"Managers like to withhold unrestricted, readily distributable earnings from shareholders, to expand their corporate empire over which the managers rule, to operate from a position of exceptional financial comfort."
-- Warren Buffett in a letter to shareholders
During the go-go years of the tech bubble, we witnessed many companies withhold significant amounts of cash -- wealthy tech darlings Dell (Nasdaq: DELL ) , Cisco, and Microsoft (Nasdaq: MSFT ) . The option abusers were clearly stacking the deck in their favor. When you're issuing oodles of options, one way to ensure that those options are worth more in four years is to simply let the cash pile up on the balance sheet. To its credit, Microsoft started expensing options before it was required to and now pays a dividend of just over 2%. Dell, on the other hand, seems to be content to sit on its cash and pursue acquisitions. Based on its past history, I think it's unlikely that will prove to be a profitable path for shareholders.
I've written before about how most CEOs are lousy investors. The allocation of capital is a critical question to ask of any of your potential management teams. While Wall Street has taken most of the heat for leverage, overcompensation, and corporate excesses, smaller companies aren't immune to empire-building. It hits home with one of my investments, Susquehanna Bancshares (Nasdaq: SUSQ ) . This is a once-proud community bank from Lititz, Pa., that was led astray.
Running a bank isn't rocket science. You borrow money, in the form of deposits, lend it out at a higher rate, and book the spread as profit. Unfortunately, Susquehanna engaged in some serious empire-building at a very inopportune time.
Since 2004, Susquehanna has grown considerably:
- Total assets doubled from $7.5 billion to $13.7 billion
- Employees increased from 2,027 to 3,000
- Revenue grew 21% $318 to $385 million
But this growth came at a significant cost to shareholders:
- EPS dropped off cliff, from $1.60 to -$0.05 per share
- Shares outstanding increase from 43 million to roughly 129 million
- Tangible book value per share declined from $10.71 (2004) to $7.25 (2010)
- The dividend has been decimated -- from $0.89 per share to $0.04
With that kind of performance, you'd think the CEO would have been out the door long ago, right? Not so. A recent read of the company's proxy statement is indicative of what got Susquehanna where it is today:
The compensation committee determined that Restricted Stock Unit Awards were essential in order to continue to provide a continued incentive to executive officers and to reward their performance during 2009. [They are asking for approval to issue 25,000 shares of restricted to stock to the CEO William Reuter and 15,000 each to the other executive officers]
Note that this company had to borrow money from the government and still hasn't paid it all back. Mr. Reuter received over $1 million in total compensation in 2006, 2007, 2008, and 2009. Clearly the board of this small bank is content to reward empire-building. Usually these types of rewards go to the CEOs who are brought in to turn the ship around. In this case, they're rewarding the person who caused the mess.
When assessing management teams, make sure you read the proxy statement and investigate the quality of the board of directors. A good compensation system would include a much larger percentage of executive pay coming from meeting certain shareholder friendly metrics like growth in book value per share.
Perhaps at a future shareholder meeting someone might suggest that the CEO of Susquehanna be required to hold five years' worth of pay in company stock and that they be required to purchase that, along with fellow shareholders, on the open market. I'm hopeful that these two changes would go a long way toward restoring the luster of this bank, and that one day the stock performance will be representative of the proud community and loyal shareholders that the bank serves.