Scale for the Sake of Scale
March 2, 2010
Warren Buffett seemed pretty grumpy in his latest letter to shareholders, lobbing grenades at the press, bankers and even taking some thinly veiled shots at some of Berkshire's holdings.
At the risk of landing on the wrong side of Buffett's issues with the press and his distaste for 'sound-bite reporting,' I thought one of the more interesting points he made in his letter was a throw-away line in his diatribe against stock-for-stock mergers. Specifically, he set up a hypothetical situation (Kraft/Cadbury) in which the CEO of so-called Company A, following a deal, "now runs a company twice as large as his original domain, in a world where size tends to correlate with both prestige and compensation."
I actually wrote a story about this that will appear in April issue of Mergers & Aquisitions, which asks the question: are boards and compensation committees unwittingly incentivizing empire-building among CEOs?
The answer is always a bit more nuanced than simply yes or no, but if you look at the three best paid CEOs from 2009 -- Oracle's Larry Ellison, McKesson Corp.'s John Hammergren and Flextronics' Michael McNamara -- it's hard to argue that there isn't, at least sometimes, a connection between pay and dealmaking.
Like most things in M&A, compensation is all about comparables. And typically, revenues are the metric favored by compensation consultants. Sure, recent trends have tried to emphasize variable income, but as Flextronics' proxy statement seems to highlight, boards can easily move the targets around to the benefit of their chiefs.
Flextronics, for instance, determined McNamara's salary using a peer group that included the likes of Dell Inc., Tyco, Xerox, Honeywell and Cisco, among other giants. Suddenly, Flextronics' $3.6 billion acquisition of Solectron, which added roughly $11 billion of revenue, looks pretty smart in hindsight for McNamara, who sealed the purchase roughly a year and a half into his tenure.
When Flextronics' stock tanked, meanwhile, the board introduced option grants for executives, saying that the shift was designed to create better alignment with shareholders and to reward the employees for the successful integration of the Solectron deal.
Sure it's just one example, but it seems as egregious as anything seen on Wall Street. And while Buffett's continued shots at the press are starting to get a bit grating, even if I do agree with his premise, he's always proven to be pretty adept at identifying incongruities.
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