Wednesday, November 2, 2011

Asimov in the News: Change is Good

From Financial Post: Change is Good
Investors may not like the direction the stock markets are heading, nor company execs, but it should be viewed as an opportunity to look at things in a new, perhaps more profitable, light. Many of the country’s top 100 CEOs are already doing just that

The only constant is change. It’s been said in one version or another since about 500 BC, although it’s a line typically credited to 20th century author Isaac Asimov. But some might be feeling that perhaps we could use a little less change right about now.

At the start of 2011, economists were relatively bullish on the future, noting the world had, more or less, recovered from the most recent recession. Now we’re on the edge of a double-dip downturn, even here in Canada. The dollar, once an albatross because of its low value relative to the greenback, reached parity again this year and became an albatross of a different sort. And investors who watched their portfolios dwindle during 2008 and 2009, are watching them dwindle again as we approach the end of 2011.

But change is good. Change presents opportunities to examine things in a different light. It’s a chance to surrender what you are for what you could become. With that in mind, Financial Post Magazine has changed its annual CEO Scorecard to better reflect how corporate executives at some of Canada’s biggest revenue-generating companies are handling change. In short, to qualify for this year’s scorecard, a CEO must have been with a company (or predecessor) for at least 18 months as of the end of Aug. 2, 2011, a fair period of time for an executive to implement new policies or get rid of bad old ones. In other words: change things up, for better or worse.

Fortunately, almost all the execs that made the grade this year managed to eke out a positive two-year total return for their company shareholders. Overall, the average two-year return for the 100 executives on this year’s scorecard was 23.8%, a very decent return given that the S&P/TSX Composite Index returned 15.7% during the same time period.

The Top 100 is led by J. Michael Pearson at biotech firm Valeant Pharmaceuticals International Inc., which has been on an acquisition spree (the 2010 purchase of Biovail Corp. being perhaps the most notable) that investors seem to like, nearly doubling the company’s stock value. Close behind is another life-sciences exec, Mark Thierer, whose SXC Health Solutions Corp. posted a two-year return of 87.7%. For their efforts both execs are handsomely rewarded by mere mortal standards. Pearson was paid more than $1.1 million in salary, bonus and other fixed compensation during 2010, while Thierer was paid $3.4 in fixed compensation, plus he could cash in on a swing of $8.3 million in the value of his outstanding stock options.

But while both executives are paid well by most standards, they earn less than the average $4.1 million that companies paid the top executives on our Top 100 Scorecard, led by the $12.5 million Onex Corp.’s Gerry Schwartz took home. (Both Valeant and Magna International paid more in total compensation, but both had two chief executives during the period under consideration.) At the bottom of the payscale is Murray Mullen, the chairman and CEO of transportation firm Mullen Group, who in April 2010 following a round of company layoffs decided to cut his annual salary to just $1. Mullen’s decision, certainly an admirable one, belies the fact that most executives are getting about what they deserve, according to our Bang for the Buck index, which makes a return following a one-year hiatus.

Check out the index on page 52. Any executive scoring around $1 is getting what they should be getting, according to a proprietary algorithm that takes into account a CEO’s comparative compensation and company revenue as well as their performance in their related TSX index. By that measure, Fairfax Financial is getting a bargain by paying V. Prem Watsa only $622,000 per year. He’s worth more than eight times that amount, or about $5.5 million, if Fairfax was paying market value.

Another “value” executive is Paul Sobey, who took home an average of $1.3 million during the past two fiscal years at Empire Co., but his company brought in almost $7 billion in revenue and had a 10% shareholder return. Both execs have substantial ownership stakes in their respective companies, proving the value of Warren Buffett’s old aphorism of having some skin in the game.

On the flip side, some companies likely overspent on executive compensation, although there are solid reasons for some of the companies at the bottom of the Bang for the Buck index. Take Valeant. It paid its execs an average of $8.7 million, but a big chunk of that was a severance package for Bill Wells, who was the CEO of Biovail and did not stay on when it merged with Valeant. The same goes for Magna International, which paid two CEOs until Siegfried Wolf departed on Nov. 15, 2010.

Most companies that did make the cut aren’t spending more on their chief execs than you might expect given the market for management talent. Overall, 75 of the Top 100 executives are getting paid what might be considered a normal salary, (that is, within the average deviation of 0.59) based on corporate performance, casting doubt on whether say-on-pay resolutions are really necessary. Say-on-pay resolutions received an average of 94% support at 67 Canadian companies holding votes this year, according to a study by Hay Group, but it also has concluded that corporate performance is not a particularly key factor in shareholder say-on-pay voting nor is it a big consideration in boardrooms.

Compensation levels vary by sector. In financials, eight of the 12 companies paid their executives more than the Top 100 average, but their index was the only one to report a negative two-year return, albeit just a 0.7% decline. The reason for the extra pay: Banks and financial services firms bring in more revenue and employ more people than the average company and likely affect more people. The telecom industry is also a big payer, but it’s dominated by some giants, BCE, Rogers Communications and Telus, who pay far more than the minnows, Bell Aliant and Manitoba Telecom Services. Again, the larger the company, the higher the executive pay and the greater the increases, as might be expected.

But many governance proponents suspected that as more compensation information was disclosed and debated, the more likely salaries would be held down. That doesn’t seem to be the case — at least not so far. Revenue at the 100 companies on the Scorecard increased 8% to $5.7 billion between fiscal 2008 and 2010, while executive salaries jumped 19.8% to $908,000, certainly more than the average worker could expect. Overall, the average executive’s fixed compensation package (excluding options) rose 23% in the past three years. And executive options have increased by an average of almost $6 million during each of the past two years.

In previous iterations of the Scorecard, options were included in a CEO’s compensation and calculated as the change in their value during the fiscal year. This led to the rather curious result that some executives’ compensation was reported as negative, which was clearly not the case. For example, the value of Patrick Daniel’s options declined by almost $20 million in 2010, but they grew by $27.1 million the previous year. Don’t feel too bad for the Enbridge CEO: He still took home $6.7 million. Potash Corp. of Saskatchewan CEO William Doyle’s options, meanwhile, grew by $113 million in value during 2010, but his take-home pay was a paltry (by comparison) $7.9 million. Both examples illustrate that the value of options can swing wildly, but they can often make up a substantial portion of a CEO’s potential compensation, which is why we have listed them.

Our Scorecard, however, shouldn’t be read as a list of winners and losers, although it’s certainly tempting to read it that way. It’s a snapshot of a point in time, a time some investors are likely longing for. If the equivalent data was pulled today, it’s likely a lot of company returns would not be so heady; quite a few might even be negative given the stock-market swoon in September. But as long-term investors and successful corporate executives know, it’s always better to be prepared for things to change.

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