Two Important Yet Overlooked Exec Comp Factors - 17 Nov 2009
We read a
lot about corporate governance and executive compensation these days,
in the wake of last year's economic collapse. Many politicians are now
jumping into the fray, saying we need to legislate certain governance
requirements, such as splitting the roles of CEO and chairman or
lowering CEO pay. Although philosophically I support many of these
arguments, it turns out that many of these prescriptions have no
long-term relationship with an increase in a company's stock price.
Which of these governance and executive pay factors should you pay
attention to as an investor?
As any good investor knows, there's
no silver-bullet metric (such as P/E ratio or price-to-book or leverage
ratio) that, on its own, predicts a stock future increase or decrease.
Even if you take a number of internal factors into account, your
perfect analysis can be thrown out the window by an industry downturn
or some random comment by Tim Geithner on his trip to Asia.
With
this in mind, I believe you can improve your investment batting average
by paying attention to two factors relating to corporate governance and
executive compensation that most people overlook.
Two Kinds of Insider Stock
First,
how much stock do the company's directors own? In a big long study I
took part in several years ago, we scoured company's proxy statements
and examined how a bunch of so-called "good" corporate governance
factors were actually linked to longer-term stock returns. Almost all
of them (such as whether there was a split CEO and chairman, or if the
board had a number of "independent" directors or not) had no
correlation with stock price increases. However, we found one variable
that had a whopping link: whether a company had a lot of directors who
had dug into their own pockets and actually bought stock in the
company. This is different from a case in which stock ownership in the
company was only due to stock grants or stock options.
When
we talked to directors about this finding, they said it didn't surprise
them. It's the difference between having "found money" on the line
(i.e., their stock was paid for from other people's money, not theirs)
instead of their own. One director said, "I sit on a lot of boards
right now, but there's one where I've got about $250,000 of my own
money on the line. It sounds bad to admit it, but I care a heck of a
lot more about how that company does. I lose sleep over it."
If you were a shareholder in that company, his sleepless nights are probably comfort to you. I bet many Bank of America (BAC) and Citigroup (C) shareholders wish they'd had more directors losing sleep (and their own money) a couple of years ago.
Payments to the Chief
The
second characteristic I like to look at is the total compensation the
CEO and his/her management team take home. Is it significantly above
other companies in that industry, even though the stock returns between
the companies over time are not different? If so, that's a big red
flag. Why does this management team (and the board members who approve
their pay packages) think they're worth so much more than their peers,
with no commensurate better historical track record?
As part of
total comp, you should also look out for extreme executive perks that
have been thrown in to supplement an executive's already high salary. I
mentioned recently a Las Vegas Sands (LVS) senior vice
president, Rob Goldstein, who got the company to pay $364,000 to
remodel his home and never had to pay it back. Mark Hurd and his senior
management team at Hewlett-Packard (HPQ) saw their total
compensation double last year, after they imposed 10% to 15% pay cuts
across the organization. The HP execs also get to spend hundreds of
thousands of shareholders' dollars jaunting around the country on the
HP corporate jets for personal use, with hotels and meals also covered
for personal use.
I've heard some people say, "Who
cares about the perks? Shocking that there's gambling going on in the
casino. Come on." I disagree. Not every CEO or management team does
this. It says something about how they approach executive decisions. To
me, it tells me that they will look for every chance to make decisions
that benefit them first and foremost before the shareholders. I don't
want to invest in a company like that. (Maybe not surprisingly, I
currently have short positions in LVS and HPQ because of many factors,
but the perks factor certainly played a role in my decision.)
So how do you find this information? It's easy: go to the SEC's Web site.
Search "company filings" and look for the company's most recent proxy
statement. Its technical filing name is "DEF-14A," which stands for the
company's definitive proxy statement. In there, you will find info on
who is on the board of directors, how much they're paid, their bios,
and how much stock they own in the company. It's not always immediately
obvious how much of their current stock ownership is from past stock
grants and stock options given to them (for free) vs. how much they've
bought themselves, but it can be figured out if you look over a number
of these past filings.
In the same filing, you'll find everything
you've ever wanted to know about how much in total comp the management
team is making (and more), down to the often most illuminating
footnotes. The SEC is often tinkering with its requirements on
companies in how they present this data. However, the current version
makes it clear what each exec's total comp is.
These two
characteristics of outside directors' stock ownership in their
companies and the size of CEO total comp and executive perks aren't
silver bullets. They should supplement all the normal financial
analysis you do. However, they can often be very helpful in deciding
whether to proceed with an investment or not.
Disclosure: At the time of publication, Jackson's fund held a net short position in LVS and a short position in HPQ.
This article was originally published in RealMoney.com.
http://seekingalpha.com/article/173817-two-important-yet-overlooked-exec-comp-factors
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