H-P's Approach to Executive Comp Is a Lot Better Than JP Morgan's Handwaving

We posted recently about the formulaic and uninformative discussion of JP Morgan Chase's executive compensation philosophy and metrics that might justify a $20 million compensation award to CEO Jamie Dimon. 

Today, in HP's proxy we see the kind of approach that is both mandated by SEC guidelines and which gives a shareholder an insight into how the board looks at the task of setting executive compensation.  Their approach stands in stark contrast to that of JP Morgan Chase's board. 

Having sat on both sides of the board table for public company executive compensation discussions, I can tell you that cannot be solely a highly quantitative, black box process, no matter what the consultants say. There is quite a bit of luck in how equity-based compensation can work out. (see Rakesh Khurana's writings on this issue) It is not the magic bullet, but it is an important part of the compensation tool kit. 

There is no perfect structure that can apply to all companies.  That is why the issue of setting out the philosophy and choice of metrics is important.  Shareholders deserve to know, and management needs to understand, how targets are being set and how they are designed to align with shareholder interests.

HP states that their Human Resources Committee, which met eight times during the past fiscal year, reviews their process and structure annually.  Like management, boards can always get better. 

Their institutional audience of 5% owners has remained unchanged from the prior year: Dodge & Cox own 8.1% of the equity, BlackRock own 6.1%, and on behalf of mutual fund owners State Street holds 5.5%. 

Whereas JPM's board uses the boiler plate term "alignment," the HP board shows how they interpret and implement the concept both in executive compensation and in corporate governance.  I think a diligent analyst or shareholder familiar the company's history can glean a lot from this presentation. 

ALIGNMENT WITH STOCKHOLDERS
Pay-for-Performance		Corporate Governance
• The majority of target total direct compensation for executives is performance-based as well as equity-based		• We generally do not enter into individual executive compensation agreements
• Total direct compensation is targeted at the median of our market		• We devote significant time to management succession planning and leadership development efforts
• Actual total direct compensation and pay positioning is designed to fluctuate with and be commensurate with actual performance		• We maintain a market-aligned severance policy for executives that does not have automatic single-trigger equity vesting upon a change in control
• Incentive awards are heavily dependent upon our performance against objective financial metrics which we believe link either directly or indirectly to the creation of value for our stockholders. In addition, 25% of our target annual bonus is contingent upon the achievement of qualitative objectives that we believe will contribute to our long-term success		• The HRC Committee utilizes an independent compensation consultant
• We balance growth and return objectives, top and bottom line objectives, and short- and long-term objectives to reward for overall performance that does not over-emphasize a singular focus		• Our compensation programs do not encourage imprudent risk-taking
• A significant portion of our long-term incentives are delivered in the form of performance-contingent stock options ("PCSOs"), which vest only if sustained stock price appreciation is achieved		• We disclose our performance goals and achievements relative to these goals
• We provide no special or supplemental pension benefits		• We conduct a robust stockholder outreach program throughout the year

Instead of talking about reasonable compensation, HP's board talks about targeting direct compensation at the median of its market, or peer group.  The interesting thing is the choice of peer group, which is effectively very close to the top ten or twenty stocks owned by institutional investors who might look to own HP. At least, this is how I interpret the table.  In addition to Microsoft, Cisco, Google and other technology bellwethers, the peer group also includes Pepsi and Johnson & Johnson two high quality growth stocks which often appear in their 5% owners' portfolios.  As a whole, the peer group companies are subject to economic forces, market forces and technology cycles which should make the median comp metric an appropriate measure. 

In fiscal 2013, 75% of the incentive comp targets were made up of quantitative metrics: revenue (25%), corporate net earnings (non-GAAP) also 25%, and corporate FCF as a percent of revenue at 25%. The other 25% were composed of qualitative factors. 

