Even in Silicon Valley, CEO pay is a sensitive topic

Open Editor's Digest for free

Rula Khalaf, editor of the Financial Times, picks her favorite stories in this weekly newsletter.

Dear reader,

Linking CEO pay to company performance seems very reasonable. Why are the interests of the company's president not aligned with its investors? Giving CEOs performance-based stock awards has the added benefit of reducing cash outlay on base salaries and makes calculating pesky bonus ratios between CEO and worker more difficult.

The problem is that it is not always easy for investors to evaluate the rewards on offer.

Take an Uber.

Last week, the Financial Times reported that a stunning rise in Uber's share prices this year led to its CEO, Dara Khosrowshahi, obtaining stock options worth $136 million. This was a reward for the company's value, which reached $120 billion. It's the payday that once seemed impossible. The $120 billion goal was the goal Uber was hoping to achieve when it joined the markets in 2019. But the company's lack of profits and the difficulties its competitor Lyft has faced as a public company led Uber to lower its forecast, first to $100 billion and then to $100 billion. Just. More than $82 billion.

Even this was too high for some investors. For years, Uber has traded below its listing price. It decreased in light of the epidemic, with flights halted. The uptick in food delivery orders did not offset the decline in bookings elsewhere.

Uber's cost-cutting and steady march toward positive net income and free cash flow since then is impressive. After 15 years and billions of dollars in losses, Uber shares are now trading at 75 percent above their listing price, surpassing its $120 billion valuation. Khosrowshahi received his choices.

However, what may at first seem like a simple prize, turns out to be rather complex. There is no consensus on the targets used for performance-based pay or the method for calculating them. For example, DoorDash bases its CEO bonus on the stock price. Tesla based some of Elon Musk's huge awards on market cap. But Uber used a capitalization number that requires a number of shares that includes options and restricted stock units (RSUs) — a number that is higher than market value.

Look back a few years and you'll see that conditions have changed too. Uber cut the exercise price of Khosrowshahi's options from $41.65 to $33.65 in 2018, after an investor put money into the company at a lower value. A year later, Uber joined the markets at $42 per share.

Companies often seem anxious to ensure they do not lose their executives. Sven Reithmueller, a professor at Yale Law School, has noted the frequency with which private companies offer low-priced options to executives in the tighter preparation period before a listing. He refers to these as eleventh hour discounts. More than half of the companies he studied offered discounts of 45 percent or more on their IPO price, guaranteeing a windfall for presidents and other executives.

For investors, being able to evaluate these prizes is important because they make up a significant portion of the rewards. CEO base pay tends to be low. Technology takes this to the extreme. For example, Mark Zuckerberg of Meta earns a symbolic amount of $1.

This arrangement is not, as Zuckerberg once claimed, because he made enough money. The generous rewards largely come in the form of broad stock options, which give the holder the right to buy shares at a predetermined price, and RSUs, which vest over time. Some are time-based, others are performance-related. These could be accounting-related goals, valuation goals, or internal company plans. Apple has introduced environmental, social and governance targets for executive bonus accounts in 2021.

Companies view performance-based awards, especially those tied to the stock market, as a way to appease shareholders dissatisfied with the size of bonuses received by corporate leaders. Apple has increased the performance-related portion of Tim Cook's pay after an investor revolt. Of course, it doesn't always work. Watch investors revolt over Musk's massive performance-related deal in 2018.

Performance-related awards do not guarantee superior performance, even those linked to the stock price. Market movements can be driven by external forces. Companies will need to take into account the performance of their peers to set a realistic objective target. This naturally means more complex calculations for investors to address.

Quick links to Lex

Elsewhere in the world:

UK Finance Minister Jeremy Hunt's move to scrap domicile-based exemptions is radical and may not raise £2.7bn a year. But domicile is a poorly understood concept, encouraging wealthy people to move to Britain while keeping their money elsewhere. Change is overdue.

Spaces are not done yet. . . Chinese-owned online financial brokerage Webull is preparing to list its shares on the Nasdaq through a merger with a special purpose acquisition company. Expect tough trading. The new shareholders will own less than 2 percent of the company and will control zero voting rights.

Who will benefit most from Beijing's increased defense spending? Lakes points out that AviChina Industry & Technology, China's largest helicopter manufacturer, is trading at a significant discount to its European counterparts even after the recent rise in its share prices.

Things I enjoyed

Nara Smith is a young American model who has built a huge fan base on TikTok with her elaborate cooking videos (her lasagna starts with her own mozzarella cheese). Now she's unwittingly become the boss of an online battle over Mormonism and so-called “merchant wives.” This Rolling Stone profile does a good job of explaining the drama.

Elon Musk's lawsuit against OpenAI makes this a good time to draw your attention to an excellent review of Walter Isaacson's biography of Elon Musk published a few weeks ago. What makes Musk interesting isn't just his money or deals, but the ideas behind them. Who are the other presidents tweeting about Rocco's Basilica? By ignoring them, Isaacson fails to explain why so many people are drawn to Musk's cause.

Enjoy your weekend,

Elaine Moore
Vice President of Lex