British advertising giant WPP Group (NASDAQ:WPPGY) wanted to pay its CEO, Sir Martin Sorrell, an amount that could approach $160 million over three years once incentives were taken into account. Two large, powerful shareholders, the National Association of Pension Funds and the Association of British Insurers -- which between them control approximately half of all value on the British stock market -- urged investors to vote against the plan.
And they did. Nearly 48% of all WPP shareholders either voted against or abstained, giving WPP a narrow victory. Take out the votes from all the insiders at the company, and even though WPP has permission to implement its compensation plan by virtue of the bylaws, it should be clear that the investment community is not the slightest bit amused. Since I featured WPP in Stocks 2003, I find the willingness of the company's board to overpay its top executive extremely disturbing.
WPP has grown by leaps and bounds through acquisitions, most notably the boffo $4.8 billion takeover of Young & Rubicam in 2000. The company's shareholders have unquestionably benefited from the guidance of Sorrell, who bought into a sleepy wire and plastics products (thus "WPP") in 1985 and transformed it into a global powerhouse. Even so, his pay package seems to have morphed from the generous into the absurd. WPP's defense: Since Sorrell has such a large portion of his assets invested in the company, his interests are aligned with other shareholders'.
I've always found this line of reasoning bizarre. Oracle (NASDAQ:ORCL), Apple (NASDAQ:AAPL), and Siebel (NASDAQ:SEBL) have used it in the past, but it has never made sense. When a top executive is also a founder/massive shareholder, isn't he or she already deeply aligned with shareholders? What is it about some gargantuan pay package that would make this any more true? Furthermore, there are plenty of potential investors who look at abusive pay packages as a deal breaker.
Personally, I'd rather drink vomit than invest in Oracle. This really has nothing to do with any prospects that I think Oracle has or does not have. But Oracle's 40 million share option grant in 2000 to CEO Larry Ellison simply left me awestruck. If you recall, at 10% appreciation at the time, this would have generated a pay package of more than $440 million for Ellison.
Oracle argued at the time -- which WPP reprised this week -- that such packages align the managers' interests with shareholders. WPP went further to state that Sorrell has a significant amount of his net worth tied up in the company. Ellison, for his part, owns just shy of a quarter of Oracle, a stake valued at the moment at $16 billion.
My question is: Isn't that motivation enough? I mean, the $440 million to Ellison, even if the stock did really well, is little more than a rounding error. It wouldn't make much of a difference in his total net worth nor his net worth attributable directly to Oracle stock. Sorrell owns a substantial portion of WPP Group as well. Does a package worth so much money potentially make him more motivated? I don't really think so. He's got plenty enough motivation to see WPP continue to succeed as it is.
Superior performance, superior pay
As far as I know, neither the British pension funds nor the insurers are arguing for some socialistic "pay equality" nonsense. I certainly believe that people who are outstanding stewards of their companies should be paid very, very well.
I do not believe, for example, that Warren Buffett's model is necessarily a good one. Buffett, the chairman of Berkshire Hathaway (NYSE:BRK.A) pays himself about $290,000 per year, and grants himself no other form of bonus, a level almost laughably below the normal pay rate for executives -- almost none of whom have a capital appreciation record that approaches Buffett's even over the short term. Executives should be paid for success, and there should be no doubt that shareholder fortunes hang in the balance based on decisions made by the person whose fanny sits in the big chair at any company.
Buffett has some luxury to pay himself such a small salary because, as 38% owner of Berkshire, there is no amount of money he could pay himself that would make that much of a difference. His net worth goes up when the stock price does, and drops when the stock price drops. As Buffett has never sold any of his Berkshire Hathaway stock, if -- horror of horrors -- the company were to collapse, 99% of his vast wealth would evaporate.
Most executives of public companies are not in the same position of having founded the company they manage (or at least in its present form). In order for them to benefit from their decisions, their incentive packages would necessarily seem large in any given year. But Sorrell does. So do Ellison, Jobs, and Siebel. As such, the compensation and options packages they've rammed down their shareholders' throats just don't make much sense. The benefit to them is relatively small, and the cost to shareholders is potentially very large, not just in the form of dilution and lower cash reserves, but also in making the stock look less attractive to people and funds as a result.
Did you say funds?
Mutual funds and other institutional money have, unfortunately, been part of the problem. Institutional investors comprise a much larger percentage of the market than individuals, and the lack of activism among this component of the "consumers" of equities is nearly pandemic.
Complicit in this is the high level of turnover among funds. The average fund holds the average stock for well less than one year anyway, so why get so distressed about compensation issues at an individual company? Additionally, many fund companies are public, and as such the management thereof has benefited from the same environment that allows CEOs to essentially pay themselves as much as they want. Why would they rock that boat? Finally, until now, fund managers haven't been required to disclose how they voted their clients' shares, so since there's not that much money in activism....
I think mutual funds were up in arms about the new SEC requirements that they make their proxy votes available to shareholders not because of the expense of disclosure, but rather that many of them will now have to bother voting at all.
But that's another topic. It's also past tense, since in the span of several months, the SEC has voted to require funds to disclose to shareholders how they voted their proxies, coupled with the fact that this week, as Tom Jacobs reported, companies must put all equity compensation plans up for shareholder vote. These two rules in tandem could have shed a great deal more light on executive compensation abuses.
This, once again, could take a little bit of power away from those shadowy executive compensation consultants and their bogus standard of keeping executive pay at individual companies "competitive" with that of other companies. A little bit of light on this process and a little bit of additional pressure on boards to control compensation couldn't hurt.
Whether any of this matters depends on investors playing a more active role. In the last few years, we've seen CalPERS, TIAA-CREF, and other big institutions swing their weight around regarding corporate governance issues, but from most there is a deafening silence. Moreover, most investors buy into mutual funds because they don't want to think about such things as proxy votes. And once again, at companies where shares are dominated by management or insiders, it doesn't really matter what the minority shareholders want.
All of this makes the Sorrell vote all the more extraordinary, even though the effort failed. Ideally, the folks at WPP will not look at this as a mandate. Take out the insider votes and they would have lost the compensation vote. Badly. How many investors will sell in disgust, or carry with them a vague distaste toward WPP as a result? The answer is not zero.
Michael Eisner at Disney (NYSE:DIS) saw his reputation go from corporate savior to greedy villain over his pay package. It is an article of faith that Disney stock will rise the day he steps down. Yeah, maybe there are always more suckers out there, but insider avarice costs shareholders in several different ways. It's possible that we won't be so powerless anymore.
Fool on!
No, Bill Mann wouldn't really drink vomit. He has beneficial interest in Walt Disney. The Motley Fool is investors writing for other investors.
