Discovery Inc.’s earnings fell nearly 20% last year by some measures, but the entertainment company’s CEO still got $26.4 million in performance bonuses.
Hospital giant HCA Healthcare Inc. disregarded earnings results from Covid-19’s crushing initial months in giving its CEO a $3.5 million annual bonus.
And Coca-Cola Co. admitted the pandemic made its executives’ performance-incentive targets impossible to reach—but gave its CEO a 2020 bonus of nearly $1 million anyway.
Many companies stack the deck in ways that often help their executives get big annual bonuses no matter how the business performs, Bloomberg Tax research shows. They “adjust” and boost the earnings numbers they use, or lower their own performance goals—making it more likely they’ll hit the targets that trigger bonus awards.
“There are so many ways to game the system,” said Nell Minow, vice chair of ValueEdge Advisors, a corporate-governance consulting firm. “It’s absolutely atrocious.”
The tinkering is legal, but often it’s poorly disclosed and hard for investors to see. Corporate-governance advocates are pushing the Securities and Exchange Commission to require companies to spell out more about how they calculate the financial metrics they use for bonuses, and how executive pay is tied to performance more broadly.
“All we’re asking for is transparency,” said Simiso Nzima, managing investment director of global equity at the California Public Employees’ Retirement System.
Companies skew the bonus process to help their executives get the best possible pay package and don’t think about leaving for another job, some governance advocates and executive-pay experts say. But catering to the executives like this— critics of executive pay contend—can make companies less responsive and accountable to their shareholders.
As the 2022 proxy season kicks into high gear, investors should be on their guard for such maneuvers that sweeten compensation packages, the critics say.
“The annual bonus has become almost an entitlement, a routine part of pay, and it shouldn’t be,” said Rosanna Landis Weaver, wage justice and executive pay program senior manager at As You Sow, a shareholder-advocacy group.
Moving the Goalposts
It isn’t clear just how widespread such practices are. To find them requires close reading and analysis of companies’ compensation disclosures: Bloomberg Tax combed through corporate proxy statements and talked to executive-pay experts to find examples.
But cases in which companies move the bonus goalposts are far from rare. While performance bonuses are typically awarded based on whether earnings hit certain targets, corporate boards have wide latitude to decide which measures of earnings are used, how they’re calculated, and how the targets are set.
“Most large companies are going to make some kind of adjustments,” said Michael Varner, director of executive compensation research at SOC Investment Group, a corporate watchdog that works with union-sponsored pension funds.
At Norwegian, executive bonuses were to be tied to whether the company hit the board’s target for its adjusted earnings per share. But when the pandemic intervened and devastated the cruise industry, the board scrapped that approach: Now the goal would be to keep costs down.
But not all costs. The new goal was to keep “adjusted net cruise cost” below a certain level, but the board excluded a host of costs related to the pandemic, including spoilage and inventory write-offs for canceled voyages, costs to get ships back up and running, and unscheduled expenses to keep grounded ships in dry dock.
That helped Norwegian beat the new, adjusted goal handily, and Del Rio got his targeted bonus, plus an added $2.8 million bonus to induce him to stay on at the company—part of a $36.4 million pay package for 2020.
Norwegian employees didn’t get the same kind of help—the company had furloughed thousands of them during the pandemic. Norwegian said it based its 2020 decisions “on the belief that it was essential to keep our management team intact to steer our company through the extraordinary impacts of Covid-19, ensure stability in the organization and to ultimately drive our company’s recovery.”
On the other side of the equation, Discovery set its targets at seemingly low, easy-to-clear levels, and surpassed all five of the financial targets its board had set. But as proxy adviser Institutional Shareholder Services pointed out in a report, the company had set some of those targets below its numbers from the previous year.
That enabled Discovery to beat its targets, and helped give CEO David Zaslav his $26.4 million in bonuses, even though the producer of reality and nonfiction programming didn’t perform as well as it had in 2020. Discovery’s adjusted free cash flow, for instance, fell 19% year-over-year, but that was still enough to clear a target that the company had lowered by 23%.
In its proxy statement, Discovery (which has since merged with AT&T Corp.'s WarnerMedia and is now known as Warner Bros. Discovery Inc.) hailed Zaslav’s “exceptional leadership” during the pandemic in awarding him his bonus, part of his $246.6 million pay package for the year. Discovery didn’t respond to requests for comment.
One tactic some companies use is to “double-adjust” their numbers.
Many companies report adjusted, “non-GAAP” earnings, which are unofficial numbers that don’t comply with U.S. generally accepted accounting principles, and strip out various one-time and noncash items. But some companies take it a step further: When using those earnings numbers as their performance yardsticks in determining executive bonuses, they strip out even more costs.
That pushes the earnings numbers higher, and makes the performance targets that much easier to beat. And the only place the companies disclose those additional adjustments is deep in their proxy statements. At some companies, the second adjustment is enough to make the difference between meeting the target and missing it.
Herbalife Nutrition Ltd. double-adjusted in 2021. The company took an operating-income number it used in its earnings announcement, which already stripped out items like legal costs and Covid-19 expenses, and adjusted it further to account for items like changes in currency exchange rates.
The two sets of adjustments added about $60 million to Herbalife’s operating income, taking it from $734.1 million in its earnings press release to $794.9 million for compensation purposes. That took the company over its bonus target of $772.1 million.
Result: Herbalife CEO John Agwunobi was awarded a bonus of nearly $1.5 million, part of a $7 million pay package. A spokesman for Herbalife declined to comment.
Still other companies relaxed their targets, often because of the pandemic, making them easier to beat. Or they decided to move away from hard-and-fast numbers to less-quantifiable goals.
