In the September/October issue of Chief Executive, an article titled ‘What’s a CEO Worth” by David Meredith, Chairman and Chief Executive of Personnel Corporation of America designated our CEO, Mr. Walter E. Bartlett, as a high-pay, low-performance Chief Executive. This was especially surprising considering that our company went through the first leveraged recapitalization in corporate history on October 1, 1985, at which time our stock traded at $193/8 and on the three-year anniversary of the recapitalization, September 30, 1988, closed at $751/2.
After studying the information in the article, I inquired by telephone as to how the pay and performance computations were done, and was referred to officials of PCA, and they agreed to send me copies of the computations. My review of the computations and further discussions revealed that PCA failed to consider the impact of the most significant financial transaction in the history of Multimedia, that is its leveraged recapitalization on October 1, 1985. Specifically, the article was based on computations which contain the following two factual errors:
· The price of the stock used for computing Mr. Bartlett’s compensation from stock options was incorrect. PCA used $58.50 per share instead of the first trade price after the recapitalization, $193/8 per share. (An argument could be made that the $10 option price should be used instead of the first trade price of $193/8. This would result in a much lower “pay factor.”)
· When computing the return to shareholders (company performance), PCA did not include the shareholder distribution of $886,640,000 on October 1, 1985. At that time, each share outstanding received a minimum of $47.19 in cash or other consideration as a dividend. This distribution was not included in the computations. We have reviewed this information with PCA, and they have agreed that these two items were not accurately reflected in their computations and would have had a significant impact on the results. Attached (see box) is a schedule comparing the results reported in the article with the results we have computed after giving effect to the above two errors. The reported “actual pay” was $4,256,000, as compared to our recomputed “actual pay” of $1,594,000. The recomputed “actual pay” results in a “pay factor” of plus 42 percent instead of the reported plus 280 percent. (The “pay factor” would be minus 15 percent if the $10 stock price was used.) The reported “performance of 31.8 percent was actually 11.5 percent better than the median industry performance instead of 10.3 percent worse. As you can see, the consideration of all material facts involved reaches significantly different results than those reported in the article prepared by PCA. It is very disturbing and disheartening that officials of PCA, after acknowledging these errors, simply stated that they were aware that some type of significant event had occurred in 1985, but since they were unsure of what it was, did not consider it in their computations. It appears to me that when someone prepares an article judging performance they would at least have the professionalism, and courtesy to inquire about a transaction approaching $1 billion when they did not understand it. This action indicates poor judgment by PCA and hurts the credibility of your magazine.
Robert E. Hamby, Jr.
Chief Financial Officer Multimedia
Greenville, South Carolina
David R. Meredith replies:
Mr. Hamby is right when he states that our analyses “…failed to consider the impact of the most significant financial transaction in the history of Multimedia…” While it is little consolation, Standard and Poors and Value Line also failed to report this event. Moreover, it is interesting to note that even Multimedia failed to disclose in its “10 year review” in their 1987 annual report, any such dividend. While the astute investor might have gleaned this fact from footnotes 1 or 6 of the most recent 10K, this is hardly a subject for reading by most individual investors.
When this fact was brought to our attention by Mr. Hamby, we agreed that Multimedia’s performance would have been 19.7 percent, based on our study methodology. While Mr. Hamby makes an argument that the “dividend” could have been reinvested, with the resultant performance increasing to 31.8 percent, it would appear that at least some of the payment was made in the form of debentures with a coupon rate of 16 percent (well below the 19.7 percent growth rate our methodology would indicate).
Moreover, it is not clear from the annual report, the proxy or even the 10K, what various shareholders actually received. Some, apparently, got $47.19 (according to Mr. Hamby’s letter presumably all cash-while other outside shareholders were reported (in the 1987 annual report) to have received $52.46 to $63.13 in some combination of cash and other considerations. Mr. Jack Kent Cooke and certain of his affiliates were reported to have received $70 per share plus $1.7 million in reimbursement for legal fees incurred in connection with the transaction. The annual report does not state which “certain shares owned by company management” were paid. Thus, it is impossible for us to figure what the real value-and thus performance-was.
It’s too bad that such an apparently good story has been obfuscated by such sketchy reporting.
Turning to the issue of compensation, there is no question that the “value” of the package hinges on two factors: (1) the growth assumption used in valuing Multimedia’s restricted options, performance options and new key executive plan grants, and (2) the “fair market value” of the stock at the time of grant. Here, again, the facts are not clear. On the appreciation assumption, if we were to accept Mr. Hambey’s contention that the stock value grew at 31.8 percent, Mr. Bartlett’s total pay based on our valuation methodology, would have been $3,199,350 not $1,594,000 as stated by Mr. Hambey. If one is to use this number in the performance calculation, logic dictates that this number (not 9.5 percent as Mr. Hambey used) should be the assumption used to determine pay.
“Fair market value” presents another interesting issue-what is it? Options were granted at $10, the fair market value on July 29, 1985 according to the proxy and annual report. This price apparently was set by the Board. But, the stock traded at $58.50. On October 2, presumably reflecting the “dividend”, the stock dropped to $19.50-95 percent above management’s “fair market value” yet even Multimedia’s own annual report indicates that the price was never below $39.50 per share in 1987. While the IRS may not mind this difference, FASB accounting (and thus reported earnings) will be affected if there is a difference between “fair market value” and the price of options.
For us at PCA, the lesson is clear. If the facts are not clear, even sophisticated analysts like those at Standard & Poors and Value Line may miss them and missing relevant facts, shareholders might conclude that a 186 percent pay premium is not justified. Even with agreement on the facts, if options are granted at a price that appears below market and pay is stated to be only 42 percent higher than the competitive rate by the boss’s CRO, many could question whether they, the shareholders, can subscribe to a pay for performance philosophy, and this could hurt an emerging trend that we believe is helping make corporate America competitive.
LIFESTYLES OF THE BRONZED AND FAMOUS
Contrary to the article on CEO portraits in your November/December 1988 issue, William Simon’s school is not at Lafayette College but at the University of Rochester. Moreover, there is a life-sized, bronze W.E. Simon at Rochester. It stands in the entrance foyer of the school, where the striking likeness to Bill Simon and 360-degree accessibility have made it the focal center of the school-and a favorite of our students. They dress it up for holidays, rub its ears for good luck, and occasionally remove all six hundred pounds of it to other locations to operate the elevators or to read bulletin boards. As we had hoped, the statue has come to stand for more than the initiative and energy of our patron; it is a unique representation of our school’s aspirations and goals. It is so much more mobile and interactive than the portraits-as good as they may be shownin your last issue.
Paul W. MacAvoy
William E. Simon Graduate School of Business Administration
University of Rochester, Rochester, NY
Although the William E. Simon School of Business Administration is not at Lafayette College, we are extremely pleased that William E. Simon is a dedicated and active alumnus of the college and pleased, as well, that he made possible a major renovation/addition to the campus in the form of the William E. Simon Center for Economics and Business Administration, which houses our Department of Economics and Business.
David W. Ellis
Office of the President
I was pleased to be included in the “Captured on Canvas” article featured in the November/December 1988 issue. Mr. Finkelthal conveyed a colorful and accurate insight into an artistic profession and its relation to the corporate world. I heard similarly from many CEOs I had portrayed.
I am reminded of the late great portraitist, John Singer Sargent, who remarked, “A portrait, don’t you know, is a painting of someone with a little something wrong with the mouth!”
Everett Raymond Kinstler
The National Arts Club
New York, NY