Friday, March 31, 2006

April 1: Compensation This Weak

What an incredible couple of weeks it has been in the world of compensation. I intended to blog much earlier but the deluge of media stories kept me reading instead of writing. Here’s a recap:

Job Bank for the Jobless
General Motors has a program, known as the Job Bank, that provides full pay and benefits for workers when there is no work for them to do, if they continue to report to the workplace or an alternative facility. Following innovator GM’s lead, Silicon Valley firms have established a Job Bank for software developers displaced by offshoring of their jobs. There will be a facility where the unemployed will be able to solve theoretical math problems that have no practical application, write poorly functioning code, and send email to each other. “This is just like working at that big software company” said one unemployed programmer “except we’re required to actually show up for work, there’s no telecommute option.” Plans are underway for a similar facility on Sand Hill Road for venture capitalists displaced by the movement of VC activity to India. This program will allow the unemployed to spend their day playing Monopoly and sitting in conference rooms listening to presentations of untenable business plans.

Living Wage Legislation
Outraged by the soaring cost of jet fuel, illegal domestic staff, and defense attorneys, an influential group of CEOs has proposed “living wage” legislation in Congress. “I don’t know how anyone is supposed to live on $10 million per year” said one CEO. “And now that there’s an expectation of performance in return for the money, it’s just gotten ridiculous. What’s wrong with America?”

SEC Disclosure Rules Struck Down
The SEC’s proposed rules for increasing disclosure of executive pay have been struck down by the Supreme Court citing the community standard for obscenity. Justice Potter Stewart’s quote “I know it when I see it” was cited in the unanimous opinion. Several Court Justices were reportedly unexpectedly aroused by reading about executive pay levels in US companies. “We can’t have our nation’s youth seeing this sort of information” said one Justice who requested anonymity.

Option Expensing Rule Reversed by the FASB
In a surprise move by the Financial Accounting Standards Board, the requirement to report stock options as an expense has been deleted from the US accounting standards. “We had no idea this was going to reduce company profitability” said the head of the FASB. The rule change is expected to immediately improve profitability of all US companies, with the exception of airlines.

Airline Industry Lobbies for Accounting Rule Change
The US airline industry has urged the FASB to adopt a new accounting rule that would exclude the cost of labor and jet fuel from the calculation of profit. “This change is long overdue” said one airline CEO. “If we had changed this rule 20 years ago think of the number of airlines that could have avoided bankruptcy.” The proposed change was applauded by airline executives participating in profit-based bonus plans.

NASDAQ to Restate Stock Prices
Citing a series of calculation errors, and following in the footsteps of companies having to restate their financials, the NASDAQ will be restating stock prices for all listed companies for the years 1998 through 2001. “It turns out there wasn’t a bubble after all” said the head of NASDAQ. Stock prices have actually only moderately increased since 1998. We apologize for the error.” Class action lawsuits are expected by shareholders seeking to obtain refunds from employees who became wealthy from stock options, and executives whose bonuses were tied to stock price who now seem to have been overpaid.

Google Adopts Severance Plan
Google, continuing the streak of innovation reflected in its Dutch Auction IPO, AdWords, and Google Maps, is implementing a unique severance plan for employees. Employees who are terminated will be required to repay to Google an amount based on the formula of $1 million for every year of service. A Google spokesman said “they make way too much money anyway and this is an opportunity for them to really serve the Google shareholders.” In addition, following the lead of General Motors under the new Google Buyout Plan employees who elect to retire early will repay Google a flat amount ranging from $5 million to $10 million. This program is aimed at the lower-paid workers in the company, prompting claims of discrimination from administrative assistants and software testers who argue that it would be burdensome to write a single check to the company covering one month’s pay. For the record, a Google spokesperson denied that it has any poor performers, pointing out that it has only hired the smartest people but the Company got even smarter rendering some employees relatively dumb.

Happy Aprils Fools Day to our Blog Readers. Let’s all hope that this time next year I have much less material to work with as I try to point out the absurdity of some compensation practices.

Stock Option Grants Smaller? Or Not?

If you saw the article in the Mercury News Thursday morning, “Stock Option Flow Slows” you might think that (a) this is news , (b) companies are giving out fewer stock options to employees, and (c) this has something to do with new accounting rules. I think (a) no, (b) somewhat and (c) no.

