Lennar Corporation (LEN -1.51%) CEO Stuart Miller saw his annual compensation increase by 40% between 2012 and 2013 -- the latest year for which data is available -- owing to a massive increase in the company's pre-tax income, which more than tripled in the same time period. Pre-tax income also tripled at PulteGroup (PHM -0.50%), and annual compensation for its CEO Richard Dugas more than doubled. But that's where the similarities end.
Before the financial crisis, the homebuilding industry was one of the poster children of CEO excess, with executive bonuses often matching those of Wall Street CEOs. In fact, I once wrote an article with the headline: "Shock! Horror! Toll Brothers CEO Receives No Bonus for 2007" because it was the first time in 16 years that the CEO of Toll Brothers had not received a bonus, which in some cases had amounted to more than $30 million.
But those were the bad old days.
Well, sort of. Little seems to have changed at Lennar, while reforms at Pulte have gone a long way to making compensation policy there both effective and effectively tied to performance.
| Company | CEO | 2013 Annual Bonus | 2013 Total Annual Pay | 2012 Annual Bonus | 2012 Total Annual Pay |
|---|---|---|---|---|---|
| Lennar | Stuart Miller | $8.3 | $9.4 | $5.6 | $6.7 |
| Pulte | Richard Dugas | $8.2 | $9.4 | $3.3 | $4.6 |
Source: Company proxy statements. All numbers in millions.
Lennar's bonus plan
Miller earned $9.4 million of annual pay in 2013 according to the company's proxy statement this year, compared to $6.7 million in 2012. Most of that was a cash bonus, which is based on 2% of pre-tax income under normal circumstances. Last year, his bonus was reduced to 1.25% of pre-tax income, or $8.3 million, compared to a bonus of $5.6 million based on 2% of 2012's pre-tax income. This was partly because 2% of 2013's pre-tax income would have generated a bonus of $13.6 million. But that's not the real problem with the plan. The real problem is that it is solely based on pre-tax income, meaning it's too easy for executives to "game" the system. Also, this is a form of bonus that might have been appropriate for the first five years of the company's history, but can no longer be considered appropriate for a mature homebuilder.
To make matters worse, the company's long-term incentives are based on a kind of multiple choice of performance measures. Long-term incentives, or LTIs, are based on revenues, homes sold, gross margin, active community count, and debt-to-capital ratio. But in order to earn the LTI, performance must hit target at any three of the five measures. What's more, performance seems to be measured over any six-month period, so it can hardly be considered long-term.
Pulte's bonus plan
Dugas also earned $9.4 million in annual pay in 2013 according to the 2014 proxy statement, compared to $4.6 million in 2012. The increase was largely driven by the cash bonus that rose from $3.3 million to $8.2 million, but it is based not just on pre-tax income, but also adjusted gross margin, SG&A, and inventory turns, making results much harder to manipulate. Pulte maxed out on all these measures.
Even better, LTIs that paid out in 2013 at Pulte are based on economic profit (return on capital less the working average cost of capital) over three years, a difficult performance metric to manipulate. The latest LTIs are now based on return on invested capital, with a total stockholder return modifier, a combination that is also tough to "game." Consequently, both annual cash bonuses and LTI payouts tend to be lower at Pulte than at Lennar, even though operational performance is just as good.
The recovery
Lennar's stock price rose by more than 147% over the last five years, while Pulte's rose by only 51%. Pulte, however, was dealing with major losses during 2011 and 2010. Nevertheless, if I were making an investment decision based on how well I thought the CEO was being incentivized to deliver value to shareholders, I'd buy Pulte.
