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ON A COLLISION COURSE

“If you can’t explain it simply, you don’t understand it well enough.”  Albert Einstein

We often wonder how many of us relate to Albert Einstein’s quote when dealing with the complexities of executive compensation. It’s one thing to know compensation philosophy is to attract, retain and motivate the best talent possible; and it’s another to actually achieve it. However, it is a completely different field to not just see linearly, but around the “corners of the corners” to position your company strategically for events ahead. At Longnecker & Associates, we work hard to tie a company’s strategy and culture to governance and compensation. Sometimes, we are surprised at what’s around the corner. One of those recent surprises is when a well-known proxy advisor approved a pay package for certain directors at Dow that was performance based. Add to that—per the link below—this does not appear to be for all the directors, only the directors of the activist fund, Third Point. Third Point has an excellent reputation in the market and appears to create value for their funds and investors. However, our question lies in the issue of whether or not one can serve three masters—your company; your funds and the shareholders of the companies you invest in. We’ve always believed in that adage, “never tempt good people to do bad things.” Pay for performance Board of Director compensation as opposed to pay for governance can potentially cloud the independent judgment of board members and even potentially further a particular agenda of a director(s).

I heard Harvard University’s Jay Lorsch state that “Board governance depends on where you sit.” No truer words have been spoken. We believe that director pay should compensate for being sound fiduciaries, where the duty of care and loyalty to shareholders is first and foremost. Executive pay definitely needs to be based on performance, but that can lead down a slippery slope if directors’ packages start to align more with executives and company performance than they should. The last time we saw that example was with Enron, resulting with a plethora of legislation around compensation. From a sound governance perspective, board members have to refrain from self-dealing. Self-dealing occurs when directors use their position for personal profit at the expense of the company. What’s worse is that the facts and circumstances around Dow may warrant this approach, but how many companies will want to institute pay for performance across the board in their companies?

To further examine this question, we reached out to an ex-activist friend of ours for his thoughts. He said:

“I see nothing ‘evil’ with the arrangements.  First and foremost, they are disclosed. Second, the arrangements add transparency to something that shareholders are left to wonder about when an activist appoints directors, namely, whose side is the appointed director really on. Sounds like a simple question, but often appointees of activists do not ultimately subscribed to the activist agenda over the course of their board service. If ISS or shareholders don’t like the arrangement, they can simply vote against the nominee at the next annual meeting. Likewise, if the SEC decides that such an arrangement means that you are part of a 13D filing group, practitioners would likely be accepting of that.

One of the lessons here is that a company subject to attack by an activist needs to address the issue up front in a settlement agreement that has an extended duration. If the company does not, the activist and their appointee could well enter into an agreement after the director takes his seat.”

Just when we thought compensation couldn’t get more complex…

Caveat emptor…

To be continued.

Here is a link to the Wall Street Journal article, "Proxy Advisor ISS Blesses Pay for Activist's Directors at Dow" by David Benoit.

 

wriiten by Brent Longnecker and Danielle Jiacomin.

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