create a disincentive for directors to challenge executives.” Do directors have an incentive to sign off on high pay even during a bad year in order to protect their own financial interests?

There might be something to this theory. In it’s article, the Boston Globe compiled a chart that shows the median pay awarded to directors within various sized companies. Directors of companies with revenue between $2.5-$10 billion are paid a median of $214,283, while directors of companies with revenue over $10 billion are paid a median of $258,000. If you look at the companies with the top five worst performing CEOs according to the FindTheCompany study, you will see that directors are being paid well in excess of the market median for comparable companies.

For example, let’s look at how directors are paid in comparison to the market median at FindTheCompany’s top five worst performers:

  1. Linn Energy – Mark Ellis took home over $10 million while the stock price dropped by 67%. The median pay of non-executive directors during 2014 was $296,387, well over the $214,283 median paid by comparable companies. This doesn’t even include a unit award paid to seven Linn directors in January of 2015 worth over $146,219.
  2. Chicago Bridge and Iron Company – Philip Asherman took home $14.3 million while the stock price dropped 49%. Chicago Bridge’s revenue is significantly higher than Linn Energy’s and thus it’s comparable market median director’s pay is $258,000. Chicago Bridge, on the other hand, paid its non-executive directors $288,140.
  3. Ensco PLC – Carl Trowell took home $10.3 million while the stock price plunged 47%. Non-executive directors were paid a median of $393,112, which is significantly higher than the comparable market median of $214,283.
  4. Cobalt International Energy – Joseph H. Bryant took home $10 million while the stock price dropped 45%. Cobalt’s median director pay was $277,500. The company had no revenue, making it difficult to compare to those companies with revenue. However, it pays more than the $258,000 median income paid to directors of companies with revenue over $10 billion. Pretty handsome for a company with no revenue.
  5. Avon Products – Sherilyn McCoy took home $10.2 million while the stock price dropped 45%. Avon’s non-executive directors were paid a median of $225,574, slightly higher than the market’s median of $214,283.

The Boston Globe could be on to something. Further research into this area could produce fascinating results. The bottom line is this – don’t just pay attention to what the CEO is pocketing. Look at who is making the decision to pay him that amount and see what they are being paid to keep quiet.







Across the Pond: A Pay Gap Worth Widening

Just a quick note of interest this week. The Financial Times has reported that European bank CEOs are paid less than half of what bank CEOs in the United States earn. CEOs at the top nine European banks earned an average of £4.8 million pounds, while those at the big US banks earned an average of £10 million. The Financial Times and PWC attribute these findings to two causes: the weak performance of European banks, combined with EU rules that limit bonuses to two times salary. Although the EU’s banker bonus cap regulations were not perfectly drafted (see my earlier blog post on this), at least they can be credited with having some impact.

It is not entirely surprising that this transatlantic pay gap is widening. For one, the American executive pay culture is far more out of control than it is in Europe. Secondly, American banks tends to be significantly bigger than European banks, “justifying” bigger pay cheques in the minds of remuneration committees. Finally, European banks have had an all-around poor year. It would be shocking to find the pay gap narrowing given recent performance.

While this should be seen as a partial measure of success to advocates of reining in executive pay, I am sure it will cue predictable cries of a looming brain drain from other circles.


UK’s remuneration regulations have not had an enormous impact

Vince Cable, former Secretary of State for Business, Innovation and Skills, recently spoke to attendees at a High Pay Centre event about whether the 2013 Enterprise and Regulatory Reform Act had been effective in tackling the executive pay problem. Among other requirements, the Act directs companies to disclose a single figure for executive pay and to hold a binding shareholder vote on their remuneration policies.

According to Cable, while the regulations have had “some” effect in forcing institutional shareholders to think more about the long-term impact of remuneration, they have not had an “enormous” impact. Shareholders and fund managers have been given the information and tools needed to curb excessive pay, yet pay continues to rise.

One reason for the unremarkable response to these regulations is that shareholders are not necessarily the best opponents to income inequality. In fact, shareholders are very poor guardians of societal values – they are self-interested individuals with a lot on their plates. To expect them to be concerned enough with income inequality to actually vote against remuneration policies at annual general meetings, or to put pressure on their fund managers to do so, is to expect too much of busy people who, at the end of the day, really only care about the return on their investment. Many shareholders will only be motivated to act if they can see that a company’s remuneration policy is significantly negatively impacting their returns. When a company’s remuneration policy is merely high, but not out of line with what other companies are offering, an individual shareholder may not be motivated to take action, or might erroneously believe that companies need to pay top rates in order to retain their executives.

