Is CEO Reed Hastings Betting on Big Gains For Netflix Inc. Stock in 2015?

Source: Netflix.

Digital video maven Netflix (NFLX +0.01%) just published the compensation structure for its named executive officers. In an 8-K filing with the SEC, the company revealed smaller base salaries almost across the board -- but also much larger stock option allowances.

Is Netflix's board of directors punishing the management team for a disappointing 2014 -- or could the executives themselves actually be betting on a return to form in 2015?

What's new?
Let's start with the most obvious figures: base compensation. Here's how that number works out for Netflix and its five named executives:

From this perspective, CFO Wells got a big upgrade, and streaming guru Peters held steady, while the most visible trio of Netflix executives received huge pay cuts.

But wait -- there's more!

These Netflix leaders also saw big changes in their stock-based compensation awards.

Netflix CFO David Wells. Source: Netflix.

Starting from the bottom of the list, David Wells more than tripled his stock option allowance to $1.675 million. His cash-plus-options compensation rose by 145% year over year.

Greg Peters almost tripled his options haul as well, landing his total base compensation at $3.725 million. That's an 86% increase.

Neil Hunt's stock options in 2015 will only be 7.5% richer than his 2014 collection. His combined base pay in cash and options actually fell by 18% to $2.875 million. But Hunt has a special wrinkle in play this year. Previously, Netflix didn't offer any bonus payments, even to its executive leadership. "The Company expects all individuals to perform at a level deserving of a bonus and therefore such bonus amounts are taken into consideration in determining total compensation for the Company's employees," Netflix said in last year's proxy statement.

Neil Hunt is estimated to qualify for a generous $5 million cash bonus next year. Sarandos might get $2 million, and Peters is slated for a $1 million target bonus, but neither Wells nor Hastings will draw any bonus payments at all.

Sarandos may have slashed his cash salary drastically, but he also multiplied his stock-based compensation many times over. That line item rose from $2.2 million in 2014 to $9.6 million for 2015, so don't cry for Ted Sarandos.

Finally, you'll see plenty of headlines claiming that CEO Reed Hastings took a massive pay cut in 2015. That's true for his all-cash paychecks, but his options awards soared from $3 million to $13.7 million. Overall, Hastings almost tripled his total compensation. It's just delivered in a different format this time.

Netflix content guru Ted Sarandos. Source: Netflix.

Okay, but why ?
Why the big swings between stock-based and cash-based paychecks? Well, here's what's going on.

Last year, each named executive was able to allocate up to 50% of his paycheck to the stock-based side of the equation. Hastings, Hunt, and Peters maxed out their 50% elective stock-based takes, while Wells and Sarandos stopped at 37% and 44%, respectively. These rules also applied to all salaried staff members at Netflix.

But the rules changed for 2015. Not just for the named officers, but for everyone on the company's payroll.

Now, all Netflix employees can pump as much of their salary as they like straight into the stock option plan, as the 50% cap was removed.

Reed Hastings chose to take 93% of his salary in the form of stock options. Sarandos settled for 91%. Going down the scale, Greg Peters wanted 73% of his 2015 base pay in the form of stock options, and Neil Hunt stopped at 66%.

Only David Wells elected to take less than half of his compensation in stock-based form, falling all the way to 46%.

On the surface, this looks like a very reassuring vote of confidence in the stock's likely future. Why would these insiders elect to take most of their compensation in stock-based form otherwise?

As it turns out, there are other reasons than a simple expectation of rising share prices. In this case, it has to do with tax payments.

Enter section 162(m) of the U.S. Tax Code, which has been part of the taxation framework since 1994.

Netflix cited this section of the law when it asked shareholders to vote for a performance bonus plan at this summer's shareholder meeting. The section limits corporate income tax deductions to the first $1 million of any employee's compensation (except the CFO!), but the restriction doesn't apply to performance-based bonus payments.

So, introducing a large potential for bonus payments can reduce Netflix's income tax bill. Sometimes, tax strategies override philosophical positions like expecting everyone to perform on a bonus-earning level. The plan was approved by an overwhelming majority of shareholder votes, and here we are.

Netflix toes the line of the section 162(m) rules, here, with every named officer except CFO David Wells taking exactly $1 million in cash-based pay checks. Wells, being exempt from that tax-reducing requirement, grabs a bigger cash pile in 2015.

Netflix CEO Reed Hastings. Source: Netflix.

The final verdict
So, Netflix isn't actually slashing executive paychecks with wild abandon. These adjustments are simple tax-code adjustments, and they actually amount to very large total compensation boosts for everyone involved. Even Neil Hunt, who appears to get the short end of the stick based on cash and stock compensation alone, ends up with a 125% increase in total compensation if he hits his performance targets under the brand-new bonus program.

We'll know more about the bonus program by the end of April, when Netflix is slated to publish the proxy statement for its 2015 annual shareholder meeting. That's where most companies spell out the performance parameters of their executive bonus programs. Until then, you should know that these five Netflix executives aren't being punished with tiny 2015 base salaries, nor making any grandiose statements about the stock's future by going all in on share-based compensation.

The shift into mostly stock-based and bonus-branded payments isn't exactly a grand vote of confidence in the company's direction, either. It's simply a result of the section 162(m) tax deduction rules that Netflix finally decided to exploit. If it's a quality assessment at all, I'd focus on the large total compensation increases as a reward for jobs well done in 2014 -- with a new set of rules on how to qualify for big bonus checks in 2015.