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For previous Forum attention to issues addressed in the article below, see the Forum's 2006-2008 Options Policies and  2008-2010 "Say on Pay" programs, and  the "Stock Buyback Policy" section of the reference page for the Forum's 2014 Walgreen project.

Post--publication note: The MarketWatch report of the week's "10 biggest stories" included the article below with the following summary:

The latest in MarketWatch’s “Fixing the Market” series is a discussion of the real reason you should worry about high executive pay. The focus of the article is how the explosion of stock-based compensation for executives has hurt shareholders through dilution and the redirecting of executives’ efforts toward pushing up stock prices over the short term, rather than focusing on long-term business improvements.

Say-on-pay votes have become influential, and the article shows how easy it is to get the results of those votes for any company.


Source: Dow Jones MarketWatch, July 16, 2015 article


Opinion: What you can do about obscenely high executive pay

Published: July 16, 2015 5:30 a.m. ET

Voting at company meetings isn’t enough — you have to take the matter into your own hands



van Doorn

 Investing columnist



MarketWatch photo illustration/Shutterstock


Executive compensation in the U.S. is usually discussed in moral terms. It’s not fair that chief executive officers are paid up to $156 million a year, the argument goes.

But those outsized pay packages, in the form of stock-based compensation, are financed by shareholders, who suffer a loss in earnings per share and ownership of the company. And because CEOs are paid mostly in stock, they tend to obsess over the share price, training them to focus on short-term company gains.

Total pay in the past seven years has risen four times faster for executives than it has for the average worker. A CEO of an S&P 500 member company received a median $10.1 million in 2013, the last year for which figures are available. Some executives’ pay seems as if a decimal point was misplaced, such as that of Twitter Chief Financial Officer Anthony Noto, who took home $72.8 million in 2014.

“Basing compensation on a stock price is creating incentives to increase the stock price and not necessarily the business fundamentals behind it,” said Gary Lutin, a former investment banker at Lutin & Co. who oversees the Shareholder Forum in New York. In an interview, Lutin said measuring executive performance that way “encourages manipulation of the stock price.”

Many investors don’t realize how harmful executive compensation is. In fact, they typically approve top executives’ pay at annual meetings in non-binding voting.

But that may change. And there’s an easy solution that doesn’t involve new rules and regulations.

Stock-based compensation

Since 2007, the Securities and Exchange Commission has required publicly traded companies to report the total compensation of their top five executives for the previous year.

Here’s information provided by Equilar showing the rise in median total pay for the top five executives among S&P 500 companies over eight years:


Median pay for top five executives ($ millions)

















Source: Equilar

The median pay for executives has risen 67%. In 2009, compensation stalled as the S&P 500 Index plummeted 38% the year before.

In contrast, the average weekly earnings for U.S. workers have risen only 17%:


Average weekly earnings

















Source: Bureau of Labor Statistics

Median executive pay numbers mask the egregious pay packages for some. Oracle Corp. founder and Chairman Lawrence Ellison received $67.2 million in fiscal 2014. The year before, he made $96.2 million.

Oracle’s shareholders have rejected the company’s executive compensation listed in its annual proxy statements over the past three years in non-binding “say on pay” votes.

Most large-cap U.S. companies include stock-based awards as a part of executive-compensation packages. The awards typically make up the great majority of a top executive’s annual pay. Stock-option awards, for example, accounted for 97% of Ellison’s pay in fiscal 2014.

Oracle earned $10.96 billion during fiscal 2014. But not every company that hands out huge awards to executives is profitable. An egregious example is Twitter. Of CFO Noto’s total compensation last year, stock-based compensation made up 99.8% of that.

Noto joined Twitter a year ago, so his total compensation package looks rather fat for half a year’s work, especially when you consider that Twitter lost $577.8 million for the year.

