I've always admired Warren Buffett's ability to admire others (and profit from their excellence), even when he has a fundamental disagreement with them. Case in point: Berkshire Hathaway (NYSE: BRK-A) is one of the largest shareholders of Wells Fargo (NYSE: WFC), and Buffett has wonderful things to say about Wells' Chairman Dick Kovacevich, despite the two men's vehement and long-standing differences regarding the appropriateness and treatment of employee stock options.
So allow me to say this -- there is no management team in the homebuilding industry whom I find more competent than the folks running Motley Fool Hidden Gems recommendation M.D.C. Holdings (NYSE: MDC). Larry Mizel, David Mandarich, and their team didn't go way out on a limb during the boom times, which is frankly why M.D.C and Toll Brothers (NYSE: TOL) are among the precious few homebuilders that haven't seen their stock implode over the past year. Compared with Hovnanian (NYSE: HOV), Lennar (NYSE: LEN) and the like, M.D.C.s performance has been spectacular.
Still, shareholders expect managers of well-run companies to align their interests with shareholders'. In that respect, any outside M.D.C. shareholder would have to be completely deranged to vote "yes" for any of the items in the company's just-released proxy, relating to changes in how management and employees are compensated.
Ears of tin, feet of clay
Given that we can credit M.D.C.'s current outperformance to management's previous good decisions, I don't mind that Larry Mizel and his crew are paid well. And during the days of wild growth, well-paid they were, with Mizel pulling down more than $20 million in 2004 and 2005, as excellent operating results triggered massive bonuses for him and other managers.
No one at the company seemed to be upset that such monster payouts suggested a poorly constructed bonus system. But this past December, when housing markets throughout the country were in freefall, M.D.C.'s board elected to pay bonuses of $2 million each to Mizel and Mandarich, even though the existing incentive compensation formula would have paid them nothing. The proxy notes that the existing bonus plan failed to account for a soured market; in effect, the company paid a "lousy market" bonus.
I get this. It should be obvious that M.D.C.'s bonus structure was deeply ill-conceived. But I'm angered that when the homebuilding industry was so robust that a company could rake in cash even with a mentally impaired chimpanzee in charge, M.D.C. took no action to correct its incentive plan's obvious flaws. Now that the worm has turned, the board has decided that the lack of a bonus payment fails to reward management for a job well done.
I'd say "you can't have it both ways," but in fact, if shareholders approve proposals 2, 3, and 4 in M.D.C.'s proxy, management will be doing just that. When the market's in a bubble, they'll get tons of money as a reward for conditions beyond their control, and when times are bad, they'll get paid despite conditions beyond their control.
They're not stock options, they're a sure thing
Proposal 2 exchanges the (admittedly) flawed earlier bonus program for an arguably worse one. If passed, it will amend Mandarich and Mizel's bonus plan to include an "alternative minimum bonus opportunity" based on a nondisclosed formula involving 18 different criteria. In effect, the board will be able to point to almost anything to justify payments to the top managers of the company.
Proposal 3 suggests that the extraordinary decline in the company's share price means that stock options issued in the last few years, now deeply underwater, do not effectively motivate or help retain existing key employees (including Mizel and Mandarich). The company's asking shareholders to approve repricing these options down to current share levels. Proposal 4 requests that shareholders do the same thing for outside board members.
Doing so removes the "option" concept from stock options. They're meant to align shareholders and management, not to create a sure stream of additional cash flow for management even when the shares struggle. There are few things that I like less -- short of actual fraud -- than stock-option repricing. It's borderline dishonest. Not to mock the overall industry too harshly, but any employees at M.D.C. who don't look at the massive, industrywide layoffs and thank their deity of choice for still having a job are certifiable.
I've got one more qualm. Options are expensed at the price they're granted. Remember, Mizel and Mandarich, and presumably dozens of other managers at M.D.C., received massive bonuses based on the company's performance during those periods. But if you reprice the option, you're essentially saying that its grant price was too high, and therefore your hit to expenses in that period was too low. In short, if M.D.C. reprices its options from past periods, the reported earnings for those periods are too high.
Anyone want to join me in holding your breath that the bonuses paid in past periods will be adjusted for the additional "cost" of those options? Anyone? Bueller?
One last thing: Mizel and Mandarich hold many the options potentially eligible for repricing, yet the repricing's aimed at retaining and motivating option holders. Where else will Larry Mizel be more motivated than at a company he founded, and in which he owns more than $300 million in stock?
Make a good bonus plan
I hope that M.D.C. gets its compensation issues right, but the company's wholly, deeply self-serving to propose these specific changes right now. I'd like to remain an unabashed M.D.C. management supporter for years to come, but I don't think shareholders should allow themselves to be steamrolled by an absurd dislocation between the interests of management and outside shareholders. Unfortunately, individual shareholders have to hope that big institutional holders like Greenlight Capital, Ziff Capital, and Third Avenue Management, which collectively control 22% of total shares, vote against these proposals. Otherwise, there's almost no chance of their being rejected. (All the same, M.D.C. shareholders should make absolutely sure to vote their proxies.)
I believe that excellent managers should be highly compensated -- and M.D.C.'s team is certainly both. But shareholders should demand accountability, and a method that always pays insiders, whatever their performance, fails that standard on every level.
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