Replies to post #84100 on Biotech Values

[DewDiligence]

Golden Pay for CEOs Sinks Stocks

http://online.wsj.com/article/SB10001424052748704718204574615950355411042.html

›DECEMBER 26, 2009
By JASON ZWEIG

Why does it seem that it's always Christmas in corporate boardrooms? And how can investors tell whether those glittering pay packages are worth the cost?

The answer sounds obvious: Pay the boss more for good results now, and you should get even better results later. But the evidence for that is surprisingly weak, and two new studies even suggest that when chief executive officers get paid more, shareholders end up earning less.

The first study, led by corporate-governance expert Lucian Bebchuk of Harvard Law School, looked at more than 2,000 companies to see what share of the total compensation earned by the top five executives went to the CEO. The researchers call this number—which averages about 35%—the "CEO pay slice."

It turns out that the bigger the CEO's slice of the pie, the lower the company's future profitability and market valuation. "These CEOs," says Prof. Bebchuk, "seem to be trying to grab more than they should."

Finance professor Raghavendra Rau of Purdue University and two colleagues looked at CEO pay and stock returns for roughly 1,500 companies per year from 1994 through 2006. They found that the 10% of firms with the highest-paid CEOs produce stock returns that lag their industry peers by more than 12 percentage points, cumulatively, over the next five years.

Companies at the top of the pay pile, Prof. Rau concluded, award their CEOs an annual average of $23 million—but leave their shareholders poorer (relative to other companies in the same industry) by an average of $2.4 billion per year. Each dollar that goes into the CEO's pocket takes $100 out of shareholders' pockets.

Prof. Rau's team is still validating these findings, so regard them as provisional. But both studies are a reminder of a profound point: There may be no way to prove that paying CEOs more money leaves outside shareholders better off.

"Compensation changes so quickly, in so many ways, that it's one of the least stable variables in finance," says David Yermack, a finance professor at New York University. "And stock prices gyrate for reasons no one understands. These are such noisy variables that it's very hard to determine direct causation. You really need to know what you don't know."

Given the vast array of factors that affect business results and stock prices, it is extraordinarily difficult for the directors on a compensation committee to know whether the past results they are rewarding came from luck or skill. Nor can they reliably tell how much of the company's future performance should be attributed to those rewards. The truth, says Prof. Yermack, is unknown and may never be knowable.

Further muddying the waters: Many CEOs expect to be bought out of their interests in their former company when they are recruited to join another firm, as Bank of New York Mellon Corp. CEO Robert Kelly recently sought when he was a candidate for the top spot at Bank of America.

Mr. Kelly ultimately decided to stay at BNY Mellon. But when a CEO does get bought out in order to jump to a new ship, that "creates an expectation or baseline for future pay that's uncorrelated to the success of the new firm," says Harvard Business School management professor Rakesh Khurana.

Years ago, the great investor Benjamin Graham pointed out that directors shouldn't merely be independent, but also "businesslike." They must have an arm's-length relationship with management; they also should combine "good character and general business ability" with "substantial stock ownership." (They should have purchased most of their shares outright rather than getting them through option grants.)

The independent directors, Graham believed, should publish a separate annual report analyzing whether the business is "showing the results for the outside stockholder which could be expected of it under proper management." Executive pay should be part of that analysis.

The annual proxy statements that report on pay still fall short of what Graham advocated in 1951: a kind of interrogation in which directors are "called upon to justify…the generous treatment they are asking the stockholders to approve." Added Graham: "The stockholders are entitled to be told…just what are the excellent results for which these arrangements constitute a reward [and] by what analogies or other reasoning the board determined that the amounts accorded are appropriate."

Surely the financial crisis should have taught us all that we must acknowledge the extent of our ignorance. What's urgently called for in the CEO pay process, says Prof. Yermack, is "a great deal of humility." It's high time for corporate compensation committees—and investors—to start doubting whether the lavish pay packages they endorse actually work.‹

[DewDiligence]

James Bianco better hire a tax attorney—the IRS is going
after abusive deductions for such perks as corporate jets.
(See #msg-44867998 for a related story.)

http://news.yahoo.com/s/nm/20100122/bs_nm/us_tax_execcomp

›IRS Peers Into Executive Compensation

By Kim Dixon Kim Dixon Fri Jan 22, 4:13 pm ET

WASHINGTON (Reuters) – As the Obama Administration seeks backing for a tax on banks' lucrative pay packages, the Internal Revenue Service has been stepping up its oversight of executive pay through its auditing and other powers.

President Barack Obama needs the U.S. Congress to help him pass the 10-year $90 billion tax on bank executive compensation, but the tax agency had already been bearing down on lavish pay and perks across industries on several fronts.

Next month, the IRS begins an effort to audit 6,000 companies with a focus on their employment policies, including fringe benefits and officers' compensation. The IRS has also taken an increasingly tough stance on deductions companies take for highly paid executives and how deferral of pay by such executives is treated.

