The Advisors' Blog

– Broc Romanek, CompensationStandards.com

As a follow-up to this blog about Mark Van Clieaf’s study & the related NY Times column, Mark sent me these bullets to drive home the point from his study:

– The median over-pay for the 74 companies was $ 7.8 million for the CEO role.
– If we use a 2.5x pay differential estimate to Layer 2 – then the overpay at that level is $3.1 million X 4 officers = $12.5 million per company.
– Then multiply that by 74 companies = $931 million overpay estimate at the median
– Add that to the actual CEO overpay of $835 million – and the total overpay estimate for the 370 name officers is easily $1.7 BILLION.
– That’s real money for under-performance.

Meanwhile, I received this note from a member in response to my original blog about the NY Times column:

It is hard to let another Gretchen Morgenson story that bashes executive pay go by without some commentary. While not intended to be a point-by-point refutation of her assertions and the data on which it is based, here are four comments for your readers to consider (items in quotations were taken from the article; my observations follow):

1. “Companies love total shareholder return in part because it is easy to calculate. But a company’s stock can rocket even when its operations are being run into the ground. So basing pay on total shareholder return can encourage an executive to manage more for a company’s share price than for its overall health.”

Observation: According to the author, therefore, the stock market is inefficient and cannot recognize companies are merely propping up short term results at the expense of long-term performance.

2. “Mr. O’Byrne and Mr. Van Clieaf began by examining each company’s return on capital over the last five years and then comparing it with companies in the same industry. This resulted in a relative return on capital for each corporation.”

Observation: It is worth noting that companies that do not make acquisitions will have much higher returns on capital than their industry peers, as the acquisitive companies are required to reflect the acquired company’s assets at FMV (i.e., the acquisition price) and the non-acquisitive companies have generally written-off their assets over time, and what is left on their balance sheet is the historical cost of their assets, less years and years of depreciation. The point here is the denominator of the non-acquisitive companies for purposes of calculating return on capital is much lower, thus generating a much higher return. Not to be repetitive but does the author believe the market does not understand this dynamic, and therefore only high return companies should be rewarded with good stock price performance?

3. “For example, at Salesforce.com, return on capital fell 23 percent over the last five years. As a result, Marc Benioff, its chief executive, received almost $31 million more last year than was warranted by the company’s performance against its peers”

Observation: To quote Mark Twain, “there are lies, damn lies and statistics”. Everyone knows percentages of percentages are used to exaggerate the results. Moreover, it is possible to drop 23% and still be a great performer. Recall Ted Williams hit .406 and won the batting title in 1941; the next year he hit .356 and won the coveted triple crown ( i.e., best batting average, most home runs and RBIs). The author would have you believe Mr. Williams had a lousy year in 1942 because he hit below 14% below the prior year. As an aside, no major league baseball player has hit over .400 in the last 75 years.
As noted by Salesforce.com “and over the last five years, Salesforce has delivered returns of 111 percent, more than double the S.&P. 500 index.” As a small aside, Salesforce.com’s ROC did not drop 23%, it had negative ROC, which was 23% below the peer group’s ROC. Ms. Morgenson did not correctly state what the minus 23% represented.

4. “Representatives for all of the companies challenged the idea that return on capital was the best way to measure their operations.” Response: Not surprising, as maximizing ROC often motivates shrinking the company so all that is left is the highest return businesses; it also motivates reduced CapEx since almost any new investment involves some level of risk and could reduce ROC.

Observation: One of the most fascinating findings of the study is the Co-CEOs of Chipotle are among the most underpaid executives. Chipotle’s shareholders may be surprised to learn they are underpaying these executives. But, I do not expect them to plea for a big increase given Chipotle’s stock price is down 17% year to date, and has performed at roughly ½ the S&P 500 the last 5 years.