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When a CEO pay cut doesn't paint the full picture

New analysis finds awards such as stock options can more than make up for cuts

Of the 554 companies that had announced cuts to executives’ salaries by May 29, according to the pay consultancy Equilar, the FT found 51 which had both the same CEOs and awards programme as last year. Image: iStock

Wed Jun 10 2020 - 10:18

When the chief executive of US retailer Dick's Sporting Goods said in March that he would temporarily relinquish his $1.1 million (€967,472) salary, Edward Stack became one of hundreds of US executives to signal they would share the pain the coronavirus shutdown was inflicting on employees.

But the announcement, which came shortly before the sporting goods chain announced that it would put most of its 40,000 employees on temporary unpaid leave, told only part of the story.

Just a day earlier, when market turmoil had sent shares in Dick’s Sporting Goods to their lowest level since the 2008-09 financial crisis, its board granted options to a host of executives.

Mr Stack received more than 950,000 stock options, which he can exercise in stages over the next four years. The initial value of the award on paper was calculated based on the depressed share price in March, but by June 9th it had rebounded by 133 per cent, or $21.5 million in potential gains – far outstripping the sum he had sacrificed in salary.

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Not only was the timing of the grant slightly earlier than in previous years, but the number of options was far larger. The number Mr Stack received this year was greater than the total he was granted in the past six years combined. If the price of Dick’s Sporting Goods shares return to their January high and remain there through to 2024, those options would be worth about $31 million.

A Financial Times analysis found that Mr Stack is far from alone in receiving such potentially lucrative grants during the Covid-19 crisis. Governance experts warn that such awards risk provoking a backlash from employees, shareholders and politicians over rich executive rewards, which have come into sharper focus as the pandemic exacerbates economic inequalities.

The year-on-year increase in stock-based rewards at Dick's Sporting Goods was the largest of any in the FT's analysis, but other companies' executives saw marked increases in this part of their pay packages. Equity awards for the CEOs of Abercrombie & Fitch and Designer Brands almost tripled in number this year. Within two months of being granted, the awards have risen in value by 44 per cent and 27 per cent, respectively.

Of the 554 companies that had announced cuts to executives’ salaries by May 29, according to the pay consultancy Equilar, the FT found 51 which had both the same CEOs and awards programme as last year. Those CEOs had been awarded on average 52 per cent more options or shares than in 2019.

Michael Marino, managing director and head of the New York office for FW Cook, an executive compensation consulting firm, said several factors may have contributed to the increases. Companies could have been seeking to grant stock or options with a similar dollar value. Another scenario could be that "the executives are deferring salary into stock and stock options or some other long-term vehicles", he said.

Equity awards

MGM Resorts, for example, said its new acting chief executive, William Hornbuckle, would forgo the remainder of his 2020 pay in exchange for equity awards of equivalent value, according to securities filings.

Since Bill Clinton changed the US tax code to prevent companies from enjoying tax deductions on salaries exceeding $1 million, bonuses and stock-based awards have come to make up the lion's share of CEO pay.

Mr Stack’s base salary, for example, accounted for just 10 per cent of his latest package, and Equilar found that stock awards alone accounted for 67 per cent of the typical chief executive’s pay in 2018.

CEOs’ total pay has also grown consistently above inflation in that period, attracting political scrutiny. The Associated Press, using Equilar data, reported that the median pay package for the head of an S&P 500 company exceeded $12.3 million in 2019, with the gap between CEOs and their workforces widening to the point where it would take the typical employee 169 years to make as much.

While corporate governance specialists expect the blow to profits many companies have suffered in the pandemic to affect the performance-related elements of executives’ pay, some are already warning that large windfalls could lead to investor protests.

A report from the Conference Board, the US business research organisation, warned last week that boards should try “to avoid potential backlash from shareholders” when adjusting executives’ performance targets.

“Investors understand the need for flexibility, but they may be sceptical of granting compensation committees too much discretion and their say-on-pay votes may be influenced not only by alignment of executive compensation with shareholders, but also with the welfare of the broader workforce,” it cautions.

Paul Washington, executive director of the Conference Board's ESG centre, said it was relatively straightforward for boards to decide to cut salaries but much harder to determine how, if at all, to adjust equity awards.

“You don’t want to make changes until you understand the full impact of the pandemic, nor do you want to appear to be focusing on executive compensation to the exclusion of urgent priorities, or to do something that creates a backlash among investors, and others will judge changes through a lens of fairness and corporate citizenship,” he warned.

Most of the awards examined by the FT were consistent in terms of timing and process with the previous year. However, in the market rout in March, a common time of year for such grants, some boards appear to have made up for their stock’s depressed prices by granting substantially more stock or options than in 2019.

Outsized gains

The combination of lower exercise prices and a larger number of options or shares positions executives to reap outsized gains if stocks continue to recover.

Salary cuts have been common in the sectors that have been hit hardest by the pandemic, such as retail, restaurants and hospitality, though a few, such as Darden Restaurants, have already restored their executives' full salaries.

Executives in these sectors were also among those receiving notably larger equity awards than last year.

AMC Entertainment used equity awards to show its "deep conviction" about the future of the largest US movie-theatre chain, AMC's CEO Adam Aron said in a recent press release. AMC slashed 14 top executives' cash salaries and bonuses by 15 per cent for three years. In exchange, senior officers "voluntarily signed on to a new compensation program" that will only vest if AMC's stock at least doubles during that period, the company said.

Split into six equal tranches, Mr Aron’s 1.5 million of share equivalent grants would be worth at least $33 million if the company’s stock returned to its 2017 high by 2023. He has also been awarded about 444,000 restricted stock units - more than double the amount that was awarded around the same time last year.

Large hotel operators including MGM Resorts, Marriott International, Hilton, Wyndham and Hyatt all granted their senior executives restricted stock or options in late February and March.

Among the seven hotel group CEOs, the biggest gains would be enjoyed by Mark Hoplamazian from Hyatt, whose stock appreciation rights and restricted stock would be worth a potential $17 million if Hyatt's stock returns to its February high. Hyatt announced that Mr Hoplamazian is forgoing his April and May salary, which is worth about $205,500, based on public filings for 2019.

Some of the worst-hit companies, however, avoided granting options or long-term incentive packages during the market crash. Macy’s, which suffered a downgrade in its credit rating to junk status, normally grants executives options in late March. A spokesman for the battered department store group said it had delayed annual equity grants until later this year to improve financial flexibility during the crisis.

Most companies made their awards decisions before March’s precipitous market decline.

Timing awards

However, dozens of boards timed their equity awards in line with the market bottom, and many have already seen their stocks rebound to pre-crash levels.

"Given the market sell-off earlier this year, the incentives, obviously, were aligned to not delay option awards at the low prices. In the past, we have seen [boards of directors] re-price or backdate options," Nick Mazing, a researcher at data group Sentieo, told the Financial Times.

Methodology: The FT's analysis included a list of 554 companies that announced executive pay cut programmes, as provided by Equilar as of May 29, 2020. Of the 122 companies that granted option or stock awards in March, the FT's analysis only included 51 companies which had not changed CEO since February 2019 and extended the same equity awards programmes. For example, if a CEO was awarded both restricted stock units and options, these were calculated separately. Only restricted stock units and options and long term incentive plans were included in this analysis. The calculated gains are paper gains. Many shares and options awarded this year will carry over a period of several years and have not yet vested. Some grants are also linked to performance, and so might never be earned. – Copyright The Financial Times Limited 2020

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