The Canadian Centre for Policy Alternatives said this week that average compensation for chief executive officers at the top 100 companies listed on the TSX clocked in at $9.5-million for 2015. To add salt to the wound, it pointed out that by noon on the first working day of the year, the typical CEO will have earned the average full-year Canadian industrial wage of $49,510.
As usual, the total is skewed by outliers. In 2015, for instance, the former CEO of Valeant Pharmaceuticals International Inc., saw a total compensation of $183-million. You may recall that the Valeant stock price is down about 90 per cent since the beginning of 2015, which gives new meaning to the concept of pay for performance. If we exclude this outlier and divide by the remaining 99 participants, we have an adjusted CEO pay of $7.75-million – still not exactly loose change.
The report's author points out that there are outliers every year, but in the previous two years the range was less extreme – $88 to $90-million for the CEOs of Blackberry and Onex Corporation respectively. Adjusting for these top paycheques, we find that the trend is actually down from $8.40-million in 2013 to $8.14-million in 2014 to the current austerity of $7.75-million.
This discussion of executive compensation is timely: Investors will shortly begin to receive annual reports for the year just ended along with a management information circular which outlines the compensation for the top executives. You may even be invited to vote on a “Say on Pay” motion, though the result will be considered advisory and the board may choose to ignore the result.
So as an investor, how can you find out whether you are getting value for money?
The compensation committee of the board invests time, effort and money in benchmarking the compensation of the senior executives while the individual investor has limited access to these resources. But there are some things you can look for in the annual report to decide whether the payroll numbers and direction are in the ballpark.
As a starting point, check the trend in book value (net worth) a share over the past few years. Management has little control over the stock price in the short run and earnings-per-share may be under pressure for a host of reasons, but if book value a share is declining then your equity in the firm is eroding. This may be as a result of “non-recurring” write-offs or because a leveraged balance sheet has been shored up with the sale of additional shares at a discount to book value. If the management team is new, this may represent a necessary clean-up of the balance sheet, otherwise we are looking at current management’s abysmal track record.
If the company is in a clean-up phase, next check the size of the company, (in terms of revenues or staff count), compared to a few years ago. Management often favours acquisitions because a bigger company attracts higher payroll comparators, but when the trend reverses, the payroll may not follow suit. BlackBerry, for instance, enjoyed revenues in excess of $11-billion in 2013: More recently the annual run rate is closer to $2.5-billion. There may be great challenges in running a company facing a declining market share, but sheer size is not one of them.
You should also consider the size of the company’s pretax income in relation to the total executive remuneration. There is no right answer here: Superior management generating a growing income stream is obviously worth more than caretaker management in a mature industry, so you will have to decide how much value-added can be attributed to the management team.
In the case of Valeant, the $183-million CEO compensation for 2015 compares with $1.18-billion in 2014 pretax income, or about 15.5 per cent. In retrospect, those accounting numbers are now open to dispute, but the percentage was quite generous in any event.
The eye-watering compensation figures that we see in North America are typically the result of payouts from options and other stock-based calculations. A few years ago, it was commonly thought that these packages would align management incentives with the interests of the owners (shareholders). More recently, there is concern that they encourage short-term actions on the part of managers with one eye on the stock price while long-term projects of greater potential benefit are passed over. This raises a fundamental question: Do the actions of management have much of an impact on the stock price or are the payoffs primarily the result of good luck?
In the case of resource stocks, it isn’t hard to make a case that the stock price movement is mainly driven by the price of the underlying commodity. Management has no control over the price of globally-traded commodities and so any option-priced payoff is mainly a reward for being in management during the up phase of a cycle.
A paper by Moshe Levy of the Jerusalem School of Business Administration published in September, 2016, suggests that as much as 90 per cent of “Pay for Performance” dollars are actually “Paid for Luck” dollars. He asserts that a truly talented manager with an at-the-money option package who can improve her company’s performance by two percentage points over the industry average, (quite an achievement in the current low-growth environment), should expect only a 12-per-cent compensation increase over the level of the average manager in the industry. This is because of the effects of factors beyond her control. The equations in the paper are quite intimidating, but the conclusions are similar to active portfolio management; even if you have real talent, the volatility of the market is such that you must outperform the market by a wide margin for many years before the result can be attributed to skill and not luck.
Prof. Levy goes on to suggest that a better motivator would be to set the option strike price at a 50-per-cent premium to the grant day price and index that price to the overall market or the relevant industry sector.
Finally, you should be reluctant to approve generous compensation up front for managers who are brought in to turn around a struggling company in a mature or declining industry. I have no complex equations to support this view, but Warren Buffett expressed it clearly: “When management with a reputation for brilliance tackles a business with a reputation for bad economics, it is the reputation of the business that remains intact.”
Robert Tattersall, CFA, is co-founder of the Saxon family of mutual funds and the retired chief investment officer of Mackenzie Investments.Report Typo/Error
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