Management delivered revenue of $112.3 billion, short of the target $117.9 billion, attaining a 19.6% incentive payout versus the target 25% available. The actual payout on corporate net earnings fell 5 percentage points short of target, whereas FCF as a percent of revenue was 8.1% versus a target of 6.3%, and the outperfomance on the latter metric, along with some consideration of the total stockholder return of 81 percent put the overall achievement for the quantitative metrics at 2 percentage points above target.

Our objective is not to provide a complete review of this document, but to show that there is plenty of meat for an interested party to consider in their decision whether to own, hold, or sell HP shares.The document gives a clear picture of management's performance and a window into how the board looks at that performance and pays for it. 

By contrast, JPM's discussion of executive compensation reflects poorly on their board and on their governance.  

Sony Bows Out of PCs

I've always admired Sony Corporation, from that day in eighth grade when my parents gifted me an AM pocket radio which was one-third the size of the better known radios from Zenith. It was a beautiful object with good sound for a great price, and I still have it, but alas no one makes the transistor which has burned out. In those days, nobody bought Japanese products because they were "cheap" and lacked our technology. Well, my radio was way ahead of its time, and Sony shook up our industrial smugness.

From there, I always admired the iconic CEO Akio Morita whose introduction of the Sony Walkman changed the way people interacted with their music.  Innovation and great design were hallmarks of the Sony brand.  I've had two of their Trinitron color televisions, each for about twenty years: the best color tube around, and they both still work.

So, it's a sad day today to learn that the new CEO, charged with rescuing Sony from its serial reorganizations and shuffling its business portfolio, announced a one billion yen loss and another restructuring which involves the sale of the Vaio computer business to a Japanese private equity group.  This line was innovative, well designed and always got high ratings from tech magazine reviewers.  Sales and market share never followed those great technical reviews.

So, yet another giant bows out of making machines which were commoditized and may be on their way to becoming dinosaurs.

Samsung, as I look at the Galaxy phone and their smart televisions, reminds me of today's Sony.  The fate of today's Sony though may be in doubt.

Banks and Regulators Break Faith With Consumers

Bank managements have put their institutions down a path away from their traditional mission, namely to take in deposits and, acting as intermediaries, to transform this base into consumer and commercial loans, using a modest amount of leverage. Financial intermediation and maturity transformation were the bread and butter of the banking model.

Having sat at the side of a respected banking analyst for many years, I was troubled by the increasing number of bank CEOs who trumpeted the growing importance of fee income, as opposed to net interest income, in their revenue lines.  Next, came the move to get into all sorts of other businesses, like asset management, mortgage lending, investment banking, trading, and unsecured lending, or credit cards. Consolidation, driven by changes in banking laws, was the next step.

Soon, consumers were faced with fewer choices for their banking needs.  Finally, the current financial crisis made the U.S. consumer banking  highly concentrated.  The top ten banks hold about a 50% share of deposits, according to the FDIC. The extensive network of community banks, your friendly neighborhood banker like Jimmy Stewart, can't really compete with their 20-30 bp cost of funding disadvantage compared to the larger banks.

After the latest financial crisis, with the advent of regulatory schemes advocating for bigger layers of equity and higher capital reserves, regulators are making the traditional bank model even more unattractive than ever.

The upshot of all this?  According to the WSJ, 80% of  U.S. financial institutions offered free checking accounts as recently as 2008, but the number is down to 59% now.  What this number doesn't highlight is that the biggest banks have abandoned this model almost completely, even for their better customers as everyone migrates into an asset gathering model, as opposed to a banking services model.

Credit unions and community banks which should really be havens for new immigrants to begin building their financial relationships are increasingly marginalized, and so piranhas like the pay day lenders and all other forms of predatory financing are flourishing among a vulnerable population.

All these regulators looking backward at yesterday's problems have created incentives for rational bank CEOs to walk away from their primary mission as bank charter holders, viz. to serve consumers and small business customers with affordable, high quality financial services while earning attractive, but not outlandish, returns on equity.

