Read these three thumbnail corporate case histories. See if you can spot the key differences from the perspective of a portfolio manager. Go on. Close your eyes and try to think yourself into the mindset of an institutional investor: you’ve committed a not insignificant proportion of your clients’ funds to these stocks and you read in the press about the bonuses paid to their respective CEOs. How do you feel? What do you want to do to the chair of the remuneration committee responsible for setting the figures in question?
Okay. Open up those eyes and read on.
Case One: The CEO of a UK telecoms company does an impressive job of winning a takeover battle for a German firm – against all odds, including the fact that it was the world’s largest takeover at the time and the first successful hostile takeover of a German company by a foreign one.
The CEO was widely applauded for pursuing and articulating an explicit corporate strategy with which the proposed deal clearly fitted. He talked to the German target’s shareholders extensively – which was crucial since, by and large, their first instinct was to stick with the perfectly competent incumbent German management; and he generally gave strong support to an effective IR campaign that resulted not only in a successfully concluded bid but also in an award from Investor Relations magazine – voted by the UK’s investment community – for best investor relations during a takeover.
So far, so good. Happy shareholders all round. But all that took place in early 2000. The months passed and then the time came to hand out the bonuses. In the case of this CEO, the board awarded him a bonus of £10 mn. There was uproar among UK investors who complained that this was an example of extreme corporate excess. The final result? The telecoms company, tail between its legs, apologized. In public. And it promised not to repeat such action.
In so doing, it avoided a potentially much more serious revolt.
Case Two: In March 2000 four directors of a UK bank shared a total of £2.5 mn in special bonuses for a joint achievement: the successful completion of a takeover of a competing UK bank, involving – in this case – defeating a rival bid. As a result, the CEO’s compensation alone increased 250 percent over its 1999 rate. Moreover, the bonuses came on top of impressively high executive salary increases – 115 percent in the case of the CEO, for example.
Like the company in our first example, the bank has since confirmed to shareholders that it will do no such thing again.
Case Three: Finally, a leading listed UK fund manager says good-bye in April to its chairman of 16 years. His leaving present?
A cool £5 mn. Well, it was a leaving present when first announced, but the company subsequently recast it as a thank you present – for orchestrating the sale of the firm’s investment banking division to a US financial services giant for £1.35 bn.
As sales commissions go, that’s a pretty low percentage.
But shareholders still objected to the lack of a detailed justification provided for the payment – and to ex gratia payments in general. And for sure, those old arguments about the need to pay competitive compensation hardly seem relevant when the chap’s already on his way out. The issue was not put to a vote at the company’s annual general meeting following announcement of the payment, but a significant minority voted against reappointing the chairman of the compensation committee. However, with nearly half the shares in the hands of the company’s founding family, there was never a risk of any vote failing to pass.
Unmasked
There are no prizes for working out who’s being described in the preceding summaries but, for your reference, the recipients of the corporate largesse outlined above were as follows: 1. Chris Gent of Vodafone, for the takeover of Mannesmann; 2. Fred Godwin (CEO), Sir George Mathewson (executive deputy chairman), Iain Robertson (head of corporate banking) and Norman McLuskie (head of retail), all from the Royal Bank of Scotland, which took over NatWest Bank; and 3. Win Bischoff of Schroders, who sold the company’s investment banking operations to Citigroup before retiring earlier this year.
So how would you react to this bountiful bonus-giving by the boards and remuneration committees of these companies if you held stakes in them in your professional capacity as an institutional portfolio manager? Based on the evidence, your answer may depend on which side of the Atlantic you’re on. The average US fund manager has long since learned to accept high executive compensation packages in general, and special bonuses in particular, especially where these are seen as a reward for successful performance.
In continental Europe, huge differentiation in salary levels between the top execs and lowliest staff are frowned upon. The UK – as so often – falls somewhere between the two, but hostility to bonuses is especially strong in the UK.
Let them vote
At first sight, a recent move by a group of eight activist institutions might seem to be an example of this UK attitude toward high rewards for CEOs and chairmen. The eight concerned – including Baillie Gifford, Calpers, Co-operative Insurance, Gartmore, Hermes Fund Management, the UK Coal Industry Pension Schemes and the Universities Superannuation Scheme (one refused to be named) – have written to 750 British CEOs to try to cajole them into submitting their boards’ remuneration reports to annual shareholder voting.
Yet Peter Butler, corporate focus director at leading UK pension fund Hermes, says he is not at all against rewarding merit. On the contrary, he describes this move as a means of ‘legitimizing high levels of pay where these are justified.’
Similarly, Peter Montagnon, head of investment affairs at the Association of British Insurers, denies that ABI members are hostile to high pay or unwilling to reward success. ‘We don’t mind paying a great deal for stellar performance,’ he avers. ‘We would rather have the performance and pay for it than put up with mediocrity.’
Yet the ABI (whose membership controls some £1,000 bn in assets) has been vociferous in its objections to bonus payments. In response to the payment to Win Bischoff at Schroders in case three, it said it ‘does not regard ex gratia payments as appropriate.’ And it’s not impressed by bonuses paid merely for the completion of a takeover; when details of the Royal Bank of Scotland scheme were first announced, it said, ‘Our aim is to see executives rewarded for performance as a result of a takeover rather than the takeover itself.’
Delayed response
Fair enough. After all, bedding down an acquisition takes time; proving that the acquisition strategy was wise in the first place takes even longer. Yet bonuses are increasingly being paid for completed takeovers, rather than for successful takeovers. Of course, they may turn out to be one and the same thing; but no-one can be sure of that a short two or three months after the deal has gone through.
As one activist fund manager told Investor Relations, ‘We don’t like the sense that the board woke up one morning and decided to dole out some cash to the CEO for getting a deal done. Rewards are all about ensuring alignment of the recipients’ interests with shareholders’ interests which means it doesn’t make sense to pay a bonus as soon as the deal is done. You have to delay any reward until it’s clear whether it has generated shareholder value or not. A share award that didn’t vest for two or three years would be fine. But just handing over cash immediately is unacceptable.’
That seems reasonable. But what about sales as opposed to purchases? Case three should surely be the least offensive of the bonus-paying bunch from the viewpoint of investors, since Bischoff’s reward was for returning money to shareholders through a sale to an appropriate owner. Surely here the chairman was being paid for having actually crystalized value – already – through a sale?
Well, no, actually. As the ABI put it, the payment was ‘of doubtful appropriateness,’ for a number of reasons. Generally, shareholders still objected to the immediacy of the payment, which preempted the question of the longer-term effectiveness of the disposal strategy. Anyway, many feel that rewarding sales of assets can send the wrong message to executives. The other point was that Win Bischoff was already on his way out the door, so arguments about the need to adequately reward senior management in order to retain their services could not be used to justify the pay-out.
But who needs a valid justification when 47 percent of the company’s voting shares are held by the founding family?