"The IRS knows that there is considerable noncompliance with regards to employment taxes," said Anthony Arcidiacono, of Ernst & Young, who spent three decades at IRS as an agent.

IRS Commissioner Doug Shulman has made tax evasion by high-wealth individuals and corporations a priority. Last year, the agency formed a new unit to study structures created by high-net worth individuals to avoid taxes.

Obama's 2011 budget proposal, expected early next month, is expected to reintroduce measures to limit corporate tax breaks and rein in use of the tax code by companies to park money overseas to minimize U.S. tax.

The 6,000 exams, to be conducted over three years, will be deeper than typical audits and look at fringe benefits such as executive use of corporate jets, company cars and other reimbursements arrangements, Arcidiacono said.

"The examiners have been instructed to leave no stone unturned," he said on a recent call with clients.

The IRS has not taken a systematic focus on employment issues in decades, according to tax lawyers. The agency will examine a cross section of companies by size and industry.

"We've had quite a few clients who have had more intensive employment tax and executive compensation audits," in recent months, said Anne Batter, an attorney at Miller Chevalier who previously worked in the IRS chief counsel office, which interprets the tax code.

$1 MILLION DEDUCTION CAP, DEFERRED PAY

Also under a microscope are deductions companies can take for lucrative salaries. The law limits such deductions paid to certain top executives to no more than $1 million per year.

This limit does not apply to compensation received for meeting pre-established performance goals [a colossal loophole]. But the IRS has been chipping away at that exception, lawyers say.

The IRS ruled in 2008, for example, that such compensation is not excepted when an executive is entitled to payment even if that person is fired.

Another tax code section in the agency's arsenal, dating to the second Bush Administration, is related to executives' use of deferred compensation to minimize taxes.

In 2004, in the aftermath of public anger when executives of energy trader Enron withdrew deferred compensation before the company went bankrupt, Congress enacted a law that limited deferred compensation.

Companies are slapped with a 20 percent extra tax penalty when the compensation vests if they don't meet the new rules.

Several tax lawyers said it is precisely the wrong time to be discouraging deferred compensation, when the Federal Reserve and others are encouraging the opposite.

The rules have "been interpreted in an extremely tight-fisted and unforgiving manner," said Richard Skillman, an attorney at Caplin and Drysdale who worked in the IRS chief counsel office from 1999 to 2002.

Still, the IRS can only enforce current law and needs further action from Congress to dig deeper.

"If you go underneath all of it, there is clearly a lot of negative feelings on Capitol Hill about highly paid executives," Skillman said. "But there is only so much they can do. They are really charged with not going beyond the law."‹

[DewDiligence]

What do Shell and Hemispherx have in common?

Answer: Both pay lucrative bonuses to management for crummy performance.
While HEB’s executive compensation is surreal (#msg-46604721), Shell is
emblematic of what’s wrong with compensation packages at many corporations
where attainment of performance goals are purportedly required for bonuses
to be paid, but the BoD ignores the performance shortfalls and awards bonuses
anyhow. Shell, which now vows to cease making such giveaways (see below),
has been the very definition of mediocrity in the oil patch for many years.

http://online.wsj.com/articleSB20001424052748704804204575068902954218266.html

Royal Dutch Shell PLC on Tuesday unveiled far-reaching changes to the way it rewards senior managers, less than a year after shareholders staged an unprecedented revolt against its executive-pay policies… In a letter on its Web site Tuesday, Shell said it responded to last May's vote by consulting with major investors and undertaking what it called a "wholesale review of remuneration policy." It said the proposals that resulted were designed to show "appropriate restraint in the current economic environment."

The changes address performance-based shares, distributed under Shell's long-term-incentive plan. Previously, executives were only to be awarded the shares if Shell placed in the top three of its peers in a ranking of total shareholder return, based on its share price and dividend payouts. Last year, Shell ranked fourth, but the board awarded the bonuses, anyway.

Under Tuesday's proposals, Shell's board won't apply such upward discretion for 2010 and in the future will only do so after "engaging" with shareholders [whatever that means]. Also, executives will have to hold the shares awarded under the plan for five years, and the CEO will have to own shares equivalent to three times his salary, from two times currently, to provide "greater alignment with shareholders' interests."

Additionally, annual bonuses will be linked to measures such as making sure Shell's oil and gas projects are delivered on time and on budget, rather than total shareholder return, and executive directors will have to use 25% of their bonuses to purchase shares in the company.

[DewDiligence]

CEO Severance Packages Lower Performance, Says Finance Professor

[A new twist on the story in #msg-44867998.]

http://online.wsj.com/article/SB10001424052970204397704577074301463590914.html

›DECEMBER 5, 2011
By Leslie Kwoh

Companies might want to think twice before offering their CEOs severance packages.