More important than the individual shareholder is the institutional investor. These individuals are the ones that actually vote the majority of shares at annual meetings on behalf of numerous beneficial shareholders. According to Cable, institutional investors have a lot of issues to take up with companies, only one of which is remuneration. Whether company remuneration receives the attention it deserves depends on what else is on a fund manager’s agenda. Given that fund managers tend to be highly paid themselves, and entrenched in what has been coined the “high pay culture” by the High Pay Centre, it is unlikely that these individuals will put sufficient energy into tackling a remuneration problem that ultimately benefits them personally. 

So what is to be done? During his remarks, Cable recognized a void in the 2013 regulations that could potentially be addressed through future amendments. While the Act gave shareholders tools to tackle executive pay, it largely ignored the role of the employee. Cable was supportive of requiring companies to disclose pay ratios and also to declare whether or not the company had consulted the workforce over its remuneration policy. His hope was that these regulations would cause companies to exercise greater restraint. However, Cable cautioned that over-regulation in this field would have the opposite effect: if you bring too much pressure to bear on executives and their pay, they will simply take their companies private.

Regulations designed to empower shareholders can only take us so far. Shareholders are primarily concerned with their own pocket book. More actors are needed to bring pressure to bear on companies and change the culture of pay. A step in the right direction would be to involve employees in this process and not only arm them with information about the pay differentials within their companies but also consult with them when drafting remuneration policies. A requirement to disclose pay differentials in a company’s annual report would also arm consumers with information to avoid supporting companies with extreme differentials. This will not solve the pay problem entirely – but it would take some of the burden off of shareholders.

Oracle: Fourth time’s a charm?

Last year, 54% of shareholders voted against Oracle’s say on pay proposal.  This is a slight improvement from the opposition Oracle received in 2012 and 2013, but only by a few percentage points. On November 18 of this year, shareholders will have a fourth opportunity to vote against Oracle’s pay policy. In preparation, let us examine some of the changes that have been made this year to Oracle’s executive remuneration.

Larry Ellison, Oracle’s former CEO, stepped down in September 2014 to become Oracle’s Chairman and Chief Technology Officer. He handed the reins to co-CEOs Safra Catz and Mark Hurd. As a result, Catz and Hurd received certain one-time equity awards during the year to account to for their change in position, in addition to routine equity awards.

The following table discloses the three main executives’ compensation over the past three years:

Executive Fiscal Year Salary Stock Awards Option Awards Cash Incentive Other Total*
Ellison 2015 1 22,764,375 23,804,550 0 1,547,635 48,116,561
2014 1 0 64,979,600 741,384 1,540,266 67,261,251
2013 1 0 76,893,600 1,165,502 1,547,056 79,606,159
Catz 2015 950,000 27,625,625 24,647,250 0 20,795 53,243,670
2014 950,000 0 36,240,500 456,236 20,014 37,666,750
2013 950,000 0 42,620,500 717,232 20,105 44,307,837
Hurd 2015 950,000 27,625,625 24,647,250 0 22,253 53,245,128
2014 950,000 0 36,240,500 456,236 21,942 37,668,678
2013 950,000 0 42,620,500 717,232 22,074 44,309,806

Note that none of the three executives earned a bonus since performance conditions were not met. Had bonus targets been achieved, this would have bumped their compensation by over $4 million each.

Yes, both Catz and Hurd make less in 2015 than Ellison made in 2014 when he was CEO. But now there are two of them, sharing Ellison’s former job title. Combined, they made over $100,000,000 or $100 million. For a job one person was paid $67 million to do the year before. Oracle stated in its Annual Report that the compensation committee’s goal was to reduce executives’ overall remuneration. However, it does not count to reduce the remuneration paid for one job slightly and then to split that job into two positions. This effectively doubles the amount being paid out.

Additionally, it has been reported that nothing has actually changed in how Oracle is run. A Business Insider article reports that the three executives are essentially doing the same jobs they were before the change in title, with Catz stating that there were to be no significant changes in how Oracle was run. Thus, what we really have is the former CEO taking a pay cut while the two people who are CEO in name only receive a significant pay raise. Shareholders, take note. This does not count as Oracle meeting its goal of reducing executive remuneration.

*note that Ellison’s stock and option award values are calculated after removing certain awards that were cancelled as a result in his change of position. The amounts are therefore different than those reported in the annual report.


