How Firms Pad CEO Pay

Dividend payments on unvested stocks can increase an executive's annual salary by 25%

May 14, 2018 | Crain's

In baseball, it’s hard to get a hit without swinging the bat. On the music scene, no singers have recorded a hit song without opening their mouth. But at some publicly traded companies, top executives are paid hundreds of thousands of dollars or more in dividend payments on stocks they don’t actually own and may never own.

For instance, in 2016 JPMorgan Chase’s chief executive, Jamie Dimon, was paid $658,000 in dividends from shares in his bank he didn’t own. That same year, the CEO of Philip Morris International, André Calantzopoulos, was paid more than $1 million for shares he didn’t hold in the tobacco company. Peter Kraus, former CEO of money-management firm AllianceBernstein, pocketed $2.8 million this way.

“Not many people know about these payments,” said Don Chance, a finance professor at Louisiana State University who in 2016 co-authored the first academic paper on the practice. “This is a form of stealth compensation, and most companies generally don’t talk about it.”

Chance found that about 10% of all companies on Standard & Poor’s 500 pay executives dividends on shares they don’t own. He said these firms appear to have been quietly making the payments since at least the early 1990s. Crain’s reviewed the most recent regulatory filings disclosing pay at 150 New York–area companies and found at least 10 that pay dividends on unowned shares.

Payments on these stocks boost the average CEO’s yearly pay by more than $300,000, Chance discovered. That may seem like small potatoes for executives awarded tens of millions’ worth of compensation, but much of that generous pay is deferred, meaning the stealth dividends can increase their annual salary by 25%. What’s more, those dividends are quickly becoming more valuable because companies have raised payouts by an average of 14% since President Donald Trump signed the tax-reform bill, according to Standard & Poor’s. More details on these payments will be divulged in the coming weeks as companies begin releasing 2017 executive-pay information.

Cashing in on the fine print

Dividend payments on unowned shares aren’t better known in part because most companies rarely acknowledge their existence. Generally the payments are disclosed only in the fine print of regulatory filings—but companies often decline to reveal the exact sums involved. Calculating their value can require digging through several years’ worth of data to see how many restricted shares an executive has been granted, how many are actually owned and how much the company paid out in dividends in a given year.

“I’ve been fighting companies on this for a long time, and it still goes on,” said Tony Daley, an economist at the Communications Workers of America, who took General Electric to task over these payments more than a decade ago.

So how do executives profit from stocks they don’t own? It works like this: Companies regularly compensate top executives by granting them restricted shares that don’t vest for several years. Sometimes these awards pay out when certain performance hurdles are met; others are paid simply if the executive keeps his or her job. But some companies go ahead and pay executives dividends as if they own the restricted shares, even though they haven’t vested.

Companies often defend making these payments by arguing they aren’t especially large relative to total pay. But Chance argues that one of the big problems with paying dividends on unearned shares is that it further weakens the sometimes tenuous link between executive performance and pay.

Up until 2013, Bristol-Myers Squibb stated in filings that its dividend-payment program “promotes greater retention of our executives.” But the drugmaker has since changed its policy and no longer pays dividends on unowned shares. In a 2014 filing, the company said its decision "simplifies employee communications and administration to further engage and retain employees."

Other firms that have quit the practice include Citigroup, GE and IBM. These companies often allow dividends on restricted shares to accrue but don’t pay them out until the stocks vest. If the shares don’t vest because performance wasn’t up to snuff or the executive didn’t stay in the job, typically those restricted stocks are forfeited, along with the dividends.

After years of pressure from shareholders and advocates such as Daley, more than half of S&P 500 companies have banned the practice. Institutional Shareholder Services, a powerful corporate-governance advisory firm, last year started taking into account dividend payments on unearned shares when deciding whether to recommend that investors vote in favor of a compensation plan.

“Prohibiting dividend payments on any type of unvested equity is definitely considered a market best practice,” said Sydney Carlock, a senior compensation analyst at the advisory firm.

Nonetheless, some companies continue to find that stealth dividend payments are a hard habit to quit. In 2016 JPMorgan began granting Dimon a type of restricted stock that doesn’t pay dividends before vesting, but several top executives at the bank are still paid dividends on unowned shares. Asset management chief Mary Callahan Erdoes received $613,000 this way that year, while $580,000 went to Daniel Pinto, head of corporate and investment banking, according to calculations by Crain’s based on data in the firm’s most recent pay-disclosure statement. The firm declined to comment.

Philip Morris International is also trying to wean its CEO off this type of dividends. Under a new plan, only 40% of the restricted shares granted to Calantzopoulos pay dividends before vesting, down from 100%, a spokesman said. The representative did add that the dividend-paying unvested shares "incentivize executive retention" and "align executive interest with that of the shareholders." Like most tobacco companies, Philip Morris’ dividends are quite generous, with the firm’s $6.5 billion 2017 payout exceeding its profits by about $200 million.

AllianceBernstein, which manages more than $550 billion in client assets, continues to pay its CEO dividends on unvested shares. Kraus left the firm last year, and the amount paid on the restricted stock granted to his successor, Seth Bernstein, wasn’t disclosed but would have been $165,000 based on the dividends issued after Bernstein’s tenure began.

Stealth dividend payments appear especially popular at financial and real estate investment firms. They have played an important role in how top people are paid at Greenhill & Co., a Wall Street firm that advises some of the world’s leading corporations on mergers and acquisitions. The firm’s stock price fell 3% in the five-year period beginning in 2011, a significantly worse performance than its peers’, but the payout to CEO Scott Bok for his pile of unvested shares rose 75%, to $580,000, in 2016. That gravy train has since slowed down: After the long stretch of disappointing performance, Greenhill slashed its dividend payments by 89% last year.

The company didn’t respond to a request for comment.

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