Page 136 - Bruce Ellig - The Complete Guide to Executive Compensation (2007)

122 The Complete Guide to Executive Compensation

When shares are in an individual’s name, that person retains voting power. Where stock is
part of a mutual fund, it is the fund manager who casts the ballot. Pension fund portfolios
continue to grow as a proportion of total stock investments. Many of today’s shareholders
are not owners (interested in the long-term return); they are investors looking for the best
short-term return on their investment. Whether short or long term in focus, each is look-
ing for a favorable return on their investment. Shareholder return is typically described as
current market price plus dividends received minus original investment cost. Many believe
that institutional investors focus more on cash flow and revenue growth than earnings.
However, this flies in the face of stock sell-offs when anticipated quarterly earning targets
are not met.
It is not uncommon today for large companies to have more than half of their stock in
the hands of institutions. These are the large mutual funds where individuals have accounts
in the fund but not individual stocks. The fund manager makes stock selections. Then there
are private money managers who invest for individuals directly or indirectly through a
company pension fund. Thirdly, there are the public sector retirement funds. CALPERS and
TIAA-CREF are examples. Such funds may exist for states and municipalities or for job
categories (e.g., law enforcement officers or teachers).
Shareholder Concerns

Electing directors who are sensitive to the executive pay issue is especially important if
it is believed executive pay is excessive. This is a major factor behind activists arguing for a
majority voting policy rather than a plurality system where individuals could be elected
if receiving one vote if all other votes were withheld, to elect truly independent having no
relationship with the company or its CEO.
Shareholders want executive pay to be largely in company stock and variable in relation
to performance. They also expect the level of pay to be comparable to that of similar posi-
tions with similar performance. Shareholders with significant ownership in a company can be
an important voice on issues such as executive pay especially if shareholders are able to get
an advisory vote on a shareholder resolution as to the appropriateness of the CEO’s pay
package. Even though nonbinding a significant number of votes may impact board action on
the CEO’s compensation. More than ever, the focus of major shareholders has been not
on “how much” but rather on “how” executives are to be rewarded. The view is that if the
“how” were tied to shareholder value (i.e., stock price and dividends), the executive would not
prosper without the shareholder benefiting. Stockholders are also concerned about dilution
(an increase in the number of shares outstanding) caused by executive pay programs. Because
stock-option plans typically use about three times as many shares of stock as share award
plans, they obviously have a more dramatic effect. As described in Chapter 2 (“Performance
Measurements and Standards”), unvested stock awards and “in the money” unexercised stock
options divided by shares of common stock outstanding equal dilution.
The treasury stock method is used to compute the effect on dilution of outstanding in-the-
money stock options (i.e., option price if below market price) and other unvested stock
awards. This method assumes all these shares have been converted to outstanding stock at the
beginning of the year and the proceeds received (including cash equivalents of tax deduc-
tions) are used to buy back as many shares as possible, thereby reducing the number of shares
outstanding for dilution impact. Should a company actually buy back the stock (making it
treasury stock), it is typically earmarked for compensation and benefit plans.