Most CEOs make token statements about taking care of shareholders. Some mean it, others don’t. We investors don’t have a good way to judge them. We are not privy to discussions in boardrooms or corner offices. We can’t read their minds either. We don’t get to observe many internal decisions CEOs make every year while running their business. The best we can do is to judge them from their public words and deeds.
Business results are of course paramount, but they lag. We investors often need to assess a CEO well before business results become evident – else we could potentially miss out on a good investing opportunity. This is especially true for businesses that are undergoing change in leadership or some industry (or product) transition. Or maybe they are too new to have any financial history yet.
When it comes to a CEO’s public words and deeds, two things I am particularly interested in are:
- How well does he (or she) communicate with shareholders business strategy, long-term goals, and analysis of near-term performance?
- Does he have significant skin in the game? In other words, is he a fellow shareholder in a significant way? Do her actions show she is really thinking like a shareholder?
I have previously written about how much I admire CEOs that pen insightful letters to shareholders. I won’t go into details in this article but you can read about my takes on Jeff Bezos’s and Warren Buffett’s annual letters here and here.
I also like founder CEOs who own large stakes in their own companies. But this post is not specifically about them either. Here, I want to focus on one unambiguous action that some CEOs occasionally take: voluntary pay cuts. This doesn’t happen very frequently – and for good reason too. If a business is doing well, its CEO deserves all the praise and good compensation that comes with it. However, every once in a while, a business might get into some trouble, its stock price suffers, and shareholders feel the pain. This is when if managers voluntarily take a pay cut, I take notice. It’s not a common thing and it goes against the norms of executive compensation. You don’t have to look hard to find examples of excessive CEO pay even when company performance is subpar.
Voluntary CEO pay cuts can’t possibly be sure bets on a company. There are many other factors to consider when investing in a business. But because pay cuts happen so rarely, they are certainly worth looking into.
In last five years, three of my investments had voluntary CEO pay cuts. In each case, I was an investor in the business before it happened. Nonetheless, that CEO action reinforced my belief that the company was in good hands.
Apple (AAPL): 
In August 2011 when Tim Cook took over the CEO role from Steve Jobs, he was awarded a one-time one million share award (in form of Restricted Stock Units or RSUs). Based on the stock price at the time, the award’s total market value was about $385 million. The RSUs were not tied to the company’s future performance – they were instead time-vested with the first 50% vesting in five years and the rest in 10 years. This was a very substantial award though not unprecedented for a premier technology company. Also note that this is the only stock award Apple board has ever awarded to Tim Cook since he became CEO. He does not receive RSUs every year.
Apple stock did not do much for the next two years as concerns mounted regarding the direction Apple was taking with the new CEO. Media and investors fretted about apparent lack of innovation and wondered whether the new CEO was the best choice for this company. In early 2014, Apple board was studying ways to tie future executive compensation to company’s performance. They had already decided on 3-year total shareholder return (relative to its peers’ performances) as the key performance factor. Tim Cook asked the board then to retroactively apply the same criterion to his 2011 stock grant – almost three years after that award was granted to him.
Effectively what this meant was that Cook could potentially lose up to 50% of his award if Apple stock were to fall to the bottom third of its peer group’s performance over the ten-year period. From the original grant, he had a guaranteed $385M package. All he had to do was to stay on as the CEO for ten years. Instead, he was willing to take up to 50% reduction if Apple didn’t perform as well as its peers. He even went one step further and got the board to not pay him any dividends either.
He [Tim Cook] asked the Compensation Committee to apply performance criteria to his 2011 RSU award as well as any potential future awards… Under the adopted modification, Mr. Cook will forfeit a portion of the 2011 RSU award, which was previously entirely time-based, if the Company does not achieve certain performance criteria… Because Mr. Cook faces only downside risk from the modification, the Compensation Committee believed that less than 50% of the annual tranches should be placed at risk. Mr. Cook, however, expressed a strong desire to set a leadership example in the area of CEO compensation and governance and requested a larger at-risk percentage. Accordingly, the Compensation Committee placed 50% of the RSUs at risk in each future annual tranche… At his request, Mr. Cook’s RSU awards do not participate in dividend equivalents.
Proxy Statement, Schedule 14A, Apple Inc, Filed 1/10/2014
This does not happen often. I was happy to see the new CEO willing to subject his compensation to the same risks that I, an ordinary investor, was taking. And I was happy to ride along with him.
Spring forward to today, Tim Cook has proven the naysayers wrong. Consider this: during the three-year period from August 2014 to August 2017, Apple stock’s total performance was at the 81st percentile of its peers. Tim Cook has earned his RSU stock grant so far and we the investors are also better off because of it.
