Paying for Failure: Lavish Pay Independent of Performance

March 24, 2014

Investor interest in executive compensation and pay for performance is as strong as ever. Mandatory “say on pay” votes and enhanced disclosure of “golden parachute” compensation have focused attention on how effectively companies link executive pay to company performance.

Never is this clearer than when companies give generous goodbye packages to executives who depart after failing to deliver performance. These packages are the natural consequence of all-too-common compensation practices that promise spectacular rewards for success – and still pay for failure. 

An example is the case of FTI Consulting, Inc., a consulting firm with rapid growth over the last decade but slowing growth in the past several years. In 2012, facing both succession concerns and long-term incentives that seemed unlikely to be earned, the company renewed long-time CEO Jack Dunn’s employment agreement through 2015. In exchange, Dunn received a $4.5 million cash bonus and a guaranteed $1 million annual payment for five years following his departure, along with a generous $1.5 million base salary and continued short- and long-term incentive awards.

Facing a slowdown in performance over 2012 and 2013, Dunn resigned in December 2013. His termination, as is typical, was considered “without cause” and triggered full vesting of his outstanding equity awards – much of which was sold off within days – together with a $2 million cash lump sum severance and continuation of Dunn’s $1.5 million salary through 2015. Between retention awards, regular salary, and severance awards, Dunn will have received nearly $10 million in cash completely unrelated to performance for his service, with an additional $3 million in salary continuation and five annual $1 million payments due under his employment agreement. The “retention agreement” from 2012 became a golden parachute that paid off nearly $18 million in cash, regardless of the company’s performance, together with significant value from accelerated equity vesting.

Shareholders saw this coming: at FTI’s June 2013 annual meeting, after seeing the details of Dunn’s employment agreement, the company’s advisory vote on executive compensation was opposed by about 60% of votes cast. In addition, each member of the compensation committee serving longer than one year received nearly 20% of votes cast against their re-election to the board.

The board and compensation committee appear to have taken little away from the strong shareholder rebuke of the executive pay policy. Indeed, current CEO Steven Gunby was welcomed in January 2014 with an employment agreement that included a $3 million stock sign-on award, also lacking performance vesting conditions. One month later, the compensation committee approved retention agreements for three executive officers, guaranteeing the $1 million bonuses merely for continuing their employment through March 2015 (and vesting in case of their termination).

FTI Consulting is hardly the only company that has failed to revise its pay policy toward an emphasis on performance following a failed advisory vote. Abercrombie & Fitch and DFC Global Corp. have each received less than 30% support for pay plans in the past two years on the back of poor shareholder returns and compensation independent of performance. Big Lots, Comstock Resources and Gentiva Health Services, Inc. have each failed advisory votes for the past two years, while Nabors Industries Ltd. has failed the advisory vote for three years running. At Yahoo! Inc., shareholders strongly supported pay plans in 2013 after just 50% approval the year prior. However, the short-lived tenure of Chief Operating Officer Henrique de Castro could have a strong influence on the vote in 2014.

Mr. De Castro was a high-profile hire of CEO Marissa Mayer, who plucked him from Google to serve as COO of Yahoo! However, after just 14 months, the company issued a filing announcing that Mr. De Castro would be leaving the company immediately, and in an unusual move, specifically attributed his dismissal to non-performance. As part of his dismissal, he will receive all severance and equity awards detailed in his generous employment agreement. All told, the payout for his failed 14-month tenure could eclipse $100 million in total equity and cash payments. Indeed, it’s very unlikely that shareholders will overlook this egregious example of pay for failure when voting on pay policy in the spring of 2014.

Despite these pay for failure examples, there are certainly publicly traded companies that are paying executives in accordance with performance. For example, Franklin Resources, Inc. is a clear-cut leader in terms of executive pay at a large-cap financial institution. For 2012, CEO Gregory Johnson received a base salary below the $1 million starting point of most large financial institutions. He received no discretionary bonus and perquisites of only $40,000. In fact, nearly 80% of his 2012 pay came from the satisfaction of specified performance measures regarding net income and earnings per share. Similarly, long-term awards vest according to specific operating results hurdles. This clear tie to pay for performance is likely why shareholders pass compensation plans at Franklin Resources by a margin of about 98%.

Bob Monks, a widely published expert on corporate governance, is the co-founder of GMI Ratings, an independent research firm specializing in environmental, social, and governance (ESG) data and analysis. For more of his commentary on topical issues in governance and investment, see his website at www.ragm.com.

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