Charlie Munger said in a BBC interview that the 4 things he looks at in a business are the following:
- A business he and Warren understand.
- A business with a durable competitive advantage, ie a Moat.
- A business with a shareholder friendly management team with a lot of integrity and talent.
- A business that is offered at a fair price.
Let me talk briefly about number 3. I go into great detail in our Value Investing course, http://www.wallstreetvalue.com/learn-to-trade-like-the-pros/value-investing/ on what to look for in a management team.
There are several things to look when researching a management team but for now I just want to give you one quick takeaway that I think is very valuable. I always look at compensation to see how an executive is paid. Is it heavily loaded with salary regardless of stock performance, or is there a fair salary with more incentives for stock performance?
The best place to find executive compensation is the Proxy Statement which is found on a company’s website located in the “Investors” or “Investor Relations” section. You can also google it and two of the websites that I find useful are Salary.com and Equilar.com.
Let me give two examples of CEO’s that I recently looked into. Kevin Plank of Under Armour and John Hammergren of McKesson. These two execs are at two completely ends of the spectrum in terms of how they are compensated.
First, let’s start with Kevin Plank, founder and CEO of Under Armour. On page 25 of Under Armours 2017 Proxy Statement (click the link below), you will find a table with the compensation of all executives. Note to readers: This is NOT a recommendation to buy or sell either UA or MCK…this is for illustrative purposes only.
Named Executive Title 2016 Base Salary
Kevin A. Plank Chairman of the Board and Chief Executive Officer ……………… $ 26,000
Lawrence Molloy Chief Financial Officer …………………………………… $675,000
Colin Browne President, Global Sourcing ……………………………….. $550,000
Michael Lee Chief Digital Officer …………………………………….. $500,000
Karl-Heinz Maurath Chief Revenue Officer …………………………………… $475,000
Brad Dickerson Former Chief Operating Officer and Chief Financial Officer ……….. $675,000
As you can see above, Kevin Plank, the CEO is making a base salary of just $26,000. If that is all he is earning, how else do you think he may get compensated? Below is an Executive Summary from the same proxy statement, found on page 22.
Executive Summary and Highlights for 2016
For 2016 nearly 100% of the annual compensation potential for our Chief Executive Officer, or CEO, Kevin Plank and a substantial portion of the annual compensation potential for our other executive officers was directly tied to the financial performance of our company, primarily through:
- our annual cash incentive plan with awards earned based on our financial performance in 2016; and
- our annual performance-based restricted stock unit and stock option awards (the “performance-based equity awards”) for 2016 with vesting tied to our financial performance in 2016 and 2017.
Beneath this paragraph, it goes on to say that although revenue for UA was up 22%, their operating income only increased 2% which was well below their target. As a result, our Compensation Committee approved no annual incentive award for Mr. Plank, and annual incentive awards for other executive officers which were well below the target award levels under the plan… given changes to our business plans following the grant of these 2016 awards, we no longer expect these 2016 awards to ultimately vest in future years, therefore delivering no value to our executives.
Unfortunately for UA, their stock took a dive last year and 2017 hasn’t been much better. As a result, the executives did not make much money, but neither did the shareholders. That’s how it should be.
Here is another paragraph worth reading on page 23 of the 2017 Proxy Statement:
Objectives of our Compensation Program
Overall objectives of the compensation program for our executive officers include the following: to attract and retain highly qualified executives committed to our brand and our mission, to motivate our executives to build and grow our business profitably, and to align the interests of our stockholders with the interests of our executives. This program is designed to reward our executives for growth in our net revenues and operating income, primarily through our annual cash incentive plan and our performance-based equity awards. In addition, our equity awards incentivize our executive officers to generate positive returns for our stockholders.
We do not offer pension or any other retirement plans for executives, other than a 401(k) plan that is offered to our employees. We have a deferred compensation plan pursuant to which executives may defer certain compensation; however, we did not make any company contributions to this plan in 2016 for any executive officers.
I highlighted some of the things I really want to see in the proxy statements…anything that shows that compensation is designed to benefit the shareholders. This shows us that the CEO and other executives are working for US, not just themselves.
Here is the TOTAL Comp for all execs at UAA for 2016:
The Compensation portion of this proxy statement continues on to page 32 and I suggest to take a glance at it to familiarize yourself on how management gets paid.
Since I want to keep this article as brief and simple as possible, go ahead and read the rest at your own leisure.