I suppose it is news that Bear Stearns issued a report with data indicating that this is the case. Their report says that companies in 2005, compared to 2000, are issuing (a) fewer options and (b) less total “value”. I think (a) yes and (b) no. But that has been occurring for the past four or five years and it is old news.

If I was really drunk right now, but much less drunk than the time I was the drunkest I’ve ever been, the news might be that I’m not really all that drunk. In 2000, US companies were drunk on stock options. There was no accounting expense required for employee stock options and shareholders were giddy about the bull market (widely misinterpreted as their investing savvy) so they didn’t mind that they were being diluted. Employees in the US got lots of options. Employees outside the US in those same companies, where pay is a fraction of US pay, often got the same number of options. New hires got big option grants (even though we hardly knew those people) and continuing employees got grants every year - even the poor performers (we can’t give them zero, they might complain or leave). Today, companies are granting fewer options than they were in a time when many granted an absurdly high number of options. But that is not news.

Remember that then the market crashed and shareholders got mad. But a lot of those employee options got “repriced” or exchanged so that the employees weren’t penalized for the stock price decline, even though others may have gotten rich during the bubble. That irritated some investors. Since then, many of the companies that were granting an absurdly high number of options cut back to above average levels - less drunk now. Shareholders of some companies refused to approve more shares for employee stock plans. No more for you, sir, I’ll call you a taxi. Some companies didn’t even bother asking shareholders to approve more shares even though they had run out. Closing time, indeed. It’s important to note that several companies gave smaller grants, or no grants, because they ran out of shares and it wasn’t good timing to ask for more. But they’ll get more this year, and may have to do extra-large grants to make up for last year. I personally know a couple of companies that are doing this. So when is a zero not really a zero?

Reports like those issued by Bear Stearns are based on data from hundreds of companies and it takes a lot of work to pull all that data together. But those of us who study each company in detail know there is much more to the story. Microsoft, instead of granting stock options, now grants restricted stock units in a number about one-third of the number of options it used to grant. So, did they “reduce” their grants by two-thirds? Or did they reduce their “option grants” to zero? A few other companies like Amazon made a similar change. I have seen, and continue to see, these types of errors in reports issued by reputable firms. (This article, by the way, notes that restricted stock is now “popular” but I have no idea what the criterion for being popular is. I do know, however, that granting restricted stock is still a minority practice, like popular orange shoes, and is very unpopular with a lot of investors.)

What about the company that didn’t issue options last year because they allowed employees to exchange worthless underwater options for newly-priced options? Is that a zero too? And what about the company that moved its annual option grant date from December to January, and went 13 months between grants with none in calendar year 2005. Zero? As the mathematicians in the audience know, zeroes can bring down an average quite a bit.

Here’s a really deceiving part of the story. You might remember that stock prices were quite a bit higher in 2000 than in 2005. The NASDAQ was roughly double where it is now. Due to a bizarre but widely accepted belief that an option granted when a share of stock is at $100 is twice as valuable as an option granted when that same stock is at $50, we conclude that we are giving less value because stock prices are lower. In other words, those $100 options we gave you are worth much more compensation even though our stock price is now at $50. For those of you who understand stock options you probably noted the absurdity of that last sentence. That’s the “duh” part. Options granted when stock prices are a fraction of what they were in 2000 are of lower “value” because the Black-Scholes option pricing model says so. Not.

But wait, there’s more! Companies definitely took action in response to the new accounting rules for stock options. Few people know that US companies spent millions of dollars of shareholders’ money over the past two years on consultants who helped them to develop “better” estimates of the value of stock options granted to employees. (Did you miss the news story on that?) This became a compelling activity because of the need to start reporting that value as an expense reducing reported profit. In virtually every case, that “better” estimate was a lower one (surprise!). Don’t take my word for it, just read their 10-Ks. Thus the reported “value” of employee stock options went down because companies got “better” at low-balling the number. Did that reduce employee pay? Of course not. And of course there are those companies that accelerated vesting to avoid recognizing any expense at all, so those options will now require an accounting expense of zero and must therefore be worthless. Hmmm. How did you calculate those, Bear Stearns? Seems to me that those options just got a lot more valuable.

