Archive for April, 2010

Commentary by David F. Larcker, James Irvin Miller Professor of Accounting & Director, Stanford GSB Corporate Governance Research Program; and Brian Tayan, Stanford GSB Case Writer, MBA ’03.

Source: CIT Group, Form 8-K, Filed February 8, 2010

In its most recent proxy, CIT outlined the compensation of newly hired CEO, John Thain (formerly CEO of Merrill Lynch). Thain will receive a base salary of $500,000. He will also receive restricted stock units worth $5.5 million and a cash incentive award of $1.5 million.
The restricted stock units vest upon grant and are subject to a holding period. $2.5 million must be held for one year before being sold. The remaining $3.0 million must be held for three years.
The cash incentive award vests two years after the grant date and is subject to an additional one-year holding period. The cash incentive award also contains a clawback provision that requires that the amount be repaid, “if it is determined that Mr Thain has taken excessive and unnecessary risk.”
The inclusion of both holding periods and clawbacks makes this an interesting case study. From our perspective, holding periods are a very effective tool to align the interest of managers and shareholders. By requiring an executive to retain stock awards (rather than simply cash them out), the company is encouraging the executive to consider an extended time horizon when making operating and investment decisions. In this way, the executive becomes a real shareholder and is more likely to manage the company with shareholder interests in mind.
While clawback provisions are intended to have the same effect, they are much less likely to do so. The board has the right to reclaim bonuses if the company later falters, but practically speaking it is difficult for them to do without provoking a lawsuit. This is why we rarely, if ever, see clawbacks implemented. Instead, clawbacks only tend to punish executives in extreme circumstances, making them unreliable as an incentive mechanism.
By contrast, holding periods force executives to suffer in accordance with the quality of their decisions. If their decisions are marginal, the value of their holdings will decline marginally. If their decisions are abysmal, so will be the value of their payout.
Shareholders should decide who they trust more to reclaim lost value: the same market that punishes them without remorse, or the board of directors that oversaw the “excessive and unnecessary risks” in the first place.

Commentary by David F.  Larcker, James Irvin Miller Professor of Accounting & Director, Stanford GSB Corporate Governance Research Program; and Brian Tayan, Stanford GSB Case Writer, MBA ’03.

Source: Clean Energy Fuels Corp., Form DEF 14A, Filed April 7, 2010

Clean Energy Fuels is a relatively young energy company that delivers natural gas for automotive fuel through company-owned fueling stations. The company was founded in 1996 by T. Boone Pickens, and went public in 2007. It currently has a market valuation of $1.2 billion.

Pickens serves as a director and is the company’s largest shareholder. According to the most recent proxy, he holds 45 percent of the common shares, worth more than $500 million.

What is interesting is the compensation that Pickens has received for his services. In 2009, he was awarded more than $4 million in compensation, primarily in the form of stock options. It was by far the most paid to a director (others received $300,000). It was even more than CEO Andrew Littlefair, who received $2 million. According to the proxy, “Boone Pickens was granted larger option grants than our other non-employee directors during 2009 in recognition of his extraordinary direct contributions to the Company’s marketing program and his advocacy for the use of natural gas as a vehicle fuel.”

We have all seen the ads, and commend his efforts. Still, it is not clear why some executives who are already wealthy and own a significant percentage of the company insist on paying themselves additional sums of money (Larry Ellison of Oracle also comes to mind). What possible incentive value does $4 million in options provide to an individual who already holds $500 million in stock in the same company? Even if the awards are merited, at what point should an individual, of his or her own accord, simply refuse to accept what is offered?

The case of Pickens makes the question worth asking. Some wealthy executives continue to take more. Others refuse to. In many cases, both continue to perform well. It may be that these actions have no bearing whatsoever on governance quality. They do, however, seem to have a moral component. Investors can decide for themselves just how important that moral component is.

Commentary by David F.  Larcker, James Irvin Miller Professor of Accounting & Director, Stanford GSB Corporate Governance Research Program; and Brian Tayan, Stanford GSB Case Writer, MBA ’03.

Last week, Ari Balogh, chief technology officer of Yahoo!, announced suddenly that he was stepping down from his position. He had been in the role for less than a year.

Turnover among the executive suite should come as no surprise. Executives retire, resign, are fired, are recruited away, and even (unfortunately) die on the job. What is surprising, however, is how many companies are woefully unprepared to act on this eventuality.

Following Balogh’s resignation, a company spokesman said that it would take a few weeks to name a successor. When former Bank of America CEO Ken Lewis announced his resignation last year, the company engaged in a prolonged, public, and embarrassing search for a successor. After being visibly refused by Bank of New York CEO Brian Kelly, the company finally settled on insider Brian Moynihan. General Motors, too, had vacancies in both the CEO and CFO positions for extended periods of time, with Chairman Ed Whitacre assuming the title of “interim CEO” until finally deciding the take the job permanently himself.

