Our Response to: The Warped Math of Executive Compensation

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A February 3, 2014 article by Vince Molinaro discussed the pay package of Tim Cook, CEO of Apple. In the article Mr. Molinaro discussed his ideas on fixing the problem, including having executives refuse bonuses and incentive pay.  A discussion followed on LinkedIn and the following are Dan Walter’s thoughts on the topic.  Original Article

Dan Walter:

Sadly, none of Mr. Molinaro’s reasons why an executive should consider taking less meets the basic WIIFM (what’s in it for me) rule. Executives are still at will employees. I agree that performance conditions should be established up front, but more risk will require even higher pay…

Shareholders are still an unforgiving lot regarding poor performance (as a general rule, in real time, but not over a long period.) Executives see the equation as this: I need to get as much as possible guaranteed right now, because right now is the only sure thing I have going for me. Even the best execs can’t control every (and sometimes any) aspect of the future. Boards look at things from the equation of, there are so few proven entities. Since nothing is guaranteed we will chose a reasonably low risk even if it requires an overtly excessive investment. Everything is like a game a no limit poker. You have to hope everyone else at the table is a reasonably good player or someone else will win from dumb luck. I could go on, but this is becoming fodder for a paper an article on this topic.

One last thing:

Apple is used as an example, but perhaps it isn’t a good one. Yes, their price is down, but from a high that was perhaps over-exuberant. And, very few seem to be saying that Apple will stay down forever. The general consensus seems to be that they will be strong for a long time. How strong, we don’t know. It depends on both their own deliverables and the speed and success of their competitors. If Apple performs as they have historically, we should not be surprised to see their stock price at $100) at some point in the next 5-10 years. If they were privately held I doubt there would be much concern at all, and Mr Cook’s pay would neither be disclosed nor up for discussion.

The biggest outrages about pay generally stem from newer executives that are brought it so “save” something and then fail. If the company needs saving then the high level of potential failure should be expected. Mr Cook is a long-time employee filling the shoes of a near mythical figure. He is in an industry where game-changing innovation happens only occasionally (not every year). If anyone considered to be a professional investor wasn’t aware of the time, effort and money it takes to build a new level of a technology pyramid they should stop expressing surprise and stop investing in tech firms.

Just one guy’s opinion in an ocean of them…

Followed by;

Richard Leblanc, Associate Professor, Law, Governance & Ethics, York University

Dan,

The article didn’t really give any indication other than some examples – of how widespread performance vesting shares were.

I found it remarkable for instance that initially Apple would have awarded Mr Cook time vested stock to begin with.

What is your sense as an expert in this field of how widespread if at all the movement is to performance based vesting of equity, as opposed to time based vesting.

Why is there time based vesting at all? I understand WIIFM, but the point of the board is WIIFS (shareholders).

As for Apple’s declining price, ask yourself what has come out that was new since Steve Jobs’ passing? The bar is very high, I agree.

Thanks for sharing you insights, Dan – very helpful.

Richard

followed by:

Dan Walter, President and CEO Performensation – Executive and Equity Compensation Consulting

Equilar has some compelling data in this area. I haven’t yet seen the 2014 report, but this is the link to the report from 2013 (discussing 2012 results). Key finding: “An early look at proxies filed with fiscal 2012 information reveals that 61.8 percent of S&P 1500 CEOs received performance-based equity grants, compared to 55.8 percent in 2011″

Equity compensation has many purposes. In a company like Apple it may be seen as an incentive to “keep steering the ship in the same successful direction.” Mr. Cook had been at the company, successfully proving his value, for a long time. It seems that that goal was to simply retain him and provide the security that he would get paid as long as he performed as expected. As performance did not meet some people’s expectations, the company and Mr. Cook decided to be prudent and change the vesting to avoid strife during proxy season. It is obvious tat Mr. Cook has a very long term (more than the 3-5 years period that seems to be the norm of most current investors) vision and expectation for the company. Apple has gone through long periods of quiet success followed by long periods of loud growth. Their volatility is more like tidal movements than the individual waves of innovation that investors seem to want. Time based stock, while perfect in many aspects is the right solution for specific situations.

Time-based vesting gives the CEO stability and security. If the CEO is always worried that any misstep will be the end of his income, job and perhaps career they have little incentive to try anything new. Systems that depend only on more of the same are destined to create nothing new of true import. Time-based vesting provides the foundation on which our technology innovation was built. Correctly designed performance-based equity provides the reward if the risks payoff )(for everyone).

Investors and companies should take a step back and look at equity more like the investments in a 401K. There should be some risky high growth, some safe slow growth, some pieces with specifically defined targets others with specifically defined peer group comparisons, etc. This would allow everyone to adjust as the world and markets moved around them. But a CEO with an average term of about 5 years and an investor with a sale horizon of 3 years both have little reason for true long term planning.

I wonder if we have built a corporate governance system and expectations that suffers from ADHD. The methods for measuring things change every year (sometimes a little, sometimes a lot). The expectations of what “performance” means are a constant debate. Shareholders seem less likely than ever to buy a stock and hold it until it it reaches its potential. Instead they invest in stock with a price set to the future potential value then sell long before that potential can ever be met. They are so many rules and issues to review that it is nearly impossible for the holder of a real portfolio to review everything that is deemed essential. We outsource much of that to firms like ISS and Glass Lewis who often have people doing the evaluation that the investors would never deem qualified enough to hire themselves.

I do not provide any advice regarding investments, but I do think that Apple will again show true innovation in the future. It may be 2 years or 5 years, but they will deliver something that sets the standard for all competitors. And everyone will once again get overexcited, spike the stock price and complain 2 year later when the incredible innovation isn’t followed immediately by 10 others. That has been Apple’s history. I think Steve Jobs has created enough culture and grown enough internal talent to make this happen for a while. It’s only my opinion of course.