Jamie Dimon's Pay Raise: It's About Principles Not Personalities

When a company like JP Morgan Chase raises their CEO's 2013 pay to $20 million, a 74% increase, the public markets should try to process this information to see what it really means. Unfortunately, with Jamie Dimon the discussion is always about personalities and not about fundamentals.

Back when there was talk about splitting the roles of CEO and board Chair, his buddies from Greenwich weighed in.  Why should their opinions matter in a public forum, rather than over a beer? With the latest news, Warren Buffett opined that $20 million was a "bargain."  It might be, but again, with all due respect, shareholders and the capital markets need and deserve more.

When the SEC greatly expanded the required disclosures about Executive Compensation in corporate proxies, it was done to at least provide some insight from the board on how they, as stewards of stakeholder interests, approached issues of compensation.  This is where an analyst or shareholder should look for answers about the $20 million and not to the interesting, but off point opinions of pals and pundits.

Ben Heineman, Jr. of the Harvard Law School's corporate governance project has written the most reasoned introduction to this issue.  After reading his piece, we went back to the original document, namely the proxy: it doesn't give a shareholder any comfort.

Here's what a reader finds about principles for governance and compensation:

• Maintaining strong governance: Independent Board oversight of the Firm’s compensation principles and practices and their implementation
• Attracting and retaining top talent: a recognition that competitive and reasonable compensation helps attract and retain the high quality people necessary to grow and sustain our businesses
• Tying compensation to performance: A focus on the qualitative as well as the quantitative performance of the individual employee, the relevant line of business or function and the Firm as a whole.
• A focus on multi-year, long-term, risk-adjusted performance and rewarding behavior that generates sustained value for the Firm through business cycles.
• Performance assessments that are broad-based and balanced, including an emphasis on teamwork and a “shared success” culture
• Aligning with shareholder interests: a significant stock component (with deferred vesting) for shareholder alignment and retention of top talent
• Very strict limits or prohibitions on executive perquisites, special executive retirement severance plans, and no golden parachutes
• Integrating risk and compensation input into compensation determination.

It's hard to disagree, because much of this is the same boilerplate that was produced by most companies before the change in requited disclosure.  What is "competitive and reasonable" compensation? Is $20 million such a number?  "Competitive" is still beset with the same peer group, compensation consultant problems which have always existed.

"A significant stock component with deferred vesting" certainly works on the upside, especially when the big grant is given post-trough with $20 billion in various case settlements having already been agreed.  

To one of Heineman's key points: there is one reference to corporate culture, that of "shared success." What does that mean?  Is that a sufficient description of what kind of corporate culture is required to assure meaningful, risk-adjusted success apart from cycles in the financial sector? 

The author writes,

"The case against the raise begins and ends with JPM’s corporate culture, for which Dimon also bears ultimate responsibility. The broad array of issues for which JPM has paid settlements totaling billions all took place on Dimon’s watch. Except for the inherited Washington Mutual and Bear Stearns bad practices, they all involved JPM employees. They involved core bad behavior: collusion, inadequate disclosure, money laundering, abusive behavior towards debtors, indifference to red flags of massive fraud. They arose in different parts of the bank, not just one dysfunctional unit. They substantially impacted profitability. They have seriously corroded the bank’s reputation with regulators, a number of investors, and the public. JP Morgan’s own report on the matters surrounding the London Whale indicates broad failings. Dimon himself, after virtually all the problems had surfaced, admitted that under his leadership the bank had failed to pay enough attention to controllership issues, and had failed to create an appropriate culture of integrity, compliance and risk management."

We wrote in a prior quarter about the strength of the JPM's last quarter and the platform it provides for future growth.  We also have to admire the CEO's rough hewn New Yorker's approach to evergreen questions like share buybacks. But, the board of JP Morgan Chase--which is not of the quality that a global financial powerhouse deserves--failed to give shareholders a window into their thinking about the $20 million which was based on their fundamental views about economic, management, and ethical principles which underpin the corporate culture that governs the firm they oversee on behalf of stakeholders.