John Donahoe’s pay pal

In September of 2014, eBay announced plans to spin off PayPal. This decision followed shareholder calls for a spin off, which were very publicly opposed (at least initially) by eBay’s CEO, John Donahoe. Three months later, eBay also announced that its executive team, including Donahoe, would be stepping down. Departing executives were offered large retention payments to remain at eBay until the spin off transaction was completed. These payments replaced severance payments required under the executives’ employment contracts and were subject to the condition that the executives not remain employed by either company following their separation.

Regulatory filings related to these payments disclose that John Donahoe, eBay’s departing CEO, would be entitled to a generous severance package, including a severance payment amounting to twice his salary and bonus. Vesting of his share and option awards was accelerated. In December, Forbes valued the separation package as amounting to $23 million. Its actual value will depend on how many share units vested at the time of the split, based on whether certain performance criteria were met.

PayPal was officially spun off from eBay in July of this year. Following the split, Donahoe became PayPal’s non-executive chairman. No longer an official employee of either eBay or PayPal, Donahoe was entitled to his “retention” package from eBay even though he had been retained as a director by PayPal. Not bad for seven months of work.

Following the separation, PayPal’s share price experienced a huge increase in value, with its market capitalization surpassing that of eBay. Simultaneously, eBay’s credit rating was downgraded – PayPal had accounted for half of eBay’s revenue.

Donahoe left his long post as the CEO of a marketplace now struggling to compete with online retailers such as Amazon. He did so with a hefty retention bonus, a pocketful of shares and a bright future with eBay’s former darling, PayPal. As PayPal’s star is rising, eBay’s seems to be fading. It was awfully nice of eBay’s shareholders to retain Donahoe, even if only for PayPal’s benefit. That’s what pals are for, after all.

Here’s the door… but keep the keys

Jeff Smisek, Chairman and CEO of United Continental Holdings, has been shown the airline’s emergency exit. Resigning amidst a potential scandal which is under investigation, Smisek was laden with an expensive golden parachute, valued at $8.4 million. According to calculations done by Equilar, this figure has the potential to rise to $21.6 million if corporate performance conditions are met on Smisek’s long-term incentives.

Smisek received a separation payment of $4,875,000 and remains eligible for a pro-rated cash bonus for the current financial year. Additionally, the company accelerated vesting of 60,746 shares. He also remains eligible for cash payments under the company’s long-term incentive and restricted stock award plans for three years.

The real kicker is that while many United employees were laid off this year in order to cut costs, Smisek has parachuted past them waving a lifetime’s worth of flight benefits and parking privileges. He retains his medical coverage until he is eligible for Medicare. He will receive indemnification for any tax he has to pay on his flights or his medical benefits, and he was permitted to drive away with title to his company car. Finally, he was given outplacement services to help him find a new job.

A clawback clause in the separation agreement requires Smisek to repay the separation payment, his bonus, the 60,746 shares and the cost of the outplacement services if he fails to cooperate with the investigation or is convicted, pleads guilty or pleads no contest to a felony or crime of moral turpitude.

However, no such clawback exists for cash payments made under United’s long-term incentive award and restricted stock plans, the parking privileges, the vehicle, the flight benefits, or the medical coverage. Even if Smisek is found guilty of a felony (note that there is no suggestion at the moment that he is being personally investigated for any crime), he would still be entitled to park his company car in a United parking spot and hop on a flight for free without even paying the tax. This should leave a bad taste in the mouths of investors, employees and fellow passengers.

Perks should be eliminated from executive separation agreements. Perks can be a good incentive for existing employees. However, perks should not be necessary to incentivize a former CEO to comply with his legal obligation to cooperate with an investigation into the company’s dealings. Perks should end with the job.  In the words of a United flight attendant, leave all your valuables behind and head for the nearest exit.

You, yourself and your peer group

Remuneration committees typically benchmark various elements of an executive’s remuneration package against what is paid at a group of comparator companies. Known as the company’s peer group, the comparator companies may be in the same industry or have similar market capitalization. Benchmarking is done to ensure that companies are able to compete with their peers for talent by paying similar amounts. The benchmarking exercise was cleverly coined an arms race by Michael Kagan, a senior portfolio manager at ClearBridge Investments. When one peer increases its remuneration packages, all of the other peers can justify following suit.

