Thursday, April 13, 2006

Coca Cola’s New Board Compensation Changes

In a feat of truly incredible timing, I wrote yesterday of some changes in corporate board requirements and management that I feel would have positive effects for shareholders. Incidentally, I believe such changes as I suggested may help curb the current epidemic of overpaid, underperforming CEOs. It was my intention to write next about how a company might transition from current common CEO and board compensation practices to those which I suggested. However, the recent Coca Cola announcement is too good to pass up as a topic for this piece.

Coca Cola has just announced, as reported in this morning’s Wall Street Journal, new board compensation policies aimed at placing directors in nearly the same position as the shareholders whom they are elected to represent. Henceforth, most of a Coke board member’s compensation will be dependent upon the fundamental operating performance of the company over several years.

This is a good start, but still woefully inadequate. Coke should have tied the directors’ compensation to total returns of the company’s stock, relative to that of the S&P500 for the same, multi-year time period.

For example, in a recent article in Business Week, entitled, “Blue Chip Blues,” the author alleges that

“…What exasperates the leaders of these corporations is that it seems there's little they can do about (it)…….delivering the earnings growth, but investors aren't responding. At work are forces largely beyond their control.”

If this is true, then Coke is targeting the wrong performance measure. However, regarding the BW article’s contention, I beg to disagree. A sizable portion of the valuation response of investors is, in fact, very much within the control of a CEO.

My proprietary research has shown, conclusively, that investors respond to long-term revenue growth more than simply to earnings growth alone. It’s up to the incredibly-well-compensated CEO to know this, and to figure out what performance will move his firm’s stock price. Then deliver that performance.

It is my contention that CEOs and board members should be compensated only for total return performance above that which investors could experience in an S&P500 Index fund.

Having discussed why total return performance is the relevant measure for shareholders to use for CEO and board member performance, rather than a fundamental target such as earnings growth, I wish to next return to the issue of whether “corporate governance”, per se, should be of concern to shareholders.

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