It's usually only government programs that see spending increases described as "cuts," but now we can also add Coca-Cola (NYSE:KO) to the list of places where it seems less really means more.
The beverage giant revamped its executive compensation practices last year by changing how long-term incentive awards will be doled out after it came in for some mild criticism from Warren Buffett.
Yet the only reason CEO Muhtar Kent's total compensation for 2014 is lower this year than last is because he turned down a $2.5 million bonus the board of directors awarded him. Had Kent accepted the big payout as he had the year before, his total compensation would have been greater.
Losing its effervescence
Led by investor Wintergreen Advisers, Coke shareholders staged a mini-revolt against the beverage giant's policies last year, believing they had the Berkshire Hathaway (NYSE:BRK-B) chairman firmly on their side. And while Buffett did tell the board of directors he was against the plan as he thought the compensation "excessive," when it came time to actually vote against the package he merely abstained. Kent ended up pocketing almost $18.2 million in 2013.
But Coke said Buffett's rebuke was enough to make it rethink how it distributed long-term incentive awards, and instead of skewing them in favor of stock options over performance awards, they'll now be split 50-50. There will also be fewer of them handed out.
Tiny bubbles bursting
According to Coke's proxy statement, Kent's total compensation for 2014 was $25.2 million, or 24% more than the $20.4 million he earned in 2013. But the bulk of the increase is the result of changes in the value of his pension and deferred compensation. Ignore them, and Kent's total is $18.12 million, virtually unchanged from the $18.18 million he made the year before.
But keeping it apples-to-apples, Kent's compensation would have been 13% higher this year had he turned down his bonus in 2013 as well.
Pay for non-performance
Moreover the folks at shareholder activist group As You Sow recently released their survey of the 100 Most Overpaid CEOs, which analyzed executive compensation using over 30 "red flag" indicators and concluded there is virtually no correlation between executive pay and company performance. It said Kent's 2013 pay package was No. 27 on the list of worst offenders for overpaying their CEO.
Using some basic statistical techniques to map actual performance to predicted levels of pay, As You Sow found Kent had "excess pay" of more than $8.3 million. Put another way, if Kent was really being paid based on how Coke performed, his total compensation would have been just $12 million that year.
That ought to be irksome for investors, but maybe they should also question why there are such big fluctuations in Kent's pension value, which happens primarily because Coke manipulates the discount rate it uses to determine the present value of its pension liabilities.
Indebted to you
When looking at pension plan accounting, there are two aspects to consider: the rate of return a company earns on its investments and the rate it uses to discount future obligations back to a present value. Playing with either one can allow management to massage results for greatest effect.
According to its annual report, Coke figures it can earn 8.25% on its investments even though more than half of its plan assets are in non-equity investments. This suggests those assets are really more low-risk than high-return (which is appropriate for a pension plan), but that allocation also makes it extremely difficult to achieve the kind of returns the pension plan needs.
Indeed Coke's pension liability is quadrupling from $34 million in 2014 to $134 million this year because of the poor performance of its investments and the changes it made to the discount rate.
The beverage giant used a 4.75% discount rate in 2013 before dropping it to 3.75% last year, a move expected to cause Coke's pension expense to jump by $94 million. That would certainly provide enough incentive for Coke to be optimistic about its investing acumen.
Digging a deeper hole
Worse, the fair value of Coke's pension plan assets totaled $8.9 billion at the end of last year while its obligations were over $10 billion, leaving a $1.1 billion deficit, which is exacerbated by its use of unrealistic assumptions. That's also nearly half a billion more than all the profits it earned in 2014.
While Kent's long-term incentive pay should see an $8 million reduction this year because of the changes forced on the board, investors will still want to keep an eye on Coca-Cola's pension maneuvers. They not only serve to inflate the CEO's compensation, but they also have significant ramifications on the company's financial health.