HCA Healthcare stripped out its results for March and April 2020 from the calculations for earnings before interest, taxes, depreciation, and amortization (EBITDA) that it used in determining whether to award 2020 incentive bonuses. The company had to restrict elective medical procedures early in the pandemic, and said it no longer believed its original targets were appropriate.
The adjusted EBITDA numbers surpassed the revised targets, and CEO Samuel Hazen got a $3.5 million bonus, part of a $30.4 million pay package. For 2021, the company again surpassed its EBITDA targets, though it had no pandemic adjustments for the year, and Hazen was paid a $4.5 million bonus. HCA Healthcare said it adjusted its numbers after “careful consideration,” in light of “the pandemic and the related factors that were outside of management’s control, as well as the extraordinary efforts of our executives and employees in responding to the crisis.”
Wells Fargo & Co., meanwhile, gave CEO Charles Scharf bonuses of $4.35 million and $5.37 million for 2020 and 2021, respectively—part of pay packages that topped $20 million each year—based on what the bank said was a “holistic” approach that didn’t spell out financial targets, or include predetermined or set weighting for any particular goals.
Among the factors the bank said it took into account for Scharf’s 2021 bonus: his “strong leadership in driving key initiatives to advance the company’s strategic priorities,” which led to “significant progress” in addressing Wells Fargo’s longstanding risk and regulatory issues.
The bank shifted away from using specific financial targets in 2019. A spokeswoman said the bank “continues to evolve” its executive-pay program “to provide greater transparency to investors and deliver strong pay and performance alignment.”
Weaver, the executive-pay researcher, said it’s easy for companies to use such nonspecific measures to simply declare that their CEOs have met their goals and thus deserve bonuses. Hard-and-fast quantitative performance metrics are “always preferred by shareholders,” she said.
Amid the pandemic, some companies threw out their bonus processes entirely and simply decided bonuses were merited.
Coca-Cola said the pandemic hurt its business enough that executives wouldn’t have gotten any 2020 bonuses, but directors approved special incentive payments for executives equal to 30% of what they could have gotten. For James Quincey, Coke’s CEO, that amounted to $960,000, part of an $18.4 million 2020 pay package.
The awards were “appropriate” based on improved performance in the second half of 2020, the “resilience” of its executives during the pandemic, and “strategic efforts to drive the reorganization of the company,” Coke said in its proxy statement. For 2021, Coke returned to its normal bonus process, and awarded Quincey a $6.4 million bonus. Coke declined to comment beyond the disclosures in its proxies.
Challenge for Investors
To be sure, not all companies tinker with their bonus processes. Some stick with their targets even when that means no bonuses for their executives. Some argue it’s unfair to penalize executives for developments over which they have no control. And even companies that tweak their bonus processes, and thereby help their executives, don’t necessarily do so every year.
“We are not against executives getting paid well,” CalPERS’ Nzima said. But the discretion that boards exercise in granting rich pay packages to their executives “has to be justified.”
Many companies don’t even tell investors clearly what they’re doing. There’s no set format that companies must use to detail their incentive-bonus processes, making it hard to compare companies. And companies aren’t required to provide the same level of disclosures about the metrics they use in their proxies that they must provide elsewhere.
As an investor, “you’ve got to roll up your sleeves and dig in,” said David Zion, founder of Zion Research Group, which specializes in accounting and tax research for investors. “You’ve got to keep an eye on things like, ‘Is this metric moving? Has it changed? Why is it changing?’”
Frequently, Weaver said, companies’ proxy-statement explanations of their bonus processes are designed to obfuscate, rather than enlighten investors.
“Shareholders really just need straightforward information,” she said. “It is very hard for an individual investor to do all this work.”
One improvement many investors want: Requiring companies to detail precisely how they calculate the adjusted, non-GAAP metrics they use for compensation purposes.
When companies adjust their earnings numbers for use in determining bonuses, they often don’t lay out exactly how they got from their previously disclosed numbers to the adjusted numbers. They have to provide such reconciliations in other documents, but not in proxy statements.
Activision Blizzard Inc. double-adjusted its compensation measures, but the video game company didn’t link back to the already-adjusted numbers it reported in its year-end earnings release, nor did it compare them to official accounting results. The numbers it used to determine bonuses were 5% to 24% higher than what it reported in its earnings. CEO Robert Kotick got a $3.2 million bonus for 2020, part of a $154.6 million pay package.
“If you’re going to use a non-GAAP measure, do a reconciliation,” Nzima said. “Also explain how those metrics are supposed to drive value creation.”
The Council of Institutional Investors has asked the SEC to require non-GAAP reconciliations in proxy statements, calling the lack of it an “anomaly” that should be fixed. The CII and representatives of big institutional investors met with SEC Chair Gary Gensler in March to press their case.
The SEC hasn’t commented on whether it plans to require such reconciliations. But in January, the commission did revive a 2015 proposal that would require companies to disclose more in their proxies about the link between executive pay and performance.
In a March comment letter on the proposal, the Americans for Financial Reform Education Fund urged the SEC to require performance measures used in determining pay to be “transparent, consistent, and not easily manipulated.”
Short of any changes the SEC may make, however, shareholders have few options to rein in executive pay. Norwegian, Wells Fargo, and Activision Blizzard all either lost or drew unusually high levels of opposition in shareholder “say on pay” votes last year, but such votes are nonbinding.
“Shareholders have just had it,” Minow from the corporate governance consultancy said. Investors “can’t go wrong by voting ‘no’ on all executive compensation. They’re all terrible.”