Friday, April 25, 2008

Just a Couple More Insights into Schering's 2007 Proxy Statement


I had intended to spend some time, this evening, doing some calculating (inside the various buckets of compensation) to determine whether the 2007 Executive Compensation payments made by the Schering-Plough Compensation Committee seemed "out of proportion" to what would-have-been the increase (or decrease) in "Market Capitalization" -- the metric that Schering has wholly-removed from the factors influencing compensation, this year, as indicated below.

But instead -- and I can't explain why this did not hit me when I was originally writing this, this morning (not enough coffee? too much?) -- I simply want to point out that it is generally inappropriate to use market cap growth as a metric for determining compensation. Issuing shares (dilution) drives it up, but to be fair, so does stock price appreciation.

And yet, Schering has apparently done so, for at least two full yars, since Mr. Hassan took the helm. Why?

I believe it especially inappropriate because, at a company like Schering, that means stock price gets a "double-weighting" in figuring compensation levels. This is so because "Total Shareholder Return" is already factored in (see page 21 of the 2007 proxy). Note that "market capitalization" is simply share price, times the number of outstanding shares. Note also that total shareholder return is really stock price appreciation, plus dividend payments.

Thus, for most of the last three years, it seems, the Compensation Committee has been double-weighting the rise in Schering-Plough stock prices -- but now, as the stock price is declining, the Committee has entirely removed the double weighting effect. So, there is little need to do detailed analysis, here, it was, in part, overweighting compensation in good (rising) stock price years, and only now, will it "normalize" the weighting in a (presumably) falling stock price environment. Well, that IS interesting, no?

And if that weren't unusual enough, note that the 2005 Schering proxy, at page 42 -- while soliciting a shareholder vote to adopt this plan, the description of it does not even list "Market Capitalization" as one of the allowed metrics for measuring performance (and thus determining/awarding executive compensation)! Take a look:
. . .the Compensation Committee may select under the Plan include one or more of the following (in absolute values or relative to the performance of one or more comparable companies or an index of comparable companies):
• Net operating profit after taxes;
• Operating profit before taxes;
• Return on equity;
• Return on assets or net assets;
• Total shareholder return;
• Relative total shareholder return;
• Earnings before income taxes;
• Earnings per Share;
• Net income;
• Free cash flow;
• Free cash flow per Share;
• Revenue (or any component thereof);
• Revenue growth;
• Share performance;
• Relative Share performance;
• Economic value added; and/or
• Return on capital. . . .

That, my friends, is rather astonishing. I have to say that I have never seen that occur. The shareholders approved a plan, and it listed many variables, in sort of a la carte fashion, here -- for measuring performance. . . . and then, for at least two full years, the Compensation Committee determined performance, in part, on a factor that was NOT permitted -- and, in effect, double-weighted for that very factor.

It would be hard to overstate the ramifications, here: Should all that compensation from 2006, and 2007, and now part of 2008, be re-assessed, and re-calculated, to exclude any amounts awarded in reliance on the impermissible, or double-counted, factors? [I don't know -- but all those plaintiffs' lawyers will definitely have a view on this.]

And what are we to make of the fact that the proxy for this year (2007) simply fails to mention ANY of this -- the word "capitalization" does not appear once in the 2007 proxy -- run a "find text on this page" on it, for yourself. It doesn't. No, it just disappears this year, without any explanation of whether the prior double-counting was an unfortunate, but "inadvertent" error, or whether it was intentional.

I am going to need to sleep on this, and return to it -- it is, as ever, possible that I've made some sort of a mistake here -- and, I'd encourage all my Schering readers (another wave!) to point 'em out -- if they see 'em. . . . because, at least from where I sit right now, this looks pretty discouraging, in terms of assessing the competence, and carefulness, of the decision-making around top executive compensation at Schering-Plough, for at least the last two full years. Wow.


It seems that Schering's "designated" Compensation Consultant, Ira Kay, of Watson, Wyatt [pictured, below, left, and a recent, and repeating, visitor to this blog! Big Wave, here!], on behalf of his patron, Hans Becherer, the Chairman of the Compensation Committee of Schering-Plough's Board of Directors (pictured, at right), has recently decided to remove "Growth in Market Capitalization" as one of the general metrics upon which Executive Compensation levels were judged, in 2007.

It was one of the metrics in the 2006 proxy (page 25), rising from $25.5 billion in 2004, to $35.5 billion in 2006. For 2007, by my lights, the analogous number would have been only a little more than $39 billion -- nothing like the rise in prior years (over 18 percent per annum, v. under 10 percent per annum for 2007).

This drop in annual percentage increase is due to the fact that the Schering stock price had already begun to decline, in large part as a result of mid-December 2007 announcement of Congressional investigations of the ENHANCE matter. So, by December 31, 2007, Schering stock prices (and thus "Market Capitalization", as a straight multiple of that price), were in decline. To be clear, then, while the 2006 proxy disclosed a 38 percent growth from base (2004) levels, there would have been scant growth in this metric for all of 2007.

Could this be why it was spiked?

Could it be that -- as the Compensation Committee Report rather oddly admits, about March 31, 2008 -- that "none would have been payable", had the measurement of "Total Shareholder Return" been made as of March 31, 2008 (instead of the previously-structured December 31, 2008 date) -- that very little, or none, of that "bucket" of the incentive compensation package would be payable, had "Market Capitalization" trends been included in this year's Schering Executive Compensation model?

I don't know. But that is a question I intend to investigate today -- and provide answers for -- unless other duties interfere. Back later.

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