Despite claiming an overwhelming victory in the approval of its equity incentive plan a week ago, Coca-Cola (NYSE:KO) appears to be bowing to minority pressure to amend the scheme. David Winters, CEO of Wintergreen Advisers, wrote a letter to Coca-Cola's board last night, which was made available to me exclusively prior to its release later this morning. Wintergreen has publicly opposed the plan for weeks, and in last night's letter Winters' anger with the way the board has behaved is palpable. It begins:
Warren Buffett has publicly stated that he spoke with Coca-Cola Chairman and CEO Muhtar Kent multiple times leading up to Coca-Cola's annual shareholder meeting and expressed his lack of support for the 2014 Equity Plan. Mr. Buffett has also said that he spoke with his son Howard Buffett, who serves as a director of Coca-Cola, regarding the 2014 Equity Plan. In an interview with CNBC hours after the shareholder meeting, Mr. Buffett stated that the plan "really struck me as quite excessive." We would like to know whether Mr. Muhtar Kent or Mr. Howard Buffett made the Compensation Committee or the full Board of Directors aware of Mr. Warren Buffett's views on the 2014 Equity Plan.
He goes on to ask whether "as head of the Compensation Committee, Ms. Lagomasino was informed of Mr. Buffett's views?" In addition, the letter questions Coke's claims that "the new plan is not any more dilutive than historical plans and programs."
The letter concludes:
As investment advisor with a fiduciary duty to our longtime shareholders, we are deeply concerned that Coca-Cola is becoming known not for great products but for excessive management compensation, the trampling of shareholders' interests, and a willful disregard for the valid concerns of its largest shareholder.
Last week, I wrote questioning how much support Coke actually had for the plan's introduction, with less than half of all outstanding stock actually supporting it. Since then I have spoken in detail to both Coca-Cola and another investor who voted against the plan, rather than abstaining from it, as Buffett's Berkshire Hathaway (NYSE: BRK.A) did.
The dilution question
In a discussion on Monday, Coke's Corporate Secretary, Gloria Bowden, indicated that although the hypothetical potential for dilution was at the levels claimed – 16% by my calculations – actual dilution never reached that level because the company took many steps to mitigate that.
For example, every time an employee exercises a stock option, the company uses the proceeds from the option exercise to buy back shares on the open market. This cancels out the "transfer of value" that many of the plan's opponents were most critical of. She also said that even if all the outstanding stock awards were exercised at once, that would only lead to potential dilution of about 8% of outstanding stock, and far less than that once shares were repurchased with the proceeds.
Executive officers do not exercise their stock options, typically, until toward the end of their term, usually 10 years, and even then are required to hold half of the resulting net stock for an additional year.
However, at least some of the objections to the plan surround the generosity of awards to CEO Muhtar Kent. Based on my calculations from the proxy statement, Kent has almost 12.6 million outstanding stock options and has been receiving grants of about 2 million of them a year for the past three years. Given the concerns over Coke's performance voiced by some of the shareholders, that level of potential compensation would seem to me to be excessive.
Bowden noted that the plan received broad investor support. She also indicated that the company had spoken to many of the investors who ended up voting against the plan, but there were no consistent objections. Sometimes they simply disagreed with stock options altogether, sometimes it was the dilution, sometimes it was the plan structure. If it didn't line up with their voting guidelines, investors would vote against it.
When asked about Buffett's abstention from supporting the plan, I was referred to the company's statement following the annual meeting, which includes the statement: "The Coca-Cola Company Board respects Mr. Buffett's philosophical stance on equity-based compensation."
However, his indication that the next CEO of Berkshire Hathaway would receive stock options would appear to show that the different stances are not so much philosophical as numerical.
Similarly, one of the other major Coke shareholders – the Florida State Board of Administration – to have voted against the plan voted for the company's executive pay policies (it had voted against them last year) while voting against the plan.
In an interview yesterday, Michael McCauley, Senior Officer, Investment Programs & Governance for FSBA, said that the Coke plan would lead to a dilution level higher than three-quarters of its peer group. He added that in their discussions with management at Coca-Cola, apart from the internal metrics that indicated concerns, they told them that each one of their three external advisors – proxy advisors Glass Lewis, and ISS, and consultant Farient Advisors – were all red-flagging the plan as excessive.
McCauley added that they had voted against Coke's 2008 plan based on similar concerns. Coincidentally, McCauley noted, in a similar conversation with management at Pepsi (NYSE:PEP) that same week, no such concerns were aired. FSBA also voted against two directors, Alexis Herman and Barry Diller, because "both sit on three boards, in addition to Coca-Cola, and are both employed full-time, creating concerns of insufficient time and resources to dedicate to each board." In line with its support of separating the positions of CEO and chairman – combined at most U.S. companies – if there are concerns about company performance, it also supported a shareholder resolution to create an independent chairman at the company.
Separately, McCauley said that he was a little disappointed with Buffett's abstention rather than no-vote, though he understood his position since they too had nothing against management and the CEO. In a survey by run by the CFA Institute, most chartered financial analysts indicated that they were unimpressed with Buffett's rationale. Asked about his decision not to back up his disapproval with a "no" vote, nearly two-thirds of respondents, 64%, disagreed with Buffett's abstention, whereas 22% felt the abstention was acceptable.
If it is true that Coca-Cola is bowing to shareholder dissatisfaction with this plan, it is another victory for shareholder democracy. Perhaps more importantly it is a warning shot over the bow of the SEC that it needs to reconsider how support for both management and shareholder resolutions is calculated. Coke's claim for 83% support does not make sense if 17% of shareholders have prevailed.
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Paul Hodgson has no position in any stocks mentioned. The Motley Fool recommends Coca-Cola and PepsiCo. The Motley Fool owns shares of Coca-Cola and PepsiCo and has the following options: long January 2016 $37 calls on Coca-Cola and short January 2016 $37 puts on Coca-Cola. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.