Amidst all of the smoke and mirrors, many companies have indeed started issuing stock-based compensation to employees on a more reasonable and thoughtful basis (I do not include the vesting accelerators in that group). But let’s not think that a massive reduction in option grants has occurred because some will take that as further evidence that the US worker has experienced a massive pay cut while executives have not and then introduce federal legislation to fix the problem. The real news is that companies are radically changing how they pay employees which is the big positive outcome of the new accounting rules and shareholder pressures. Many companies are taking the first fresh look at pay practices since a time before many business journalists had started learning their cursive. That is the really big news but the data won’t show up in reports issued by accounting analysts at investment banks who I happen to think should leave the compensation business to people who actually know something about compensation and go focus on investing.

Monday, March 13, 2006

How Did You Do?

Every year I read Parade magazine’s article on what people earn. Actually, now that I think about it, I don’t think I’ve ever actually read the article but rather scan every picture and job title and salary. As a compensation specialist I can’t resist. Usually I just see surveys or spreadsheets of what people earn - job titles and salaries; here I get to see their faces. It’s a little voyeuristic as is the whole notion of the topic of pay.

This year, however, the article appeared on the one Sunday that I didn’t make it to the corner to buy the newspaper and today a colleague advised me via email of the article online. So I didn’t get to peruse the facebook (well, there were 12 shown) - but when one shifts from print to web there are tradeoffs. I got to read the reader comments posted on the site. And I actually read the article.

As easy as it would be to launch into a political commentary, I’ll just say that the most striking comment by the writer was: “Workers need perseverance, stamina, flexibility, and patience to succeed in this difficult environment.” I always thought those are the requirements to succeed in any environment but maybe that’s because my father was born during the Depression and was thrilled to work later in life, after fighting in World War II, as a mailman (we call them “postal workers” now.) So I’m probably biased.

The comments posted, most of them ranging from irritated to outraged, blame the magazine, the President, the American economic system, our court system, the stock market, company politics, Howard Stern, Democrats, Republicans, the entertainment industry, sports teams, and others for the purportedly sorry state of American pay. It seems that Americans are getting a raw deal and it’s not their fault.

What’s interesting to me is the entitlement mentality that we Americans seem to have developed. We are entitled to real pay increases, darn it. What the heck is wrong here? Some of the quotes in the article include:

“Wages haven’t kept up with inflation.”
“Salaries just don’t seem to be keeping up with the average person’s cost to live.”
“My income will probably increase…but I doubt the increase will cover the higher cost of insurance and gas.”

I can’t think of a single source that would provide assurance that any of those expectations would or should have been met.

What really amazes me is the fourth sentence in the article: “'While the economy has been growing since 2001, all the benefits of that growth have gone into corporate profits' says Mark Zandi, chief economist at Moody’s" I would point out to Mr. Zandi, without sounding like an apologist for corporations, that corporate profits turn into more jobs, higher stock prices, dividends, capital investments, and tax revenue. I think you and I get the benefit from at least one, if not all, of those. Granted, some of those jobs may not be in the US, but read on.

Yes, the US economy is booming, and many people are benefiting from the boom, but American employees – on average – are overpaid compared with the rest of the world. An outcome of globalization is to fix that. We are seeing capitalistic US values spread around the world, and some aren’t liking it when others are better than us at the game we invented. For every disgruntled employee in America there are two or five or twenty people in other countries that are ecstatic. But Americans still have choices. Depending on your particular skill set and area of expertise you can move almost anywhere else in the world; you can find a place where the ratio of your salary to cost of living is more favorable and you can be a beneficiary of the new equilibrium. I recently read about a mid-career software manager who moved from Seattle to Shanghai for just that reason. Go online and find out what your job pays in Shanghai or Rio de Janeiro or Amsterdam.

And, yes, on average, the real pay of Americans is declining. There is a bit of the 80/20 rule occurring: the top 20% see their pay soaring while the other 80% are experiencing erosion. Of course, the government numbers miss a lot of pay elements, but the crux of the statement is true: Americans are earning less. People in other countries are able and willing to do the same, or better, work for less pay. Step back, and it’s hard to be angry about that.

No one is going to insulate American workers from pay erosion because they complain about it. What Americans can do is what we’ve always done best – work hard, innovate, and take responsibility. We can get paid for that. But blame and resentment have never been high-paying skills. Good survey data shows that what increases pay of an individual is education, skills, experience, level of responsibility, and related factors. Accumulating those require - in the words of the writer - perseverance, stamina, flexibility, and patience.

I wonder when Parade will shift their annual story to show worker pay around the world and not just in the US. I can’t wait to see the reader comments then.