WALL STREET JOURNAL.
Activist Funds Put Executive Pay Formulas Under Microscope
Marathon says it found a compensation scheme ‘run amok’ at
An activist hedge fund said Shutterfly’s executive-pay plan
rewarded scale over profits. Above, Shutterfly boxes are
prepared for shipment in Phoenix. PHOTO: WILL SEBERGER FOR
THE WALL STREET JOURNAL
June 11, 2015 5:39 p.m. ET
Big shareholders for years have grumbled about the rise
in executive pay. Now, activist investors are taking up the
compensation cause, focusing less on how much corporate leaders earn
and more on whether they deserve what they get.
Case in point:
where an activist hedge fund is
seeking three board seats at the
online photo retailer at a shareholder vote set for Friday. The
founder of Marathon Partners Equity Management LLC said once the fund
“started peeling back the onion” on Shutterfly’s pay plans, it found
“a compensation scheme that had run amok.”
Marathon’s main complaint, that the company rewards
scale over profits, is finding increasing resonance among activists
lately. Shutterfly has defended its pay plan, while it recently
tweaked the metrics it uses to determine pay. Changes to the plan
“appropriately reflect stockholder views while also balancing the
critical importance of retaining key employees,” the company has said.
Once left to governance hounds, unions and academics,
executive pay is getting a closer look from activist investors, which
take stakes in companies and push for measures to boost share prices.
These funds are scanning corporate filings for what they see as skewed
incentives and generous formulas, increasingly moving what had long
been a back burner issue to the fore.
“Compensation was not something activists cared about a
great deal, unless they could use it as a wedge to get something else
done,” said Francis Byrd, a former TIAA-CREF corporate-governance
expert. “That’s starting to change.”
have zeroed in on pay recently at
Perry Ellis International Inc.
activists argue that ill-designed plans encourage the wrong kinds of
growth—for example, boosting revenue at the expense of profitability.
Others point to nonstandard financial metrics they say reward
executives even when business falters. Criticisms tend to focus less
on the size of CEOs’ paychecks than on the yardsticks that determine
Companies say such critiques are off-base and that
handcuffing pay packages makes it hard to retain talent. They also
note executive pay is mostly stock, which ties executives’ fortunes to
those of all shareholders.
Most activists are unlikely to pick fights based solely
on pay. Arguments about corporate operations are considered more
powerful, investors and advisers say. But more are embracing the idea
that incentives matter.
One factor teeing up the issue for activists is the
complexity of compensation, experts say.
“I’ve seen bonus plans that would take a Ph.D. in
physics to figure out,” said Kevin McManus, vice president at
shareholder-advisory firm Egan-Jones Ratings Co.
That complexity presents opportunity for activists, who
typically research a handful of companies, rather than monitor
hundreds. “You’ve got someone who has the time and the incentive to
dig into the numbers” Mr. McManus said.
Take Trian Fund Management LP, which
narrowly lost a DuPont 
shareholder vote for board seats in May. It has made a small
cause out of executive compensation, regularly seeking a seat on the
compensation committee of boards it goes on, according to people
familiar with its practices.
At DuPont, however, Trian criticized how the company’s
board calculated bonuses, drawing on scores for individual performance
and overall corporate performance. DuPont’s board in 2014 assigned
zero points for the latter, after earnings inched up just 3%, but gave
executives higher personal scores.
“How can it be that the company is doing poorly
operationally but management as individuals are each doing great?”
Trian said in shareholder materials.
DuPont recently changed its plan to give a heavier
weighting to the company’s overall performance and de-emphasize
individual scores. A spokeswoman said the plans “are designed to align
pay with performance and the achievement of annual goals and
Jana Partners LLC, which
recently took a $2 billion stake in Qualcomm,
has urged the company to tie executive pay to measures like return on
invested capital, rather than its current yardsticks of revenue and
operating income, according to a Jana investor letter. Such changes
“would eliminate the incentive to grow at any cost,” said the letter,
reviewed by The Wall Street Journal.
Qualcomm has said its pay plans were aligned with
stockholders’ interests and cited the “increasing competitive threat
Qualcomm faces for talent.” An example: Its current chief executive
was courted by
Microsoft Corp., according to a
person familiar with the matter.
Another red flag for activists: metrics that change on
In 2010, Perry Ellis linked bonuses for its
father-and-son management team to earnings before interest, taxes,
depreciation and amortization, a common measure of cash flow known as
Ebitda. By 2013, the retailer had fallen short of its three-year goal.
Meanwhile, a new phrase had appeared in the company’s
filings: “adjusted Ebitda.” Adding back in certain costs, the tweaks
pushed the company just above the threshold necessary for the two men
to receive their maximum bonuses of $1.4 million each.
Activist hedge fund Legion Partners LLC said in May the
change “undermines confidence” and wasn’t adequately disclosed to
shareholders. Legion, along with a California pension fund, had been
seeking board seats but dropped the fight last month after Perry Ellis
added new directors and announced a CEO succession plan.
A spokeswoman for Perry Ellis declined to comment on
the change. She said the executives didn’t receive a bonus in 2014 or
2015 after the company fell short of the new targets.
Perry Ellis recently revamped its bonus metrics again.
Executive bonuses will soon be based on total shareholder return and a
mix of earnings before taxes and return on invested capital—both “as
The larger argument from activists—that pay too often
rewards size over profitability—echoes a common push among activists
companies to slim down and focus.
In its early years as a fledgling technology company
Shutterfly needed scale, Marathon’s managing partner Mario Cibelli
said, so tying bonuses to revenue growth, among other measures, made
sense. Now, Shutterfly is a $1.7 billion company in a maturing
industry and should reward profitability, he argues.
Starting next year, Shutterfly will tie bonuses to
measures that more closely track profits, including free cash flow and
total shareholder return.
—Michael Rapoport contributed to this article.
Liz Hoffman at