Twitter provides the usual net income or loss, based on generally accepted accounting principles (GAAP), in its earnings reports. But it highlights adjusted earnings that excludes the “noncash” expenses for stock-based compensation. For the first quarter, Twitter’s GAAP net loss was $162.4 million, but adjusted earnings came to $46.5 million, with the main factor being the exclusion of $182.8 million in stock-based compensation expenses.

One might argue that the adjusted earning figure is more important because it excludes non-cash items. But the stock issuance caused Twitter’s weighted average diluted share count to rise by nearly 2% in only one quarter. The $162.4 million net loss came to 42% of revenue, which would be remarkably high for any company, let alone an unprofitable one.

Stock awards lower earnings per share. And if a company increases sales and earnings over a period of years, it’s a good bet that it will “mop up” the dilution by buying back shares, which will probably be priced much higher. So dilution hurts earnings per share now, and expensive buybacks in the future might not be the best use of the company’s capital.


Before the SEC’s adoption of 10b-18 in 1982, companies that were publicly traded in the U.S. weren’t allowed to repurchase common shares in the open market. Buybacks today are commonplace, as MarketWatch’s Michael Brush has discussed.

When a company buys back shares, it can mitigate the dilution caused by the issuance of stock for executive awards. If it buys back enough stock to lower the diluted share count, earnings per share will rise, and the stock price can also climb because of the higher demand and lower supply.

Buybacks have become so prevalent that some companies are even borrowing to fund share repurchases. Apple Inc., though it had cash, equivalents and marketable securities of $194 billion at the end of March, has issued bonds to raise some of the money that funds the repurchases to avoid repatriating cash held abroad, which would then be taxed. Apple bought back $45 billion worth of stock in fiscal 2014 and lowered its fiscal fourth-quarter diluted share count by 6.2%.

Even after all the buybacks, Apple’s stock trades for 13.9 times its consensus 2015 earnings estimate, considerably lower than the S&P 500 Index’s 17.7.

So Apple does not appear to be overpaying for the shares it is repurchasing, while it is borrowing at historically low interest rates. Shareholders are benefiting from the buybacks because of higher earnings per share, and it’s obvious that the company is doing well with product innovation.

But massive buybacks don’t always turn out well for shareholders. International Business Machines Corp. is a frequently cited example. New York Times DealBook summed up IBM’s situation beautifully in October, pointing out that the company had spent $108 billion on repurchases from 2000 through September 2014, while its revenue was “about the same as it was in 2008.”

From the end of 1999 through Sept. 30, 2014, IBM’s stock had a total return, with dividends reinvested, of 114%. That was far better than the 78% total return for the S&P 500 Index over the same period, but the stagnation of revenue was disturbing. And IBM’s stock has been quite weak over more recent periods, down 3% in three years and up 43% in five years. Those compare to gains of 55% and 93%, respectively, for the benchmark index.

While buybacks don’t directly cause boards of directors to hand out stock to executives, they do provide plenty of “cover” by limiting the dilution effect.

But buybacks, at what might be near-record-high stock prices, may keep a company from deploying excess capital through expansion of its business, product development, efficiency initiatives or acquisitions that could drive sales and earnings. It might also keep the company from treating its non-executive employees fairly.

John Waggoner of the Wall Street Journal recently warned investors to “beware the stock-buyback craze,” citing recent research by Goldman Sachs. The amount of companies’ cash spending allocated to buybacks peaked at 34% in 2007, but hit a low of 13% in 2009, when the S&P 500 tanked. That makes it seem like many boards of directors are blindly buying back shares today, with little consideration to prices.

The Boston Globe recently discussed this topic in detail, using Cisco Systems Inc. as an example.

Basing executive awards on stock performance

According to a recent study by James Reda, David Schmidt and Kimberly Glass of Arthur J. Gallagher & Co., 173 of the top 200 companies included in the S&P 500 had formal long-term incentive plans for executives. Among this group in 2013, “45% used relative total shareholder return” for at least part of their measurements of executive performance.

