Smithfield Foods CEO Larry Pope stands to take home $46.4 million from the sale of the world’s largest pork producer to Chinese interests last September. Once the deal was announced, the fine print revealed the board had authorized more than $18 million in accelerated stock-based payments to the chief executive, including millions of dollars in previously undisclosed incentives.
In January, Wal-Mart Stores CEO Michael Duke retired after five years at the helm, as the world’s largest retailer was about to report lower earnings. Duke relinquished unearned performance shares potentially worth millions, but the board had awarded him $2 million in 2010 for “achieving at least 2.5 percent revenue growth” when unadjusted revenues grew by just 1 percent.
This March, Alcoa disclosed that its board piled new cash bonuses and stock incentives onto CEO Klaus Kleinfeld after having previously “reduced the grant value” of the CEO’s 2012 equity pay by 20 percent “in response to the decline in our stock price.” Offsetting that decline, the directors gave Kleinfeld a 28 percent greater number of stock and option units in 2012 and 35 percent more in 2013 after a further drop in the share value. Granted during two years when shareholders were being hammered, the higher number of units had a market value of $7,228,410 at last Friday’s closing price.
Three big U.S. companies. Three boards. One pay consultant: Ira Kay.
The Smithfield, Wal-Mart and Alcoa examples demonstrate that how CEOs are paid is as meaningful, and perhaps more so, than how much. That’s where consultants such as Kay, managing director of Pay Governance LLC, come in. Executive-pay specialists and the boards that hire them preside over bulging CEO pay through alternative compensation-accounting methods, amorphous performance targets, opaque disclosures and equity grants that reward longevity rather than results.
“I’m not on the committee. I don’t have a vote. It’s up to the committee to decide whether this is working or not,” Kay said, during a series of interviews last fall. At the same time, he described himself as the “vocal cords” of insider interests on executive pay issues, “not their mouthpiece.”
Until as recently as five years ago, the management teams at many big U.S. companies hired the executive-compensation consultant that advised their boards, and paid them substantially more for additional work such as employee-benefits consulting. Congress, shareholders and regulators all questioned whether the consultants’ ultimate loyalty was to the boards or management.
A Need for Change
The National Association of Corporate Directors, a Washington trade group, had recommended as early as 2003 that boards hire compensation consultants independent from management.
“Make independence a bedrock of compensation-committee governance,” the NACD said in a 76-page report that was explicit and bold for the time. In 2005, a 28-member committee of the Conference Board big business group, including Kay among 15 compensation consultants and nine company executives, took a step back, proposing that boards and management share their consultant, albeit under the administrative control of directors, to avoid “dueling” experts.
Even today, before an independent consultant’s candidacy is passed onto the compensation committee for consideration, the consultants typically are screened by corporate human relations departments and management, says Jan Koors, a managing director of the Pearl Meyer & Partners practice in Chicago. And independent consultants can still work for management so long as payments above $120,000 are disclosed to the Securities and Exchange Commission, under a law that became effective in 2010.
Concerns About Conflicts
Kay says he recognized that a growing perception about conflicts of interest challenged his future. He relates a prospecting trip to Minneapolis in 2007 to meet real estate developer Frank Trestman, then the compensation committee chair of electronics retailer Best Buy. Like most in the industry at the time, Kay's employer, Watson Wyatt & Co., represented boards and management simultaneously, and had a thriving employee-benefits practice that generally received bigger fees from the companies it served than did its work on executive pay, he said in an interview.
“What the f are you doing here?” Trestman asked, according to Kay’s telling. “I would never hire you.” When Kay asked why, Trestman supposedly responded, “Because you work for a full-service consulting firm. I don’t think it looks right.” Says Kay: “I was like, ‘You couldn’t have told me that on the phone?’ And wow, this is my future? I was the first person in our industry who had that thought.”
Trestman refutes Kay’s version of the story, including his use of the f-word, confirming only that after meeting the consultant the board chose another who was “definitely not a self-promoter like Ira Kay.”
On Dec. 5, 2007, Rep. Henry Waxman (D-CA), then chairman of the House Committee on Oversight and Government Reform, called a hearing to examine the “inherent conflict” posed by consultants who “are being asked to evaluate the worth of the executives who hire them and pay them millions of dollars.” Congressional investigators had found that, for 2006, only 33 of 113 Fortune 250 companies that hired compensation consultants with conflicts of interest disclosed the relationships to investors. On average, the companies paid the consultants almost 11 times more for other services, averaging $2.3 million, than the $220,000 for executive-compensation advice, according to the report.
“Waxman that piece of – that guy,” Kay recounted. As head of the compensation practice at Watson Wyatt, he was invited to testify at the hearing and declined, he says, at the request of his employer. On the conflict-of-interest perceptions, he says, “It was preposterous, and frankly insulting to our integrity.”
Soon after, the clubby, insular world of boards, management and pay consultants began to break up.
