By Scott Patterson, Compensation Analyst Manager
Starbucks Corporation’s founder and CEO, Howard Schultz joined the exclusive ranks of ConocoPhillips’ James Mulva and Apple’s Timothy Cook, after realizing pay of over $117.5M in FY2012. Given the runaway success of Starbucks, and Mr. Schultz’s long tenure, this number is not a surprise. However, the manner in which Mr. Schultz achieved such heights does deserve further scrutiny.
The bulk of Mr. Schultz’s FY2012 compensation came from the exercise of over 2.7M options, that had a realized value of more than $103M. Another $10.2M was earned by the vesting of over 230,000 shares. The exercise of options in exchange for millions of dollars is not new for the Starbucks CEO. In FY2011 he earned nearly $37M by exercising over 1.4M options, and $24.7M in FY2010 when 1.58M options were exercised. In FY2009 over 4M options were exercised leading to another $26.6M in Schultz’s pocket. For those keeping track, that is over $191M in option value realized over the past four years.
For Mr. Schultz, option grants have been very timely. The most questionable grant came in November 2008, when the company awarded him over 2.7 million options with an exercise price of $8.64. This was in the midst of the financial crisis, when stock prices reflected correlated market panic rather than true underlying business value. Two years prior, Starbucks shares were trading in the mid-thirties, and two years after, shares were rising above $30. Barring a complete collapse of the global economic system, it seems unlikely that the Starbucks board thought that its stock price would remain at those depressed levels. To the cynic, the large option grants at artificially low strike prices appear to be a free give away to Mr. Schultz, particularly when shareholders were distracted by other headline issues.
Although GMI has written about this “Mega-Grant” in the past and warned of its enormous payout potential, it seems the Compensation Committee was blithely unbothered about the appearance of this outcome. In following three years, a total of 1,565,342 more options were granted with exercise prices ranging from $22.06 to $43.64, well below the current $50+ stock price, thus ensuring that Mr. Schultz will be seeing more big pay days.
Though options have a place in a balanced and well-structured compensation package, persistent grants to an executive with an already large ownership position makes little sense. As founder and chairman since Starbucks’ inception and CEO for much of its existence, Mr. Schultz naturally holds a substantial share position. The company’s beneficial ownership table reveals that over 27.6 million shares are under his control. The cash earned on dividends alone would result in significant compensation given the 12 dividend payments totaling $1.85 per share since April 2010.
The abundance of options awarded to Mr. Schultz over the years is troubling; however it is not the only compensation excess. His base salary of $1.5M and $200,000 spent on security goes well beyond the tax deductible limit instituted by section 162(m) of the internal revenue code. Mr. Schultz also had the potential to earn $4.5M under the Executive Management Bonus Plan, which resulted in a payout of over $2.3M in FY2012. Performance RSUs (PRSU) that were based solely on one year Earnings per Share (EPS) netted him over $6M. The Compensation Committee has seemed to acknowledge the weakness of the PRSU plan by doubling the performance period to two years and adding ROIC as a metric for FY2013. However it is concerning that EPS and ROIC make up 50% of the annual cash bonus plan, allowing for double-dipping on the same standards.
Outside the option exercise value, the most alarming part of Mr. Schultz’s 2012 remuneration is the Special RSU Award. Despite earning over $100M in pay, the board felt the need to entice him with an additional $12M grant to remain with the company for three more years. A threshold tied to the grant calls for positive cumulative net income over the three years, making it deductible under Section 162(m), despite the abnormally low hurdle utilized.
Although Mr. Schultz at 59 years old has a few more years before retirement, he has built a comfortable nest egg under the Starbucks deferred stock plan. He has greatly benefitted in large part by deferring gains from stock options in 1997. This resulted in nearly 3.4M deferred stock units that gained millions on appreciation and dividends, resulting in a balance that now stands at over $172.6M.
Starbucks’ soaring stock price has clearly been good to its founder. Shareholders are also happy, as the stock price has risen from its financial crisis lows to a shade lower than its all-time high of $57.37. Though shareholders voted overwhelmingly (over 93%) in favor of their CEO’s compensation package at the 2012 annual meeting, there may be a limit to what they will tolerate.