Should corporate caretakers be billionaires?

Hats off to company founders who have reaped billions of dollars for building global success stories. Sometimes, we get to witness generational genius, and the world benefits.

But what of the others — the ones who come after the founders? For every Steve Jobs there’s a Tim Cook. Cook took over after the Apple founder’s death in 2011, and Forbes estimates his net worth at roughly US$2.2 billion. His tenure came after the success of the iPhone, iPad and iMac (which still account for close to 90% of product revenue). Cook has overseen the Apple Watch, the recent Vision Pro headset and the expansion of new service offerings, but could someone else have done the same for less? More broadly, should corporate caretakers really rake in billions of dollars in wealth?

In most cases, the billions are accumulated through share-based compensation gone haywire. Usually, early forecasts of potential gains from options and the like are underestimated because the share price takes off, and executives receive outsized and unintended rewards. Apple’s share price is up roughly 1,700% since Cook became CEO. While shareholders have benefited handsomely, US$2.2 billion is still a lot for someone who found the table already set when he sat down.

We’re not talking about people who, while technically not founders, still had the vision to take something small and make it famous. Elon Musk didn’t start Tesla, but you’d be hard pressed to recall who did. Musk and company can be given a pass.

Canada has seen its share of ultra-wealthy caretakers, if not billionaires. Tens or hundreds of millions of dollars gained through share-based compensation for non-founders seems unnecessary and avoidable. It’s hard to see the genius in certain situations, and it’s fair to say that some non-founders benefit from a lucky combination of frothy markets, circumstance and timing. The worst cases might be when caretakers cash out extreme rewards before a share price collapse that leaves regular investors holding the bag. John Roth, well-known CEO of once-mighty Nortel netted more than $100 million before the company’s implosion amid accounting scandals.

No obvious solutions

Companies have tried many ways to rein in runaway executive compensation. Simply capping pay seems like a non-starter. The Ontario government tried that maneuver at the province’s largest utility, Hydro One, though mostly to score political points rather than pursue a governance strategy. Unsurprisingly, what ensued was a revolving door of CEOs. No company wants to be known as just a training ground for up-and-coming executives.

Most pundits suggest tying the bulk of executive pay to long-term share price appreciation. This can end in disaster, as was the case with Valeant Pharmaceuticals a few years back. The company’s CEO Mike Pearson had a compensation package tied too closely to share price growth. This left a loophole by which he loaded up the company with debt to make acquisitions, which boosted “cash” earnings per share, and fuelled an unsustainable share price. Pearson was prevented from cashing out much of his share-based compensation due to extended vesting requirements. Unfortunately, though, this led to a reinforcing cycle that encouraged even greater risk taking to maintain share price gains over the longer term. Valeant’s fall eventually wiped out $100 billion of shareholder wealth.

U.S. non-profit As You Sow is a shareholder advocacy group that publishes regular lists of the most overpaid S&P 500 CEOs based on shareholder returns. In the most recent roundup, the top 100 were overpaid by a median US$11.6 million (and that’s for just one year). For all the attempts to align executive pay with share price, grand miscalculations seem par for the course.

Even in the case of founding CEOs, board compensation committees often cite the spurious reason of “retention” for granting excessive pay packages. It’s tough to recall an instance of a company founder ever being poached by a competitor, never mind for compensation reasons. Little can be done to claw back funds from executives who sail the ship into the shoals, especially if everything moved through proper governance channels.

Financial advisors remain in a bind regarding companies that overpay their caretakers, with no obvious systematic solution. According to As You Sow, the major proxy firms regularly drop the ball when it comes to advising on “say-on-pay” votes. Short of acting on tip-offs to avoid particularly egregious situations like Valeant, advisors might have to accept that nailing down executive pay is fraught with problems and unlikely to be fixed anytime soon.

Mark Rosen

Investments

Mark Rosen, CFA, MBA, CFE, heads ARC Research, providing independent equity research to investment advisors across Canada.