Let’s move on to John Hammergren of McKesson:
Here is how their Compensation section starts off in their 2017 Proxy Statement:
“FY 2017 Performance Highlights FY 2017 was a challenging year for McKesson and our industry overall, and we did not perform at our historical and targeted levels.” Keep this in mind as we will compare the total compensation for each CEO…each ran a company that had a negative return for their shareholders in 2016.
Based on the following paragraph found on page 24 of McKesson’s 2017 Proxy Statement, things appear to be fair for shareholders.
FY 2017 Compensation Highlights
We tie a significant portion of our CEO and executive officers’ variable incentive pay to stock price or operational performance metrics that are directly aligned with the Company’s short- and long-term business plans. Despite the strategic actions we took in FY 2017 to reshape the Company for future growth, our returns to shareholders on a three-year basis were in the lower quartile relative to our peers. Additionally, McKesson did not achieve the rigorous performance targets which determine our Management Incentive Plan (“MIP”) and cash-based Long-Term Incentive Plan (“LTIP”) payouts, so payouts were down yearover-year. Consistent with McKesson’s philosophy to align pay with performance, the following highlights our compensation actions and pay outcomes for FY 2017:
- CEO’s base salary remains unchanged since May 2010 (seventh consecutive year);
- CEO’s target annual MIP opportunity remains flat since May 2008 (ninth consecutive year);
- CEO’s total reported compensation declined for the fourth consecutive year;
- Payouts under cash-based plans were down 20% in our annual plan and 40% in our long-term plan year-over-year;
- Stock price performance resulted in no payout of shares under our FY 2015 — FY 2017 Total Shareholder Return Unit (“TSRU”) program; and
- Stock option grants that were made in FY 2015, FY 2016 and FY 2017 were all underwater at fiscal year-end.
They also go on to say that 91% of CEO comp is based on company performance (page 27). However, I get the sense (let me know if you agree or disagree) that they are trying really hard to justify their compensation. Most Proxy Statements spell this out within the first few pages of the Executive Compensation section. In this Proxy, they show us page after page of graphs, industry trends, long-term goals, comparisons with competitors, etc. before they get to the actual compensation numbers all the way down on page 45 where it finally shows Hammergren’s Total Compensation in 2015, 2016, and 2017.
In addition to his total take home pay in 2016, Hammergren is also owed a pension benefit valued at $114,000,000 (Under Armour does not offer pension benefits to executives).
I am fine with hard working people making a great living, but if I am a shareholder in a company, I want the people running the business who has my money to be paid fairly and not excessively and at the expense of the shareholders. The one thing I haven’t mentioned in this article yet is Hammergren’s severance package, or golden parachute. There was an article I read about a former employee asking him, at an annual shareholders meeting, to give his $292,000,000 severance package to the lower wage employees. That was denied. I didn’t spend any time talking about this because I couldn’t verify it in any of the company reports, but there are a few articles on Google regarding his severance package. If it’s true that he really is owed $292 MILLION in severance pay, along with his $114,000,000 pension benefits and total compensation of $500,000,000 from 1999 to 2012 (source Equilar.com), then I would say that is a bit excessive. To make matters worse, there have been 1,600 US layoffs at McKesson last year to “trim costs”. I can think of one way they can trim a lot of costs and save many American jobs at the same time.
Lastly, I always google the CEO’s name to read any articles I can find about them, good or bad. Anytime you see an article (or several in this case) that says the CEO of the company you are thinking about investing in is the “Highest Paid CEO” or “Most Overpaid CEO” or anything of the like, you better run for the hills.
- Plank’s 2016 Base Salary = $26,000.
- Hammergren’s 2016 Base Salary = $1,680,000.
- UA does not offer pension benefits to execs.
- MCK will pay Hammergren $114,000,000 in pension benefits.
- Both companies underperformed in 2016 and the stock price for each company lost value in 2016.
- Plank Earned $33,500 in 2016 due to stock underperformance. He missed out on a $2,000,000 equity award because UAA missed their goals in 2016.
- Hammergren still earned $23,600,000 in 2016 while his stock lost money for investors.
- Forbes ranks Hammergren as the #1 Highest Paid CEO.
Both companies have very good track records and very good products, and both executives have very good track records building their respective business, but as a Value Investor, we also need to see how those running the ship get paid and are their interests aligned with ours, the shareholders.
That being said, who has more incentive to increase their stock price and which one would you want to run a company that you are invested in?