Year-End Dividends, TSR Havoc, and CEO Pay - Isn't That Special?

Fred Whittlesey
Compensation Venture Group, Inc.

What do Costco, Oracle, Tellabs, Whole Foods Markets, Las Vegas Sands, Movado and National Beverage have in common?  They don't make a very good peer group given their disparate GICS codes.  

They are pursuing a tax-driven (and somewhat political) tactic in the name of "returning capital to shareholders" that may come back to bite them, or their peer companies, when it's time to look at executive compensation.

An increasing number of companies are rushing to declare and pay a "special dividend" prior to the end of 2012 to hedge shareholders against the prospect of a large increase in tax rates in 2013.  I can't help but think of Church Lady when I hear "special" used.

While this would seem to be an all-around positive move - returning cash to shareholders, improving the shareholders' aftertax gains, assuaging the corporate finance critics who believe that investors are better at allocating capital than companies flush with cash who are incented to acquire other companies - there is an interesting aspect to this going unnoticed by those who may be most affected by it.

One commentator has outlined the alternative scenarios that these dividend actions will produce on the dividend-paying companies' stock prices, this month and then throughout 2012. A stock price spike in December, then a sudden drop after the ex-dividend date.  And then, an exit by income funds from those shares - that is, investors who buy the shares for the dividend, that (in the case of Oracle) has just seen 2013 dividends "accelerated" into 2012 and thus zeroes out most of 2013.

As often happens, the taxation tail is wagging the strategy dog.  As Boards of Directors attempt to optimize shareholders' single-year tax outcome (and bash President Obama and maybe even Congress a little), they may be digging a hole for themselves with their executive and equity compensation programs.

The extreme short-term stock price volatility introduced by the announcement of a special dividend will be fueled by both high-frequency traders that can nab the share on the ex-dividend date then get out faster than can you or I, and options traders that profit from the volatility alone. As investors change their view of a company from a dividend payer to one that is not, more price pressure is introduced.

What does this have to do with executive compensation?  Are any of these companies in your executive compensation peer group?  Do you use TSR (total shareholder return) as a performance measure in your incentive compensation programs?  Do you care about what ISS and Glass Lewis think of your executive compensation pay-performance "alignment?" Ah, so there's the connection.

For those who have run the numbers for ISS's CEO pay-for-performance model, you know that 1-year stock price performance has a disproportionate impact on the results.  With sudden spikes or dives in a company's stock price resulting from a special dividend tactic in December 2012, and the point-to-point measurement of most TSR models, a company may have just bought itself a big shareholder and proxy adviser battle come proxy season, for the sake of short-term tax optimization for shareholders. This is an even greater problem given the combined volatility and flatness of equity markets over the past few years.  Relative TSR has become a lottery system and the special dividend of your company and/or your peers just made things even more random.

(And shame on you, Whole Foods Markets, who promote your mission and values, especially those regarding "increasing long term shareholder value."  Those of us focusing on Conscious Compensation©  know that a short-sighted tax-driven tactic like this is most certainly not supportive of that..and that TSR really stands for "Total Stakeholder Return" now doesn't it?)

So, watch your peer group companies for these special dividends, and watch how your relative TSR ranking bounces around between now and December 31, your incentive plans malfunction, and your pay-for-performance analysis blows up. That might be really "special" for your Compensation Committee.