While it is easy to explain away each of these as exceptions, survey data indicates that instead they are the rule. According to the National Association of Corporate Directors (NACD), 44 percent of companies do not have a formal CEO succession plan in place. While the majority have a process to replace the CEO in an emergency, many have not planned for succession over a three-to-five year period. Pending SEC regulations would require companies to increase disclosure about their CEO succession plans.

Based on our research, there are five models of succession planning: 1) hire a search firm to recruit an external candidate,
2) hire a COO who serves as an apprentice of sorts before being promoted to the CEO position,
3) initiate an internal horse race in which multiple candidates compete for the job,
4) structure an inside-outside search in which internal candidates are developed and then benchmarked against the external talent pool before a successor is chosen, and
5) be caught off guard and then scramble to do something.

From our standpoint, it doesn’t really matter which model a company follows… so long as it’s not the last one.

Board Resignation – DayStar Technologies, Inc.
(Commentary by David F. Larcker, James Irvin Miller Professor of Accounting, Director of Stanford Graduate School of Business Corporate Governance Research Program, And Brian Tayan, MBA ’03, Stanford GSB)

Source: Form 8-K, Filed November 27, 2009

“As a result of the above it is with great regret that I am immediately resigning from the Board of directors of Daystar. I will be forwarding a copy of this letter to the SEC, NASDAQ and the Auditors of the company.” Matveishen was the ninth of 16 directors to resign from DayStar in the previous three months.

Commentary by David F.  Larcker, James Irvin Miller Professor of Accounting & Director, Stanford GSB Corporate Governance Research Program; and Brian Tayan, Stanford GSB Case Writer, MBA ’03.

This weekend, the New York Times reported that Merck & Co reached a settlement in a derivative lawsuit brought by shareholders in 2004. In the lawsuit, shareholders alleged that company directors breached their fiduciary duties by not sufficiently overseeing the marketing of prescription anti-pain medication Vioxx, causing shareholders to lose billions in equity value. As you recall, Merck voluntarily withdrew Vioxx from the market in 2004, when it was revealed that use of the drug was correlated with an elevated risk of a heart attack. There was some question as to how long Merck officials knew of this risk and whether they were covering it up in order to maintain product sales. Merck stock plunged on the news, and ultimately the company reached a $4.85 billion settlement with patients.

The settlement with shareholders, however, resulted in much less.
The company agreed to implement a series of corporate governance reforms that the New York Times article described as “innovative.” Merck would hire a chief medical officer to monitor product marketing and safety. The board would convene two new committees—a product safety committee and a general corporate risk committee—to help in this endeavor. In addition, the company agreed to reimburse plaintiff lawyers $12.15 million in legal fees.

We fail to see what is innovative about any of this. As a matter of course, the company should be monitoring product safety. How this process is structured (independent chief medical officer or not, risk committee or not) is much less important than that the appointed individuals take their responsibility seriously and actually carry out the duties they are expected to perform. If they do not, the structure of oversight won’t matter at all.

As such, the Merck shareholders who brought this lawsuit have to ask themselves what they got for their efforts. Will these changes produce more in shareholder value than the $12.15 million the company spent reimbursing plaintiff’s lawyers?

Source: Natasha Singer, “Does Merck Agreement Pave a Road Toward Change?” The New York Times, April 2, 2010.

Commentary by David F.  Larcker, James Irvin Miller Professor of Accounting & Director, Stanford GSB Corporate Governance Research Program; and Brian Tayan, Stanford GSB Case Writer, MBA ’03.

Source: Onyx Pharmaceuticals DEF 14A filed on 4/9/2010

In 2009, Onyx Pharmaceuticals made a restricted stock grant with some unusual features to CEO N. Anthony Coles. According to the company’s proxy, “the award vests immediately upon the closing of Dr. Coles’ purchase of a home in the San Francisco Bay Area. If Dr. Coles has not purchased a home in the San Francisco Bay Area within 18 months of the grant, then the grant would lapse entirely and will not vest.” The grant was valued at about $600,000.

Dr. Coles previously served as president and CEO of NPS Pharmaceuticals, a biotechnology company located in New Jersey. Presumably, the company felt it needed to provide incentive for Coles to relocate closer to Onyx’s headquarters, which are in Emeryville, CA.

As for why this was structured as a restricted stock award and not some other form of payment, we cannot say. Still, it points to some of the personal issues that are often involved in recruiting a CEO. Based on our work with executive recruiters, we have heard time and again the lifestyle issues are critical to whether a CEO appointment ultimately proves successful. These include where the job is located, number of days spent traveling, quality of home life, willingness of the spouse to relocate, and the number and age of children.

We don’t delve into the personal life of Dr. Coles. Still, we hope for the sake of Onyx shareholders that Dr. Coles likes his new home.
As does his family.