Satya Nadella's Letter to MSFT Employees (Times of India)

The Times of India posted this letter from Microsoft CEO Satya Nadella to all Microsoft employees. It makes good reading,

"Today is a very humbling day for me. It reminds me of my very first day at Microsoft, 22 years ago. Like you, I had a choice about where to come to work. I came here because I believedMicrosoft was the best company in the world. I saw then how clearly we empower people to do magical things with our creations and ultimately make the world a better place. I knew there was no better company to join if I wanted to make a difference. This is the very same inspiration that continues to drive me today.

It is an incredible honor for me to lead and serve this great company of ours. Steve and Bill have taken it from an idea to one of the greatest and most universally admired companies in the world. I've been fortunate to work closely with both Bill and Steve in my different roles at Microsoft, and as I step in as CEO, I've asked Bill to devote additional time to the company, focused on technology and products. I'm also looking forward to working with John Thompson as our new Chairman of the Board.

While we have seen great success, we are hungry to do more. Our industry does not respect tradition — it only respects innovation. This is a critical time for the industry and for Microsoft. Make no mistake, we are headed for greater places — as technology evolves and we evolve with and ahead of it. Our job is to ensure that Microsoft thrives in a mobile and cloud-first world.

As we start a new phase of our journey together, I wanted to share some background on myself and what inspires and motivates me.

Who am I?

I am 46. I've been married for 22 years and we have 3 kids. And like anyone else, a lot of what I do and how I think has been shaped by my family and my overall life experiences. Many who know me say I am also defined by my curiosity and thirst for learning. I buy more books than I can finish. I sign up for more online courses than I can complete. I fundamentally believe that if you are not learning new things, you stop doing great and useful things. So family, curiosity and hunger for knowledge all define me.

Why am I here?

I am here for the same reason I think most people join Microsoft — to change the world through technology that empowers people to do amazing things. I know it can sound hyperbolic — and yet it's true. We have done it, we're doing it today, and we are the team that will do it again.

I believe over the next decade computing will become even more ubiquitous and intelligence will become ambient. The coevolution of software and new hardware form factors will intermediate and digitize — many of the things we do and experience in business, life and our world. This will be made possible by an ever-growing network of connected devices, incredible computing capacity from the cloud, insights from big data, and intelligence from machine learning.

This is a software-powered world.

It will better connect us to our friends and families and help us see, express, and share our world in ways never before possible. It will enable businesses to engage customers in more meaningful ways.

I am here because we have unparalleled capability to make an impact.

Why are we here?

In our early history, our mission was about the PC on every desk and home, a goal we have mostly achieved in the developed world. Today we're focused on a broader range of devices. While the deal is not yet complete, we will welcome to our family Nokia devices and services and the new mobile capabilities they bring us.

As we look forward, we must zero in on what Microsoft can uniquely contribute to the world. The opportunity ahead will require us to reimagine a lot of what we have done in the past for a mobile and cloud-first world, and do new things.

We are the only ones who can harness the power of software and deliver it through devices and services that truly empower every individual and every organization. We are the only company with history and continued focus in building platforms and ecosystems that create broad opportunity.

Qi Lu captured it well in a recent meeting when he said that Microsoft uniquely empowers people to "do more." This doesn't mean that we need to do more things, but that the work we do empowers the world to do more of what they care about — get stuff done, have fun, communicate and accomplish great things. This is the core of who we are, and driving this core value in all that we do — be it the cloud or device experiences — is why we are here.

What do we do next?

To paraphrase a quote from Oscar Wilde — we need to believe in the impossible and remove the improbable.

This starts with clarity of purpose and sense of mission that will lead us to imagine the impossible and deliver it. We need to prioritize innovation that is centered on our core value of empowering users and organizations to "do more." We have picked a set of high-value activities as part of our One Microsoft strategy. And with every service and device launch going forward we need to bring more innovation to bear around these scenarios.

Next, every one of us needs to do our best work, lead and help drive cultural change. We sometimes underestimate what we each can do to make things happen and overestimate what others need to do to move us forward. We must change this.