A little known fact about the arms race is that some executives sit on the remuneration committees of their peers. While an executive would not be permitted to determine his own pay directly, he can influence what he is paid by increasing his peer’s remuneration. By ratcheting up pay at the peer company, the executive is able to justify a larger pay package for him or herself.

For example, while he was the CEO of eBay, John Donahoe was also a member of the compensation committee at Intel Corporation. eBay’s annual report lists Intel in its peer group. This problem is not limited to American companies. Ian Cheshire, the now former-CEO of Kingfisher, sits on the remuneration committee at Whitbread. Kingfisher’s annual report indicates that it benchmarks itself against companies in the FTSE 25-75, a group that includes Whitbread.

Finally, Michael Roney, CEO of Bunzl, was on the remuneration committee of Johnson Matthey. Johnson Matthey’s annual report does not disclose its peer group for the purpose of benchmarking salaries, but it does describe it as a group of UK companies that have substantial operations overseas. Additionally, the report discloses a list of 40 comparator companies used for determining whether incentives should vest. This list includes Johnson Matthey and is described as “40 UK based companies…that have substantial operations overseas and…similar levels of revenue, profit and market capitalisation as Bunzl.”  Given that the description of this peer group is very similar to the one used for benchmarking salaries, it is probably safe to assume, although one cannot be sure, that Johnson Matthey is also considered a peer for the purpose of benchmarking salaries.

Some remuneration committees specifically exclude companies from the peer group when an executive sits on that peer’s remuneration committee. For example, Diageo specifically excludes Unilever from its peer group because Paul Walsh, Diageo’s CEO, sits on its remuneration committee. This should be seen as best practice – it is not appropriate for executives to sit on the remuneration committees of peers used to determine that executive’s remuneration. Other remuneration committees should take a page out of Diageo’s book and exclude these peers from consideration.

Additionally, the UK Corporate Governance Code should be amended to either prohibit this type of situation or at the very least to require its disclosure to shareholders. Currently, many shareholders will have no idea if an executive sits on the remuneration committee of a peer. While companies must disclose whether directors sit on the boards of other companies, as we have seen with Bunzl, there is no requirement to list which companies are contained in their peer group. This lack of information permits this problematic practice to continue without appropriate shareholder scrutiny.

The arms race continues, but some executives have an unfair advantage. Shareholders should be provided with information about company peer groups. Executives should not sit on the remuneration committees of companies within their peer group. These steps will not stop the arms race, but at least they will remove a tactical advantage.

Hey ump, a strike is a strike

Patrick Durkin, a bureau chief at the Australian Financial Review, reported this week that Australian companies have found a way around the two-strikes rule. The two-strikes rule provides that if 25% of votes are cast against a company’s remuneration policy for two consecutive years, the company must put a spill resolution to shareholders that, if passed, could see the entire board standing for re-election. Two strikes and you could be out.

Since this rule was introduced, there have been few second strikes and spill resolutions. The reason for this is now clear – while some companies actively engage with shareholders to avoid a second strike, other companies are able to ignore a second strike entirely. A provision in Australia’s legislation allows companies to call for a show of hands at shareholder meetings to pass resolutions. If the board sees in advance that it has received a large proxy vote against its remuneration resolution, a decision to hold a show of hands instead is all it takes to wipe the slate clean. A ball, not a strike.

The Australian Financial Review gave evidence of this practice to the Australian Securities and Investments Commission, which in turn denied that companies were flouting the two-strikes rule. This, despite the fact that the intent of the two-strikes rule was to hold boards accountable to shareholders for a failure to respond to negative criticism of remuneration practices. If directors are able to protect their place on the board by holding a show of hands when the overwhelming evidence points to discontent, boards can continue the status quo with impunity. Government action requiring a poll for remuneration resolutions (or in fact all resolutions) will be needed in order to prevent this practice.

This is just one more example of companies finding a way around regulations that are inconvenient. We recently saw similar creativity employed by banks when the EU capped banker bonuses at a multiple of fixed pay. Banks merely shifted the money they would have paid as a bonus into a “fixed pay allowance,” thus getting around the cap. These examples highlight a common problem with regulation: legislators have failed to anticipate how companies will respond to regulations before forging ahead.

It is much easier to draft a regulation right the first time than it is to find the willpower to change a flawed, but already enacted, regulation. Any country considering enacting a two-strikes rule similar to Australia’s should take note and close any loopholes that would allow a board to ignore a second strike. Hopefully the Australian government will take steps to rectify the situation in Australia. Until then, we will wait for the umpire to call a strike a strike.