Apple is one of my largest stock position and I continue to admire how Tim Cook has run the company so far. Lately, even Warren Buffett has jumped on the Apple bandwagon. The more the merrier!
Kinder Morgan (KMI): Kinder Morgan is in oil and gas transport business. It is the largest natural gas pipeline owner-operator in the country. And it also transports oil via pipelines and tanker ships. It owns storage facilities for commodities too.
Until a couple of years ago, Kinder was run by its founder CEO, Rich Kinder, who is also its largest shareholder owner. Mr. Kinder, who is in his 70’s, recently stepped down and handed CEO duties to its long time COO, Steve Kean. Rich Kinder is still the executive chairman of the board and haven’t sold a single share. He owns 11% of the company worth about $4.3 Billion. Steve Kean, the new CEO, also owns shares worth about $136 Million. Both the chairman and the CEO receive $1 token salary every year. Both have also declined to receive any cash bonuses. Their only cash compensation comes from the dividends they receive as shareholders.
In December 2015, Kinder Morgan stock price tanked due to concerns about falling oil/gas prices and the company’s debt burden. Consequently, it had to cut its dividend by 75% to preserve capital for growth. Capital raise via equity or new debt had become too expensive. The company opted for growth rather than keeping the original dividend at the expense of future growth.
At that time, CEO Kean voluntarily declined to receive dividends on his own shares for the last six months of 2015. Remember he wasn’t getting any cash bonus or base salary. His only cash income was from those dividends. This effectively got his pay cut by 50% that year.
At his request, Mr. Kean receives $1 of base salary per year and no annual bonus. Additionally, in late 2015, in recognition of the unusual disconnect between the performance of our business and the performance of our common stock price, Mr. Kean requested that he not be paid dividend equivalents on his shares of restricted stock for the third and fourth quarters of 2015.
Proxy Statement, Schedule 14A, Kinder Morgan, Filed 3/30/2016,
I wasn’t happy to see my dividend cut by three-fourths. But I was reassured by the fact the both the Chairman and the CEO were also impacted significantly by it.
Fast forward to today, Steve Kean is among the 20 lowest paid CEOs of an S&P 500 company, per Wall Street Journal 2017 report. He made $288K and $382K in 2016 and 2017 respectively.
I haven’t yet made much money on my Kinder Morgan position, but I am optimistic that I eventually will. The management is in the same boat as we are, and I trust their stewardship. Only time will tell if this becomes a successful investment for me.
Simon Property Group (SPG): I previously blogged about my investment in this retail property owner here. I won’t hash out the details again. In that post, I gave my reasons for liking and trusting the management. The CEO of the company owns 3.1% of the company worth about $1.57 Billion.
I first became interested in Simon as an investment in early 2017 at the time when its stock had been dropping in sympathy with the rest of the brick and mortar retail businesses. The market was offering a good price for a well-run wide-moat business. I bought multiple times in 2017 and 2018 as the stock kept on sliding.
Simon pays its executive officers long-term stock awards that are based on total shareholder returns relative to its peers. Returns are measured over a rolling three-year period. Given how the second half 2016 turned out to be for retail real-estate industry, CEO David Simon asked the board not to award any new stocks in 2017 to him and other officers. He also got them to cut his annual cash bonus award. By my estimate, that forfeited three-year stock award could have been worth about $9 Million.
The Company’s CEO, David Simon, requested, of his own volition, that the Committee not establish a 2017-2019 LTIP Plan based on the challenging business conditions in the retail industry that the Company is facing and the Committee concurred. In connection with this recommendation, Mr. Simon unilaterally waived his right under his employment agreement to receive the 2017 annual performance-based LTIP units.
Proxy Statement, Schedule 14A, Simon Property Group, Filed 3/31/2017
From its July 2016 peak, the stock dropped about 30% in 2017 before it recovered some this year. Retail real-estate is facing several headwinds. I suspect SPG will continue to churn in the near term. However, I have confidence in long-term viability of the company. I am not in it for quick bucks. David Simon has a big stake in the business too. I am happy to let him steer this ship through treacherous waters. Odds are good that he will succeed.
Key Questions: What to make of a CEO who takes a voluntary pay cut? I have a short list of questions you may want to ask next time you are intrigued by an executive pay cut:
- Is it really voluntary? Or is it forced by a board that might be looking for a replacement?
- Does this person still have a substantial stake in the company – even after this pay cut?
- Was compensation in preceding years reasonable (and not outrageous) for the size of the company and the industry it operates in?
If you answer yes to these questions, then I’d suggest it is time to do more research on this company, its board, and its CEO. You may have found good stewards of shareholder capital. As I wrote in this blog post, I would gladly give my capital to trustworthy business managers and let them grow it for me. You can see all my stock holdings here.
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