Finally, I truly believe that each of us must find meaning in our work. The best work happens when you know that it's not just work, but something that will improve other people's lives. This is the opportunity that drives each of us at this company.

Many companies aspire to change the world. But very few have all the elements required: talent, resources, and perseverance. Microsoft has proven that it has all three in abundance. And as the new CEO, I can't ask for a better foundation.

Let's build on this foundation together.

Satya"

Reported by the Times of India.

Samsung's Mobile Ambitions Getting Squeezed

We posted last week about pressures on Samsung from Google's sale of Motorola Mobility.  Today, the Wall Street Journal carries a story about wireless carrier resistance to rollout of Samsung's proprietary mobile OS called Tizen. 

Again, consumers will wind up paying in terms of price and competitive phone products for all the strategic chess games among Google, Apple, and Microsoft.

Satya Nadella: The Best of All Possible Directions for the new CEO of Microsoft

If the Wall Street Journal is right, then the agreement being hammered out this weekend for Microsoft executive Satya Nadella to take over the reins of Microsoft as CEO means that the company is making the best possible decision for succession, changing the internal culture and for its strategic direction.

This is quite a different position from the comments in the finance and tech press that this would be a 'safe decision.'  I'd take the polar opposite position.  The choice of a superstar CEO from the automobile or aviation industry would, in many ways, have been the "safe" decision.  The cult of the superstar CEO is alive and well in corporate America.  The buy and sell sides of Wall Street would have applauded a bold choice, like looking beyond technology, and at the same time they would be forced to hold off judgment until the new CEO learned more about the business and about Microsoft. Valuable time would have been wasted. The new CEO would be beset by the culture, as the heads of fiefdoms nipped at his heels trying to protect their empires, while undermining the CEOs effectiveness. If, at the end of the day, the superstar failed, a big severance would have been payed and Microsoft would have little credibility with investors or customers. Microsoft would then be in real danger of becoming irrelevant.

Instead, there's no question that Mr. Nadella not only knows technology, but he understands software for the powerful SQL server business, and he understands search from working with Bing.  He also, according to the Journal, had to apologize to an international customer for business losses arising from an outage of the cloud-based Azure service.

Two things about that last point.  Mr. Nadella has been on the line with a customer taking the heat for the failure of a product. Software glitches and loss of service are routine. Mr. Nadella understood the importance of an outage to a smaller customer.  His choice of personal accountability to a customer is something that has not a hallmark of Microsoft's customer relations, especially on the Windows side.  Don't think that the internal development and sales teams didn't notice what Mr. Nadella did either. All of this is a big deal for the future.

Also, don't underestimate the impact on international markets and on Microsoft's sprawling operations in countries like India.  A Redmond-centric culture may finally start to understand what it means to be a truly successful global technology leader, and that belief will be made manifest in its new CEO.

From his position within the company, it will be much more difficult for intransigent insiders to dig in their heels to cultural changes. Here again, the story talks about an executive whose personality is the antithesis of his predecessor; it also talks about people coming out of conversations feeling better than they went in. Again, things like this are a big deal.

When Mr. Ballmer launched Bing! it was a venture widely criticized by Wall Street, which said it should be shuttered. Mr. Nadella was part of the leadership team that made this venture, which we've supported in this blog, a necessary and successful part of Microsoft's technology portfolio.  Mr. Nadella's relationship with Mr. Ballmer provides a good foundation for the future.

Finally, whether or not this is speculation, the notion of founder Bill Gates taking the time and specific interest to mentor the new CEO, while relinquishing his board chair for another acceptable role would be another inspired decision for the future.

Ray Ozzie wrote, "Those who can envision a plausible future that’s brighter than today will earn the opportunity to lead." I expect that Mr. Nadella has earned this opportunity, and he would be leading with a lot of help from inside Microsoft. 

There's reason to put Microsoft back on the radar screen again, after this announcement has been made.