Are Nuance Communications' Executives Overpaid?

Here's a fun fact: Paul Ricci, the CEO of Nuance Communications (NASDAQ: NUAN  ) was the 16th highest paid CEO in the world last year, raking in more than $37 million in compensation.

Now, take a wild guess how Nuance's stock has preformed since the beginning of 2012.

NUAN Chart

NUAN data by YCharts.

There's certainly something to be said about an executive team's lush compensation package when it translates into outperformance for investors. However, it's clear Ricci and his team have not been earning their keep. Not even close.

Misaligned interests
While I agree that executives should be well-compensated to align their interests with the long-term concerns of an organization, I think there is a strong disconnect between Nuance's executive compensation practices and the best interests of the company.

Fiscal Year

Total Executive Compensation (millions)

Nuance Operating Income (millions)

2010

$27.7

$32.9

2011

$32.4

$52.6

2012

$55.3

$126.2

Total

$115.4

$211.7

Source: Nuance Communications.

Let's keep in mind this compensation package is for only five individuals. We'll have to wait until later this month when Nuance files its annual proxy statement to get official word on its fiscal 2013 executive compensation figures. For reference, Nuance's fiscal 2013 operating income declined by 61% to $48.5 million and the company's total stock-based compensation plan for all employees declined by 9% year over year to $159.3 million. The fact that total stock-based compensation has fallen slightly could indicate the executive compensation has also fallen slightly.

Putting it bluntly
If Nuance eliminated its over-the-top executive compensation practices, it would easily beat Wall Street profitability expectations. Of course, pleasing Wall Street isn't the end-all-be-all objective of a company's existence -- but cutting back on unjustified levels of compensation could signal that Nuance's executive team is becoming more aligned with the long-term interests of the company. However, it's going to difficult for investors to rally for sweeping change, even though Nuance's earnings continue to be a major disappointment.

A tough pill to swallow
Back in August, Nuance implemented a "poison pill" provision, giving the company the ability to issue an unlimited amount of shares to dilute the voting power of investors that acquire more than 20% of Nuance's stock. This was implemented at a time when activist investor Carl Icahn had already acquired more than 16% of Nuance's shares. Since then, Nuance has agreed to put two of Icahn's people in place, and Icahn has agreed not to acquire more than 20% of Nuance's stock, nor to solicit proxies for change on any matter until after its annual shareholder meeting in 2014.

Although Nuance has clearly been on the defensive by implementing a poison pill provision, it's certainly an encouraging sign that it's willing to put a few of Icahn's people on its board. This could signal that the company is open to discussions about sweeping changes. However, with the poison pill provision in place, investors should recognize that the ball is ultimately in Nuance's court when it comes to making any big decisions.

The view from within
Culture is one of those intangible elements that can determine the difference between a mediocre and truly excellent business over the long-term because it can help a company maintain its long-term competitive advantage. As former Costco CEO Jim Sinegal once put it, "Culture is not the most important thing -- it's the only thing."

According to employee data compiled from Glassdoor, Nuance has a potentially serious culture crisis on its hand.

Year

Company Rating

Paul Ricci Approval Rating

Senior Management Rating

Career Opportunities

2009

2.5

N/A

2.4

2.5

2010

2.8

36%

2.3

2.6

2011

2.6

N/A

2.2

2.3

2012

3.1

65%

2.7

3.0

2013

2.7

36%

2.3

2.6

Source: Glassdoor. Company ratings based on a 5-point scale: 1.0 = very dissatisfied, 3.0 = OK, 5.0 = very satisfied.

Although there are many contributing factors at play, it's hard to argue that Nuance's poor stock performance and lush executive-level compensation packages aren't hurting employee morale. If management doesn't acknowledge that culture is an extremely important aspect of ensuring the company's long-term health, it risks becoming a business only capable of delivering mediocre results. As Warren Buffett once put it to investors, "It's far better to buy a wonderful company at a fair price than a fair company at a wonderful price."

Voting with your dollars
For better or worse, every time you buy a stock, you're effectively endorsing the underlying organization's practices. If you are a Nuance shareholder, you're endorsing the fact that five executives have gotten rich at the expense of the company's profitability. This practice may have undermined shareholder wealth, which hasn't been to your benefit. In addition, this practice is not necessarily in the company's best financial interest, considering these five executives made the equivalent of 55% of Nuance's cumulative operating income between fiscal 2010 and 2012.

At the end of the day, shareholders have the power to "vote with their dollars" and align their investments alongside their morals. Personally, the excessive executive compensation was one of the reasons I sold my Nuance stake a few months ago.

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