Big Pay Packages Are a Powerful Weapon
for Activist Investors
Shareholder votes have focused
attention on the link between compensation and company performance.
Here's how hedge funds use executive pay as a lever.
By
Anders Melin
February 2, 2018 5:01 AM
From
Bloomberg Markets
Attacking CEOs! Shining a light on
boards’ shortcomings as independent overseers! Girding for proxy
battles!
To do those kinds of things, activists
often focus on executive compensation. Pay has become even more
important in the years since the financial crisis, which underscored
how poorly thought-out incentive structures can motivate bad behavior.
Shareholder votes on executive
compensation have focused the attention of some of the world’s largest
institutional shareholders on the link between pay and company
performance. That’s opened an additional avenue for activists to shore
up support for their proposals, says Steven Balet, a managing director
and activism expert at
FTI Consulting Inc. “Activists don’t necessarily have an issue
with the quantity of pay, which makes sense coming from a hedge fund
that charges 2 and 20,” Balet says, referring to the standard 2
percent of assets and 20 percent of profits that funds typically
collect. Instead, he says, they view pay as “a means of driving
behavior.”
Consider the campaign
by New York-based hedge fund Starboard Value LP against Darden
Restaurants Inc. In late 2013, Starboard
disclosed it had acquired a 5.6 percent stake in Darden, the
operator of the Olive Garden and Red Lobster restaurant chains. The
next year the activist investor came out with a
294-page
presentation, which famously said that Darden had stopped salting
pasta water to get an extended warranty on its cooking pots.
Starboard also argued that Darden’s
incentive structure had fueled bad decisions by executives. Because it
focused on total sales and net earnings per share, management had
tried to expand the business regardless of cost, the hedge fund said.
And after the board suddenly shifted compensation targets to link some
awards to same-restaurant sales growth, Darden five months later moved
to sell off Red Lobster, a poor performer under that metric. According
to Starboard, the pay program “encouraged excessive spending as the
answer to every problem,” regardless of whether it would create or
destroy value.
The activist’s pitch was persuasive. In
October 2014, Darden’s shareholders
voted to oust the entire slate of incumbent directors and handed
the reins to Starboard Chief Executive Officer Jeffrey Smith and his
handpicked team. The new board sped up improvements to the pay program
that Darden had begun after Starboard disclosed its stake. They linked
bonuses to adjusted per-share earnings and same-restaurant sales. And
they changed long-term awards to pay out mainly in shares tied to
return on invested capital and stock return relative to a group of
about 50 other restaurant companies. They also cut stock-option
grants.
Gene Lee, who stepped into the CEO role
after the vote, was awarded $5.8 million for his first year, according
to the Bloomberg Pay Index. Since then his pay has risen to $10
million; Darden’s shares returned 150 percent through Jan. 23, more
than double the gain of the S&P 500 for the same period.
You can get the details
on executive pay on the Bloomberg terminal. Head to {PAY <GO>} to see
who the highest-paid public company executives are in the U.S. based
on awarded pay, which values equity at each company’s fiscal yearend.
Click on the Analysis tab for a new enhancement that lets you review
pay details for more than 1,000 U.S. CEOs. The Performance vs
Non-Performance Pay enables you to see which executives have the
greatest percentage of their compensation tied to company results. The
Performance Metrics Matrix and the Performance & Vesting Periods tabs
let you explore what overarching goals awards are tied to, their time
frames, and when executives will be able to pocket the pay. You can
also narrow your queries to a specific industry to compare the
compensation plans with their peers’.
|
For details of CEO pay at major U.S. companies,
go to {PAY <GO>} on the Bloomberg terminal. |
Taking that a
step further, you can run searches on the Equity Screening (EQS)
function using the new pay metrics or data on say-on-pay, which refers
to shareholders’ right to vote on management remuneration. To see
Russell 1000 companies with the lowest support on pay, for example, go
to {EQS <GO>}. In the Add Criteria field, enter RIY and click on the
Russell 1000 Index match. Next, enter Say on Pay, click on the Say on
Pay Support Level item, and press <GO>. Click on the See Results |
WATC button for a list of companies in the benchmark that you can sort
by the percentage of shareholders supporting management on pay.
That kind of search may help you spot
the next target. Pay will remain an important metric in activist
campaigns, according to Balet. “They use it to show that a board is
beholden to management,” he says. “And it’s effective because it’s a
direct way to attack a CEO.”
Melin
covers executive compensation at Bloomberg News in New York.
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