Chipotle Mexican Grill (CMG +2.07%) has been a tremendous growth story over the past decade. With co-CEO's Steve Ells (also the company's founder) and Monty Moran at the helm, Chipotle has generated explosive growth and rewarded shareholders with market-crushing returns since the company's IPO in 2006. While few question the leadership ability of Ells and Moran, a debate is under way with respect to how much this leadership is worth. Recently, just 23% of Chipotle shareholders voted in favor of the company's executive compensation plan.
Excessive compensation?
As disclosed in Chipotle's proxy statement, Ells and Moran each earned roughly $25 million in 2013 through a mix of salary, bonus, stock, and other compensation ($in millions):
| Salary | Bonus | Stock | Other | Total Compensation | |
|---|---|---|---|---|---|
| Steve Ells | $1.4 | $3.2 | $20.3 | $0.3 | $25.1 |
| Marty Moran | $1.2 | $2.7 | $20.3 | $0.2 | $24.4 |
Source: Proxy statement filed with the SEC on March 27, 2014
Few will argue with the fact that this is a lot of money. However, making the determination whether this compensation is excessive or not requires some additional considerations.
Context for the compensation plan
It is important to note that Ells' and Moran's 2013 compensation is heavily weighted toward the performance of the company. For example, the bonus paid for 2013 is based on operational success; management set a target based on income from operations, new restaurant average daily sales, comparable restaurant sales, and new restaurant weeks of operation. These targets are closely aligned to the growth metrics that investors look to when evaluating Chipotle's performance.
The majority of the executive compensation issued in 2013 relates to stock appreciation rights ($12.3 million of the $20.3 million in "stock" compensation noted in the table above.) $12.3 million is the fair value of the awards based on a series of valuation assumptions, but the executives will receive zero value from these awards unless they remain with the company for several years and the share price rises from the price on the date the awards were granted. As a result, the amount of real money that Chipotle's executives will receive is directly correlated with management's ability to continue to drive superior share price returns over the next seven years.
Alignment with shareholder interests and performance
With bonus and stock awards aligned with the metrics (both operational and share price) that investors care about, the compensation scheme at Chipotle passes the test of being aligned with shareholder interests. Quite simply, the executive team is highly motivated to maximize shareholder value.
In 2013, management continued a trend of remarkable performance against a peer group of all publicly traded companies in the restaurant industry with annual revenues greater than $500 million. Here's a snapshot of this performance:
| Sales Growth | Net Income Growth | Total Shareholder Return | |
|---|---|---|---|
| 1 year | 94th percentile | 74th percentile | 83rd percentile |
| 3 years | 97th percentile | 88th percentile | 77th percentile |
| 5 years | 97th percentile | 100th percentile | 95th percentile |
Source: Proxy statement filed with the SEC on March 27, 2014
While not all companies in this peer group are high-growth concepts, there are a number of well-regarded growth companies such as Panera Bread (PNRA +0.00%) and Starbucks (SBUX +2.07%), both of which Chipotle has outperformed. This performance highlights the strengths of Chipotle and management's track record of success.
How much is too much?
The debate heats up at the intersection of the fact that $25 million per year in compensation is such a huge amount and the fact that management has led Chipotle to tremendous market-beating growth. How much is visionary leadership worth when the company is performing well? There is no answer to this question, just a wide range of opinions.
To help form an educated opinion, here is a frame of reference comparing Chipotle's co-CEOs with a selection of peers in the restaurant industry:
| Chipotle | Starbucks | Yum Brands | Panera | Brinker | |
|---|---|---|---|---|---|
| Leader | Ells / Moran | Howard Schultz | David Novak | Ronald Schaich | Douglas Brooks |
| 2013 Compensation (in millions) | $25.1 / $24.4 | $16.8 | $10.0 | $2.7 | $4.2 |
| Company revenue (in billions) | $3.4 | $15.7 | $13.3 | $2.4 | $2.9 |
| Company market capitalization (in billions) | $15.7 | $53.0 | $33.0 | $4.2 | $3.2 |
| Five-year share price return | 565% | 440% | 121% | 209% | 192% |
Sources: Compensation data-Company proxy statements. Company financial data-Yahoo! Finance, May 21, 2014.
All five companies in the table above have generated solid market-beating returns over the past five years. While Chipotle has led the way with a return in excess of 500%, the compensation disparity between Chipotle's leaders and the heads of larger companies such as Starbucks and Yum! Brands is difficult to reconcile. This is likely the single biggest reason behind shareholders' rejection of Chipotle's executive compensation plan.
The bottom line for investors
The fact that Chipotle's co-CEOs each get paid significantly more than Schultz, a highly regarded CEO running a much larger business, is a yellow flag from a corporate governance standpoint. Shareholders have a right to be unhappy about this, and it is worth monitoring going forward.
However, the only real metric that should matter to shareholders is the performance of their investment. Even with high compensation costs, Chipotle has delivered best-in-class returns for shareholders and continues to develop opportunities for further growth. As a result, I personally do not object to market-leading compensation for management as long as there are market-leading returns for shareholders.
If Chipotle's performance does not continue to exceed targets, I would certainly expect total executive compensation to decline as it did for Panera CEO Ronald Schaich when it dropped from $4.4 million in 2012 to $2.7 million in 2013 as bonus and other incentive compensation targets were not met. Investors would have plenty of justification to protest high compensation if returns for shareholders aren't equally exceptional. Until then, the compensation issue remains more of a yellow flag than a red flag for investors in Chipotle.
