The Shareholder ForumTM


"Say on Pay" Proposals

Forum Home Page

"Say on Pay" Home Page

Program Reference


New York Times, July 26, 2009 column


July 26, 2009

Fair Game

Benchmarks as Bendable as Gumby

SELF-SERVING compensation practices, we can now agree, played a central role in the financial wreckage that still surrounds us. For example, rewarding Wall Street’s outsized risk-takers with immediate bonuses, no matter how their trades worked out, turned out to be, well, disastrous.

With public-company shareholders on heightened alert for problematic pay plans, one would hope that corporate directors — who are supposed to serve their investors — would also be watchful for red flags. But that, alas, is not always the case.

Consider, for a moment, the incentive pay structure at Alliance Data Services, a company that manages customer loyalty programs, like air-miles reward plans, and provides private-label credit card programs through its World Financial Network National Bank subsidiary. Alliance, whose credit card clients include Ann Taylor, Victoria’s Secret and Pottery Barn, generated $2 billion in revenue in 2008.

Like most companies, Alliance dispenses stock awards to its executives each year when certain performance measures are met. Where Alliance gets creative is in the benchmark those stock awards are tied to, one that excludes some fairly significant costs that the company incurs. Alliance calls this measure “cash earnings per share.”

So how does Alliance define “cash earnings”? As income that is adjusted upward by adding back certain expenses like the cost of the stock awards that the company gives to executives and employees.

In any other universe, costs reduce earnings. But in Alliance’s happy world, expenses actually improve the bottom line.

Alliance adds other costs back into its income calculation as well. It takes a portion of the premiums that it pays when it acquires credit card portfolios and account lists, for example, and adds that to its earnings. Such premiums are normally viewed as a cost of doing business, but Alliance considers them to be an intangible asset, which it amortizes over time. Adding this amortization amount to its “cash” earnings each year generates a fatter figure.

These adjustments make for a big difference between earnings based on generally accepted accounting principles — you know, the kind where you actually subtract expenses from revenue before arriving at earnings — and the figure the company has chosen to highlight. Alliance’s “cash earnings” for the second quarter, which it reported last week, came in at 95 cents a share. Real earnings in the period were 51 cents a share.

In the first quarter of 2009, the spread between the two figures was even wider: Alliance reported “cash” earnings of $1.19 a share, compared with GAAP earnings of 45 cents.

To be sure, Alliance is not the first company to devise financial metrics that put its results in the best possible light. It has urged investors to judge it on “cash earnings” since it issued stock to the public in 2001.

But at least one analyst objects to the fact that the company’s performance pay is based on a number that management can easily massage. And basing executives’ pay on a measure that does not take into account the costs of acquisitions means that Alliance’s management is encouraged to make acquisitions with little regard for price.

You get it: Neither practice is what you would call “shareholder friendly.”

A spokeswoman for Alliance said the company doesn’t discuss matters relating to compensation beyond what it reports in its financial filings. But Robert Minicucci, chairman of Alliance’s compensation committee and a general partner with Welsh, Carson, Anderson & Stowe, a large private equity firm, said that Alliance’s board is “very interested in pay-for-performance.”

“How many companies do you know that have gone from $12 to $48 in the last six years?” Mr. Minicucci asked. “It is hard to say that shareholders are buffoons here and directors are asleep at the switch.”

Nevertheless, the cost of the stock awards that the company adds back to its earnings calculation can be significant. In each of the last two years, Alliance reported stock award expenses of about $48 million; in 2006, this expense was $36 million.

As Alliance’s stock expenses have risen by 36 percent, the company’s operating income has risen by 23 percent and net income has increased by just 15 percent. Its shares have appreciated by a third in the period.

In the first three months of 2009, Alliance awarded an additional 710,303 performance-based stock units; vesting restrictions on a third of these shares will disappear next February if the company’s “cash earnings” grow by an unspecified amount during 2009, its quarterly filing said. If that growth figure is met, the stock grants will vest completely by February 2012. Typically, restricted stock grants vest over longer periods.

Stock awards are a big piece of the pay pie for Alliance executives. Edward J. Heffernan, its chief executive, received $4.7 million in total compensation in 2008. (He was chief financial officer at the time.) Stock awards had a value of $3.34 million in the period.

J. Michael Parks, Alliance’s former chief executive, received $6.7 million in total compensation; $3.4 million of that came from stock awards.

Note the circular nature of this compensation structure. If Alliance’s “cash earnings” achieve a specified growth rate in a given year, some of the company’s stock grants vest sooner. Because the costs of these stock grants contribute to “cash earnings,” the growth target becomes easier to reach the more options are awarded.

And that makes some analysts uneasy.

“By artificially inflating ‘cash earnings per share,’ management is able to serve its desire to accelerate vesting and hit ‘cash earnings per share’ targets for the Street,” said William Ryan, an analyst and managing director at Portales Partners, an independent research firm in New York.

Of course, all of this might be viewed as a matter between Alliance and its shareholders. Except for one thing: Because the securitization market has shut down, Alliance has had difficulty selling securities backed by its private-label credit card receivables. So, the company recently turned to a government program for help raising money: the Term Asset-Backed Securities Loan Facility.

Last April, Alliance issued $709 million of securities under the program — a program that we, the taxpayers, back. So Alliance’s accounting practices are kind of our concern, too.

“The Securities and Exchange Commission and the Obama administration are all coming down on pay packages that don’t correlate with metrics that are conventionally accepted by investors,” Mr. Ryan said. “So Alliance comes up with a metric that you can adjust yourself, effectively a self-graded exam.”

Another example of how good it is to be king in some corners of corporate America



A version of this article appeared in print on July 26, 2009, on page BU1 of the New York edition.



Copyright 2009 The New York Times Company




This Forum program is open, free of charge, to anyone concerned with investor interests relating to shareholder advisory voting on executive compensation, referred to by activists as "Say on Pay." As stated in the posted Conditions of Participation, the Forum's purpose is 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 is 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.

The organization of this Forum program was supported by Sibson Consulting to address issues relevant to broad public interests in marketplace practices, rather than investor decisions relating to only a single company. The Forum may therefore invite program support of several companies that can provide both expertise and examples of performance leadership relating to the issues being addressed.

Inquiries about this Forum program and requests to be included in its distribution list may be addressed to

The information provided to Forum participants is intended for their private reference, and permission has not been granted for the republishing of any copyrighted material. The material presented on this web site is the responsibility of Gary Lutin, as chairman of the Shareholder Forum.