Financial company CEOs often talk about needing better incentives to perform. How about this one: You’re lucky to have a job when many of your peers don’t.
But that’s not how it’s working in the marketplace. Despite being hard hit by the housing and mortgage slump, some companies — including Washington Mutual Inc. and Toll Brothers Inc. — have made surprising changes in benchmarks for executive bonuses going forward.
What they are doing is moving the goal posts in a way that all but guarantees executives will score big paydays. That’s the result when you take out the bad stuff that could drag down compensation and include things that will likely prop it up.
It makes you wonder what boards of directors are thinking in the midst of a housing and mortgage crisis. Billions of dollars in shareholder value have vanished since last summer, leading to the ouster of CEOs at Citigroup Inc., Merrill Lynch & Co. and other companies.
Corporate boards, already under attack from shareholder groups for not properly monitoring risk, should be doing what they can to avoid controversy. Instead, some of them seem to be inviting more of it.
“Six years after Enron, and it’s still clear there isn’t a culture of board accountability,” said Richard Ferlauto, director of pension and benefits policy at the American Federation of State, County and Municipal Employees, a Washington-based labor group representing government workers. “They are doing things that promote risk-taking with little downside for executives.”
The compensation committee on Washington Mutual’s board looked like it was on the right track by not giving CEO Kerry Killinger a cash bonus in 2007. After all, operating earnings fell 40 percent last year and the shares of the nation’s largest thrift tumbled 68 percent in price.
But that kind of pay-for-performance accountability seems destined to slip away in 2008. The Seattle-based company late Monday disclosed in a securities filing that its board changed the executive pay structure to exclude certain credit costs when calculating cash bonuses.
Now, 30 percent of the bonuses will be tied to operating profits excluding expected mortgage defaults or the costs of real estate foreclosures. Another 25 percent of the calculation will exclude some restructuring and business resizing costs as well as foreclosures. The board will “subjectively” evaluate the company’s performance in credit-risk management.
Washington Mutual acknowledged it faces a “challenging business environment” when disclosing the new pay metrics. But that now seems like something WaMu shareholders have to worry about more than executives, especially since the revised pay structure gives them little incentive to minimize credit costs, said analyst Frederick Cannon of the investment firm Keefe, Bruyette & Woods.
“This management incentive structure could result in executive focus away from issues that we feel are critical to the success of Washington Mutual in 2008,” Cannon said, who is calling on the board to “revisit” this plan.
Upscale home builder Toll Brothers also didn’t give CEO Robert Toll a bonus in fiscal 2007 for the first time in 16 years. That happened after the housing slump resulted in the Horsham, Pa.-based company’s first quarterly loss in 21 years and sent the stock plunging more than 35 percent in 2007 alone.
Yet things might not stay sour for Toll for long; the board’s compensation committee signed off on a new way to calculate his annual bonus that will better allow him to be rewarded in a boom or a bust.
Previously, the bonus had been based on a percentage of net income, which had to exceed 10 percent return on equity and a stock-price growth adjustment was applied, according to The Corporate Library, an independent corporate governance research organization.
Starting this year, the board is proposing a plan whereby Toll stands to get 2 percent of the company’s pretax income before subtracting from earnings the compensation expenses related to the actual cost of his bonus. Toll’s bonus will also depend on the performance of a host of other factors, ranging from gross revenue and cash flow to issuance of new debt, acquisition of companies, overhead cost cuts and worker morale. His bonus will be capped at $25 million a year.
The good news is that investors get a say in Toll Brothers’ pay changes — if they vote against the plan, as two proxy advisory firms are recommending, the company will use the previous pay structure.
“It appears that the company has introduced this proposal as a way to ensure that (Robert) Toll receives a cash incentive even when company performance is suffering,” one of the advisory firms, Proxy Governance Inc., said in a report to clients.
Toll Brothers, in a securities filing Tuesday, defended the plan as being geared toward performance — if there is no pretax income before bonus then the CEO doesn’t get paid. It also noted that the compensation committee can give zero discretionary bonus if it so chooses.
Sounds good on paper, but will it happen in practice? Let’s hold them to it if business keeps going south.