In September 2009, Mercer spun off a group of consultants who became Compensation Advisory Partners, specializing in independent compensation consulting. Towers Watson, formed through the merger of Kay’s employer, Watson Wyatt, and Towers Perrin, announced in 2010 that it, too, was “reorienting its strategic approach” in response to the changing business environment. Boards preferring independent representation were steered to a new firm, Pay Governance, consisting of about 40 former Towers Watson partners. Another firm, Hewitt Associates, divested part of its business into Meridian Compensation Partners, promoting independence. Later that year, Hewitt merged with Aon Corp.
'Best Practices'
“Ira, sometimes I feel like I work for you,” Kay quotes a German-accented CEO as telling him, to express the growing leverage of independent consultants such as Pay Governance. Kay did not identify Alcoa CEO Klaus Kleinfeld as the source of the anecdote, and Alcoa spokeswoman Monica Orbe said she “can’t confirm it.”
What is public is that Pay Governance won the Alcoa board contract shortly before it “reduced” the grant value of the German-born Kleinfeld’s stock awards “below the peer median.”
Closer examination shows the board more than doubled the performance shares and options it made Kleinfeld eligible for in 2012 and 2013, amid a cumulative 45 percent decline in the stock price. The makeup shares, not available to buy-and-hold investors, injected greater leverage into the CEO's pay package that delivered an even bigger potential reward as the company's stock price rebounded over the past year.
“Alcoa follows standard compensation best practices to make stock awards based on target total value on the grant date and not the number of shares,” says spokeswoman Orbe.
Smithfield represents another example of somewhat baffling disclosures.
Ray Goldberg, the 87-year-old former Smithfield compensation chair who retired from the board in 2010, hired Kay because the consultant had “a fair way of appraising performance, and a fair way of rewarding exceptional performance,” he recounts. Early in the relationship, Kay and Watson Wyatt deemed that long-term compensation at the Virginia company known for its brands Armour, Farmland, John Morrell and others was “significantly less than” peers, according to its 2008 proxy statement.
To remedy that, the board granted executives the first in a series of incentives called performance share “units,” payable in cash if management got the stock price up. Smithfield’s shares never traded at the minimum threshold required for the awards to be granted until shortly before its sale was announced five years later. After management failed to earn any performance shares in the first year, the board shifted executives’ focus from lifting the stock price to achieving a profit goal, with a potential value to the CEO of $3.2 million, more than triple the original maximum award, proxy filings show. The company fell short of its $100 million pre-tax profit target in 2009 and 2010, and hit it with $757.1 million in pre-tax income in 2011.
Under pressure from proxy advisors Institutional Shareholder Services and Glass Lewis & Co., Smithfield shifted the metric back to raising the share price after the September 2011 annual meeting. With little to show for its stock-lifting efforts, Smithfield’s second-largest investor, Continental Grain, produced a 33-page critique of management, with slides titled “underperformance on every level” and “treading water,” that it filed with the SEC in April 2013. A month later, Shuanghui International Holdings Ltd., a private Hong Kong company that owns China’s largest meat processor, announced the $4.7 billion buyout.
The deal valued Smithfield 31 percent above its previous day’s trading price, triggering value in the original 2008 performance shares that otherwise were on course to expire as worthless in August.
CEO Pope told the Senate Committee on Agriculture in July that the deal would create U.S. jobs and exports by connecting American hog farmers to Chinese consumers, who account for more than half of global pork consumption. Almost simultaneously, the SEC was asking Smithfield to revise its merger disclosure to present management’s “total compensation” in a way shareholders could more easily grasp. The company responded that the “aggregate amount” was $134 million, and could include another $24 million in contingent payments. By comparison, the average American meatpacker makes $25,400 a year, according to the Bureau of Labor Statistics.
Smithfield did not file its usual proxy statement in 2013, so shareholders had to look closely to discover that 200,000 performance shares the board had awarded Pope in June 2012 with a target value of $4.4 million — and never previously disclosed — would double in number to the maximum 400,000 shares worth $13.6 million. It also meant the shares vested in 16 months rather than 36 months. The disclosure appears in an amended 10-K filing from August 2013.
“A lot of the time all you have to do is breathe in and out 17 times a minute to earn those shares,” retired compensation consultant Graef “Bud” Crystal, 79, says.
The board granted Pope another 130,000 performance share units in June 2013 — after the deal price was announced — in a disclosure I located only in the footnote to a Form 4 sales document the company filed with the SEC on Sept. 27, 2013, the after day the deal closed. Even with profits falling by 36 percent in the latest quarter, these units were convertible to $4.4 million in cash, the form shows.
Smithfield declined repeated requests to comment except to say all compensation was disclosed.
Usha Haley, a management professor at West Virginia University, frames the payments to management in geopolitical rather than performance terms, telling the Senate they produced short-term benefits to Smithfield executives and long-term benefits to China by making the United States “an exporter of the commodity of pork to China and an importer of higher value-added processed foods.”
In September, Smithfield produced a triumphant press release announcing that votes representing 76 percent of its shares ratified the deal. You had to calculate for yourself the results of the accompanying non-binding resolution on merger compensation, which only 44 percent approved.
Pope and his management team got to keep their money anyway.
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