Pay for no performance

How can CEOs, management and boards of directors have their interests aligned with the long-term health of the companies they run? How can their interests be aligned with the interests of their employees?

I’m grappling these questions as I look to a few glaring cases of capitalism gone wrong, and I am wondering why boards of directors ultimately do what they do. In my mind, a board should provide diverse expertise and guidance for a company, choose its CEO, and stay vigilant in making sure the chosen CEO has taken an appropriate course. Part of choosing the CEO also requires setting contract terms and compensation. And on this, I have a hard time understanding how boards in America can agree to such large compensation terms with so little downside risk for the executives involved.

It has recently come to light that in the event of a merger, Marissa Mayer, CEO of Yahoo, would receive $55 million in severance if she were ousted. Just as ridiculous is her compensation across 5 years: at minimum, it was projected to be worth $117 million across 5 years. It will likely end up being closer to $365 million, depending on the share price. Not only are these amounts ridiculous, but they are in part determined based on share price, an imperfect indicator of company health. If you happen to enter as CEO during a recession, and you stay on just as the economy and the technology sector expand, then you see the gains flow to your pay. All you had to do was nothing. This is almost precisely what happened with Yahoo: their share price increased entirely due to a large stake in Ali Baba (an investment made prior to Mayer’s tenure), which had its IPO in 2014 and currently has a market cap of nearly $200 bn.

People who defend CEO compensation in America try to draw comparisons with everyday workers and their own motivation to show up and do a good job based on the pay they receive. Money rewards good work, so their fable goes. But there is no parallel here. When most people do a poor job, they can be let go. Most don’t receive severance, and most immediately worry about how they will make ends meet, or get another job. The psychological and financial impact is often severe.

There is no similar downside for Marissa Mayer. She never has to worry about money, and she gets paid tens of millions of dollars even if she screws up and leaves. And so, I wonder: what are boards of directors thinking? This kind of thing doesn’t even seem to align with shareholder interests.

Yahoo recently laid off 1,600 people. Make the rosy assumption that Yahoo did not lose any revenue from cutting all of these workers, and that the move only cut costs. Suppose Marissa Mayer gets her severance this year of $55 million: assuming (conservatively) that employees receive a total of $200,000 in compensation on average (including health insurance and other benefits), $55 million would pay 275 workers for a year. If we consider her $365 million potential pay across 5 years, that money would pay for 365 workers for 5 years. In reality, Yahoo arguably lost some revenue from laying off these workers.

The same would not be said for the CEO. Is it at all possible to make the argument that she, or some other CEO, would have done a worse job with just $36.5 million instead of $365 million? This discussion leads easily to questions of taxing the rich. Many arguments against raising rates on the very rich seem nonsensical when put in this perspective.

There are other examples of  boards of directors making poor decisions: Men’s Warehouse tried a disastrous acquisition of Joseph A. Bank and ousted its famous founder George Zimmer in the process. In this case, the board went against the CEO, and gave him no severance. Why? Men’s Warehouse’s largest shareholder was the hedgefund Eminence, which also owned a stake in Joseph A. Bank. They had pushed for a merger of sorts (and overpaid, to their simultaneous detriment and benefit). Among the members of the board of directors was Deepak Chopra, bullshit artist and new age spiritualist. What expertise could he have brought to Men’s Warehouse’s business dealings? Zimmer deserves some of the blame, as he handpicked many of the directors.

Mr. Zimmer, who lives in the Bay Area, says he feels bad for Men’s Wearhouse employees, but not for Eminence. “I don’t have a high regard for hedge funds,” he said. “Nothing personal — I’ve never met the Eminence people — but I love the idea they might lose a fortune. Hedge funds may force companies to be more efficient, but that’s not always the best thing for every stakeholder group, like employees. It’s curious we’ve allowed capitalism to become all about shareholders.”

At least in this case, you could argue that the decision was based on large stakeholder in the company. But it sucks that the employees will ultimately pay the price. Should boards be prescient rather than short-sighted? Shouldn’t they be actual experts on business matters, representing both shareholders and the many employees that work for the company? Was Deepak Chopra qualified to be a part of that decision?

Freeport is another example where a board of directors failed to do its job properly, sitting idly by (and getting rich) while letting an overcompensated CEO take the company down. The mining company decided to get into oil at the height of the commodity boom by taking on massive amounts of debt to the tune of $20 billion. The chairman, James Moffett, argued for the purchase of two companies: Plains Exploration and Production and McMoRan Exploration, where he was also the CEO. The conflicts of interest are staggering, as he stood to get rich from buying a company he had a large stake in. Where was the board to voice these concerns?

Freeport’s chief executive, Richard Adkerson, was McMoRan’s co-chairman. Nine Freeport directors owned stock in McMoRan totaling about 6 percent of the shares. Freeport agreed to buy McMoRan for $2.1 billion — a 74 percent premium over its market price before the deal was struck. Mr. Moffett himself was paid $73 million.

Moreover, Plains owned 31 percent of McMoRan, enough to block any deal. Freeport eliminated that possibility when it bought Plains. And James Flores, Plains’s chief executive, who now runs Freeport’s oil and gas operations, was also a director of McMoRan. He made $200 million on the deal.

In addition to the $73 million, after Moffett was “let go”, he received another $79.4 million in severance. The company’s market capitalization had fallen to as low as $4bn and is now $13.08B, far below its debt obligations.

Not all companies face such dramatic ends. But the questions remain: how can boards of directors do a better job for the company and the employees, and how can CEO compensation be drastically changed?

 

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