Break-up contracts can take a toll on a company's stock performance, lowering returns by as much as 4% in the three years after the agreements are introduced, according to a study by Peggy Huang, an assistant professor of finance at Tulane University's Freeman School of Business. The study showed similar findings at the five-year mark.

Ms. Huang analyzed more than 2,000 CEO severance agreements from S&P 500 companies between 1993 and 2007. Firms that introduced such contracts underperformed in the markets by 1.6% on average in the ensuing three-year period, when compared with firms that did not, the study found.

The disparity was even greater for companies that offered cash-only contracts (as opposed to a mix of cash and stock options). These firms underperformed by 4% on average in the stock market, when compared to companies that had either severance contracts with a stock component or no severance contracts at all.

CEOs with a break-up contract already in place, especially a cash-only contract, were likely to invest more heavily in research and development, aggressively betting on risks that might end in failure, Ms. Huang says. "With a severance contract, a company is basically saying that even if a CEO fails, there will be no penalty," she says.

Still, severance agreements seem to have grown in popularity, with the share of S&P 500 firms offering such contracts more than doubling during the study period, to 56%. That could be because CEO turnover has increased and more top executives are demanding a safety net, Ms. Huang says.

Companies that insist on offering severance pacts can cushion some of the financial impact by incorporating more stock options, she suggests, thus aligning the CEO's personal wealth with the firm's performance.‹

[DewDiligence]

Re: Corporate greed

From XOM’s SEC filing two weeks ago (http://www.sec.gov/Archives/edgar/data/34088/000003408811000045/r8k120611.htm ):

On November 30, 2011, the Compensation Committee of Exxon Mobil Corporation… established a total ceiling of $259 million in respect of 2011 under the Corporation's Short Term Incentive Program, of which bonuses were granted to certain officers as follows:

• R. W. Tillerson: $4,368,000
• D. D. Humphreys: $2,994,000
• M. J. Dolan: $2,232,000
• H. R. Cramer: $1,905,000
• S. D. Pryor: $1,905,000

Approximately 50 percent of the bonus will be paid to the executive in cash by year-end and the remaining 50 percent of the bonus will be paid on a delayed basis through the use of earnings bonus units

The Committee also established a total ceiling of 11.5 million shares in respect of 2011 to be available for grant under the Corporation's 2003 Incentive Program, of which performance stock awards in the form of restricted stock were granted to certain officers as follows:

• R. W. Tillerson: 225,000 shares
• D. D. Humphreys: 124,000 shares
• M. J. Dolan: 90,800 shares
• H. R. Cramer: 77,000 shares
• S. D. Pryor: 77,000 shares

XOM did not even have an especially good year.

[DewDiligence]

[OT]—Virginia Rometty, CEO of IBM, is very well compensated:

http://www.sec.gov/Archives/edgar/data/51143/000110465912074004/a12-26040_18k.htm

On October 30, 2012, the IBM Board of Directors approved compensatory arrangements for Virginia M. Rometty, Chairman, President and Chief Executive Officer of the Company. Mrs. Rometty’s base salary will remain $1.5 million. Her 2012 Annual Incentive Target was increased from $3.5 million to $4 million, prorated effective October 1, 2012, the date Mrs. Rometty became Chairman of the IBM Board of Directors. Additionally, the Board of Directors approved a 2013 long-term incentive award of $12 million for Mrs. Rometty, comprised of 2013-2015 Performance Share Units (PSUs). These PSUs will be granted on January 2, 2013..

It goes on further, but I think that’s enough to get the flavor.

For an in-depth profile of Ms. Rometty, see #msg-79846251.

[DewDiligence]

[OT]—Former HNZ CFO gets $15.5M severance package:

#msg-88849893

[DewDiligence]

[OT/Compensation]—I just ran into a case so egregious I had to listen to the CC passage twice to be sure I heard it right.

Caterpillar (CAT) has had declining sales for four consecutive years and is forecasting a fifth consecutive down year in 2017. Making matters worse, CAT shelled out $8.6B for an all-cash buyout of Bucyrus at the peak of the commodities bull market (#msg-56696672), causing significant deterioration of CAT’s balance sheet.

To ameliorate the damage, CAT has been cutting costs relentlessly (i.e. layoff off anyone they could), so that the decremental margin* during 2013-2016 has been in the 20s, which is smaller [i.e. better] than in previous cyclical downturns.

In guiding for 2017, however, CAT said its decremental margin will rise to about 30%. When an analyst asked how the decremental margin could be so high after so much cost-cutting, the answer was that...

...incentive compensation for senior executives will be substantially higher in 2017! Why so, an analyst asked. Because CAT's financial results have been so bad for so long that senior executives hadn't received enough incentive compensation to stay incentivized.

*Percent reduction in operating profit for each $1 reduction in sales.