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Investor analysis of combining stock compensation and stock buybacks


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Source: The New York Times | Fair Game, July 8, 2016 column


Business Day

Investors Get Stung Twice by Executives’ Lavish Pay Packages

Fair Game



It’s a frustrating fact of life for many mutual fund investors: Even if they’re distressed by outsize executive compensation at public companies whose shares they indirectly own, chances are good that the votes cast by their investment managers actually encourage delusional pay.

In recent years, as executive pay has climbed, fund managers have continued voicing their approval for stratospheric compensation packages. The failure by these fiduciaries to use their power to rein in pay has led some critics to contend that the managers aren’t viewing the packages in the context of what they cost company shareholders.


Fair Game

A column from Gretchen Morgenson examining the world of finance and its impact on investors, workers and families

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It is undeniable that pay arrangements are a shareholder expense, and sometimes a significant one. Last year, despite a slight decline from 2014, the median pay package for chief executives at 200 large United States companies was almost $20 million.

When compared with those companies’ earnings or revenue, $20 million may not sound like much. But looking at pay another way, said David J. Winters, chief executive at Wintergreen Advisers, a money management firm in Mountain Lakes, N.J., brings a clearer picture of the costs that these lush packages mean for shareholders.

The analysis suggested by Mr. Winters focuses on the stock awards given to top corporate executives every year, and the two kinds of costs they impose on shareholders. Stock grants are a substantial piece of the pay puzzle: Last year, they accounted for $8.7 million of the $20 million median C.E.O. package, according to Equilar, a compensation analysis firm in Redwood City, Calif.

Cost No. 1 is the dilution for existing shareholders that results from these grants. As a company issues shares, it reduces the value of existing stockholders’ stakes.

A second cost to consider, Mr. Winters said, is the money companies pay to repurchase their shares in trying to offset that dilutive effect on other stockholders’ stakes.

“We realized that dilution was systemic in the Standard & Poor’s 500,” Mr. Winters said in an interview, “and that buybacks were being used not necessarily to benefit the shareholder but to offset the dilution from executive compensation. We call it a look-through cost that companies charge to their shareholders. It is an expense that is effectively hidden.”

Mr. Winters and his colleague Liz Cohernour, Wintergreen’s chief operating officer, totaled the compensation stock grants dispensed by S.&P. 500 companies and added to those figures the share repurchases made by the companies to reduce the dilution associated with the grants.

What they found: The average annual dilution among S.&P. 500 companies relating to executive pay was 2.5 percent of a company’s shares outstanding. Meanwhile, the costs of buying back shares to reduce that dilution equaled an average 1.6 percent of the outstanding shares. Added together, the shareholder costs of executive pay in the S.&P. 500 represented 4.1 percent of each company’s shares outstanding.

Of course, these numbers are far greater at certain companies. The 15 companies with the highest combination of dilution and buybacks had an average of 10.2 percent of their shares outstanding.

“It’s not only today’s expense,” Mr. Winters said. “It’s that the costs of dilution over time have been going up, so you have a snowballing effect.”

Wintergreen Advisers has been critical of executive pay for some time. Two years ago, the firm led the charge against executive pay at Coca-Cola, arguing that the stock awards given to Muhtar Kent, the company’s chairman and C.E.O., were excessively dilutive to existing shareholders’ stakes. Last year, the company reduced Mr. Kent’s grants by almost half.

And yet, though Mr. Kent’s total pay fell by 42 percent in 2015, with a package of $14.6 million, he is not headed for the poorhouse.

Not all companies give executives loads of stock grants. Mr. Winters provided four examples with far less dilution related to compensation plans than is typical in the S.&P. 500. Only one is in that index: the Altria Group, the tobacco company, with 0.7 percent average annual dilution.

The three other companies are European: British American Tobacco, with zero dilution; Nestlé, with 0.1 percent, and the Swatch Group, with 0.6 percent.

Mr. Winters contended that the circular arrangement of stock grants and buybacks was especially costly at companies in the S.&P. 500. One reason, he said, is that many of the large money management firms offering index funds and exchange-traded funds do not generally vote against pay packages at the companies whose shares they own on behalf of their clients.

Consider this year’s votes by BlackRock and State Street, two major providers of index funds and exchange-traded funds. According to Proxy Insight, as of June, BlackRock and State Street voted to support the pay at 95 percent of S.&P. 500 companies. This parallels data from previous years.

Why these companies don’t take a more aggressive stance on pay issues is something of a mystery. Some critics speculate that it may be because their own executive pay is high, or that they don’t want to alienate corporate clients, whose money they manage, by voting against their pay.

When asked about their votes in support of lavish pay, money managers often contend that when they see problems with a company’s compensation, they talk privately with its board to try to effect change.

For example, Anne Elizabeth McNally, a spokeswoman for State Street, which has $415 billion under management in a wide array of E.T.F.s, said it used a screening process to identify companies whose pay practices were problematic.

It engages with these companies, and if they don’t take action, State Street will vote against their compensation, Ms. McNally said. Last year, she said, State Street voted against pay practices at almost half the 1,424 companies it had selected for review.

But this kind of engagement process is slow, frustrating investors who are eager for a quicker pace of change in pay plans.

Highlighting the erosion of their wealth that lush executive compensation can mean for investors might just light a fire under more money managers. And to this end, Ms. Cohernour, the Wintergreen C.O.O., suggested that the Securities and Exchange Commission help by requiring companies to include in their annual proxy statements both the dilution that their executive stock grants represent and the cost of the buybacks conducted to offset it.

“Companies could easily make this information clear in their proxy materials instead of making investors dig through documents for it,” Ms. Cohernour said. “These are significant factors for an investor to know.”


A version of this article appears in print on July 10, 2016, on page BU1 of the New York edition with the headline: Stung Twice by Lavish Pay at the Top.


© 2016 The New York Times Company

Performance and Shareholder Support

The following graphs of corporate performance and of shareholder voting support for executive compensation are presented in the order of the article's reference to the U.S. company for which data is available, and are linked to the relevant text.

Full-size graphs of these and other companies you may select can be generated on the Shareholder Forum's websites for Returns on Corporate Capital™  and for Shareholder Support Rankings™. Definitions of both analyses are presented below.


♦ ♦ ♦

Returns on Corporate Capital™ are a performance measurement developed in a Shareholder Forum workshop project, and are calculated from the company’s SEC reports of its GAAP-defined net income plus interest expense and income taxes, divided by its prior year’s ending balance of total assets less current liabilities other than interest-bearing debt. Comparative averages for the company's industry are based on aggregate amounts for all reporting Russell 3000 companies in the six-digit Global Industry Classification Standard (GICS), excluding the amounts for the subject company.

Shareholder Support Rankings™ analyses are produced by The Shareholder Forum from research data provided by Equilar, Inc., calculated as the percentage of total votes cast for, against and abstaining in advisory “Say on Pay” shareholder approvals of executive compensation.

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