Rex Nutting recently said executives were looting their own companies at the expense of employees and the long-term health of their businesses by “using large stock buybacks to manage the short-term objectives that trigger higher compensation for themselves.”

“If the reward is based on market pricing, and especially if the reward is really big, you have to assume that a lot of contestants will play tricks,” said Lutin of the Shareholder Forum.

It seems reasonable to expect a CEO to work hard on boosting sales, expanding into new markets, developing new products, improving efficiency and widening profit margins. But a focus on lifting the stock price over short periods might not be a good thing for long-term shareholders. And it is only human nature for an executive whose pay is based on short-term stock-price performance to try to push up that price.

Ira Kay, a managing partner at executive compensation advisory firm Pay Governance, has a different view. He strongly supports tying executive pay to stock performance, as well as stock-based compensation.

“An objective look at the facts would show that stock-based incentives for U.S. corporate executives has been a great success,” Kay said in a phone interview. “It is in fact highly motivating to the executives, and they end up doing a lot of things, reducing costs, buying companies, selling divisions, diversifying, stock buybacks, raising dividends. They do a lot of things to benefit shareholders.”

“And, most importantly, the shareholders completely agree with what I just said,” Kay said.

The numbers back that up, based on the results of “say on pay” votes by shareholders.

In the 1980s, before the big increase in stock-based compensation and buybacks, and during the leveraged buyout boom, many companies were being bought out because “those corporations were under-run,” according to Kay.

“They were sleepy because executives didn’t have enough stock-based incentives,” he said. “They did try to increase sales and profits, but it was not a shareholder-value-maximization strategy and left an enormous amount on the table for other investors [the ones doing the leveraged buyouts] to harvest.”

So there’s a lot to be said for and against stock-based compensation. A positive development, according to the Gallagher & Co. study, is that executive-compensation plans are becoming more complex and “shareholders will push incentive design to become even more complex and better representative of company performance.”

‘Say on pay’

A way shareholders can put pressure on boards of directors is through say on pay voting, which was created as part of the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010. The non-binding votes take place at annual meetings, and shareholders can vote yes or no to the previous year’s compensation packages for a company’s top five executives.

The Shareholder Forum has a useful Shareholder Support Rankings tool you can use to see the results of individual companies’ say on pay votes:

The default chart shows the median vote support for the S&P 500, and you can see that Kay was correct in saying shareholders have overwhelmingly supported corporate pay packages over the past five years. Because of the six-year-plus bull market, shareholders who are interested enough to vote are likely to be pleased with the performance of the stocks.

You can change the ticker in the chart above to any Russell 3000 stock. For example, if you put in “ORCL” for Oracle, you will see that the company’s pay packages for its top five executives were soundly rejected by shareholders for three years running:

The Shareholder Forum

The majority of Oracle’s shareholders have voted “no” on the compensation packages for its top five executives for the past three fiscal years.

And here’s a telling set of numbers for Oracle, showing a decline in total compensation for its top five executives over the past two fiscal years:

Oracle executive


2014 compensation

2013 compensation

2012 compensation

Lawrence Ellison

Co-Founder, Executive Chairman




Safra Catz





Mark Hurd





Thomas Kurian

President of Product Development




John Fowler

Executive VP of Systems















That’s a big drop — 28% — in only two years, although the executives are still clearly in the 1% of American earners.

It may seem unlikely that a board of directors can be “shamed” into lowering executives’ pay based on the non-binding say on pay votes. But it is still important for shareholders to vote, because a majority “no” vote might make directors nervous about keeping their seats when they are up for reelection.

An item that may affect say on pay votes is another Dodd-Frank requirement, which says companies must report the ratio of the CEO to the median employee’s pay. That could lead to harsh assessments by shareholders. And the media, of course, will love covering the issue. The SEC has been working on a final rule for the CEO pay ratio since 2010, and the regulator on June 4 published a memo on various ways to calculate the ratio.

Politicians to the rescue?

