Thursday, April 06, 2006

Coke's Director Compensation Plan

Coca-Cola announced changes in the way it will compensate members of its board of directors. Directors will no longer receive outright grants of cash and stock. Instead, each year they will get stock units initially worth $175,000. But they can't cash them in for three years. Even then, they won't be worth anything unless the company achieves certain goals. In particular, per share operating earnings must rise by at least a target amount. Currently, that target is set at an annual rate of 8%.

At least one component of this plan is flawed. Awarding directors when earnings are growing is a good idea, but using per share earnings is wrong. This figure can easily be manipulated simply through share repurchases. Under the new plan, directors have a strong incentive to keep dividend payments to a minimum and return cash to shareholders through buybacks instead. From the shareholders' point of view, there is little difference between dividends and share repurchases. But from the directors' point of view, there could be a world of difference. Coke's plan would be much better if directors' compensation was tied to the growth in operating earnings rather than the growth in operating earnings per share.

Executive compensation is very hot issue right now. Some studies show that executive compensation is now about 400 times that of the average employee's salary. About twenty-five years ago, the multiple was closer to 20. With CEO compensation in particular going to the stratosphere, shareholders wonder if things have gone out of hand. I'll ask compensation expert Jim Reda of James F. Reda & Assoc. this question and more. This MoneyMasters interview will be posted on on Thursday, May 4.