Massachusetts Democratic Sen. Elizabeth Warren has bashed SEC Chairwoman Mary Jo White for the agency’s pace in implementing the requirements of Dodd-Frank.

The senator is focusing on several items that could change the way top executives are paid. She said in an interview with the Boston Globe on June 4 that she had asked the SEC to take another look at the 1982 rule changes allowing companies to buy back stock in the open market.

“Stock buybacks create a sugar high for the corporations,” Warren said. “It boosts prices in the short run, but the real way to boost the value of a corporation is to invest in the future, and they are not doing that.”

Warren is co-sponsoring a bill called the Stop Subsidizing Multimillion Dollar Corporate Bonuses Act, which “would revise 1993 legislation that enabled corporations to tie an executive’s pay to a company’s share price and make such pay tax-deductible,” according to the Globe.

There may be little chance of Warren’s bill passing because companies will lobby hard against it, using the usual currency of campaign contributions for members of Congress, but it is good for Warren to bring this issue to the attention of the public.

Radical solutions

Warren’s bill to ban linking executive compensation to stock-price performance would be quite a change, but bringing back the ban on open-market buybacks would be monumental.

Boards of directors would still be able to award shares to executives if the buyback ban were restored, but the dilution would no longer be covered up by buybacks, and new disclosure rules would at least shed light on outsized awards.

If boards of directors lost the ability to hand executives massive pieces of company ownership, they would have to pay the executives a lot of cash. That’s good, because it would lead to more honest accounting, without the “noncash expenses” nonsense.

Even though investors like the idea of executives facing the same risk as they do, since so much of compensation is based on the stock price, it doesn’t necessarily work that way when the awards are obscenely large. Banning bonuses based on stock-price performance would force executives to focus on running their businesses if they want the big payoff. That would make it especially important for companies to issue formal incentive programs laying out financial goals and other objectives for the executives.

A buyback ban might be a boon to shareholders because executives’ renewed focus on improving operating performance and expanding over the long term would make a company’s stock less volatile.

If a company really does have excess cash and nothing to invest it in, it could raise its dividend. And dividend payers tend to be more disciplined, enriching investors in the long run.

What you can do

The coming SEC rule that requires companies to report a CEO’s compensation as a multiple to the median employee’s pay will highlight the most outrageous compensation packages. But the radical step of bringing back the old rule banning open-market buybacks and companies from measuring executive performance based on stock-price movement are unlikely to take place.

So if you’re annoyed by the dilution of your investments or excessive CEO pay, with “excessive” being defined by you, there is action you can take besides making your say on pay vote. You can incorporate those concerns into your stock-selection process.

Lutin of the Shareholder Forum said the most important thing for individual investors to do, if they are investing directly in companies rather than just sticking with mutual funds, ETFs or index funds, is to research a number companies to find the ones that seem likely to “make real profits for 10 or 20 years.”

And it should be relatively easy to spot red flags. “Respect is an important element,” he said. “It’s also easy to see, since it’s a really basic element of any organization’s culture. If the people responsible for running a business show that they don’t respect any key constituencies — including you, as an investor — you can assume they also don’t respect others.”


Copyright ©2015 MarketWatch, Inc.



This Forum program was open, free of charge, to anyone concerned with investor interests in the development of marketplace standards for expanded access to information for securities valuation and shareholder voting decisions. As stated in the posted Conditions of Participation, the purpose of this public Forum's program was to provide decision-makers with access to information and a free exchange of views on the issues presented in the program's Forum Summary. Each participant was expected to make independent use of information obtained through the Forum, subject to the privacy rights of other participants.  It is a Forum rule that participants will not be identified or quoted without their explicit permission.

This Forum program was initiated in 2012 in collaboration with The Conference Board and with Thomson Reuters support of communication technologies to address issues and objectives defined by participants in the 2010 "E-Meetings" program relevant to broad public interests in marketplace practices. The website is being maintained to provide continuing reports of the issues addressed in the program, as summarized in the January 5, 2015 Forum Report of Conclusions.

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