As far as management teams go, the gang at Chipotle gets a lot of things right. Since the spinoff from McDonalds in 2006, Chipotle has managed to grow profits from $1.28 per share to an estimated $12.60 by the end of this year. When you increase profits almost ten-fold in under ten years, it’s probably a pretty darn good automatic indicator that you’re doing something right.
And for those of you that appreciate the process of how things get done, you can’t help but tip your cap towards how Chipotle management has generally treated shareholder capital. Chipotle has no debt, no preferred stock, no pension obligation, and hardly any encumbrances on the balance sheet (Chipotle does rent about $185 million worth of machinery each year, but other than that, no outstanding commitments). And the company has actually managed to reduce its share count from 32 million to 31 million over the past eight years, which is impressive because most fast-growth companies have the unfortunate tendency to dilute owners along the way, realizing they can get away with it because no one is really going to complain about the difference between 21% and 18% annual returns (whereas dilution that turned 9% annual returns into 7% annual returns would catch your attention).
Consistent with these returns, Chipotle executives pay themselves well. Very well. Chipotle has co-CEOs that each brought in $25 million last year (Steve Ells and Monty Moran), and the hedge fund guys didn’t start objecting to Chipotle’s compensation until disclosure statements revealed that Chipotle shareholders were on the hook to pay for the schooling of Monty Moran’s kids. And apparently, Chipotle was reimbursing the taxes of Steve Ells. That clumsy move seemed to come out of the Leona Helmsley “taxes are for the little people” playbook.
The Wall Street Journal reported this on the “Chipotle Executive Plan Vote”:
The vote, at the company’s annual meeting Thursday, was nonbinding. But the rejection of the pay plan by owners of 77% of shares was nonetheless a potentially worrisome sign for Chipotle because such reproofs reflect shareholder unrest and can draw attention from activist investors. Thursday’s meeting also included a separate, binding vote in which shareholders rejected Chipotle’s request to reserve an additional 2.6 million shares for issuance under its equity incentive plan.
The 77% opposition was the largest ratio in any such vote on executive pay so far this year within the Russell 3000 list of the largest U.S. companies, according to Institutional Shareholder Services Inc., a proxy advisory firm.
Votes on executive compensation need to transition from “advisory” to “binding.” I’ve written before that the problem with executive compensation in corporate America is that there are no bulldogs safeguarding the shareholder interest. If you’re on a compensation committee, and the new plan calls for you to receive 10,000 shares of the stock, it’s going to be damn hard to get you to vote against it. It’s a terrible incentive structure to put in place, and yes, incentive structures can be immoral. As Warren Buffett’s right-hand man once said, “So people who have loose accounting standards are just inviting perfectly horrible behavior in other people. And it’s a sin, it’s an absolute sin. If you carry bushel baskets full of money through the ghetto, and made it easy to steal, that would be a considerable human sin, because you’d be causing a lot of bad behavior, and the bad behavior would spread.” That’s how we are currently handling executive compensation in corporate—we have stock grants and the promise future promotions under the nose of those that need to approve the compensation, and it’s no wonder we have created a world where we have executive objecting mightily to raising the hourly pay of employees by $2 an hour, but then don’t see a disconnect with the 25,000 shares that they deem necessary to receive themselves.
Binding, shareholder votes are the closest approximation to creating a “check and balance” system to make sure that the interests of shareholders are adequately represented. When the owners of the company reject the pay for their executives,that should become final. The risk in that system—that shareholders would undeservedly vote no to compensation plans that executives actually deserve—is rather remote because most of the votes would be coming from institutional investors anyway, and they’re generally permissive of most pay packages until you do something particularly egregious, like taking the profit generated on behalf of shareholders from selling steak burritos and then use it to pay off the tuition bills for the CEO’s kids.
On the New York Times report of the story, the comments section ranged from terrible to great. People like “Alex S” had this to say:
“Very easy to vote with your feet [if you don’t like corporate governance]–
As a matter of immediate self-interest, he (or she) is right. If the company’s management disrespects your capital, you can always find other places to invest. The Berkshire Hathaways of the world do still exist, if you keep your eyes peeled. But as a matter of broader self-interest, the “sell when companies do something you don’t like” approach is troublesome because it suggests you should ignore and run away from those engaging in morally blameworthy behavior, rather than stand up and push back against it. If Chipotle gets away with issuing 2 million shares, who is to say that Wendy’s management won’t then emulate them? Maybe Darden restaurants will do it, too? At that point, it would become “an industry normal” and then McDonalds’ could justify it, too. It’s all one interconnected web, and when bad behavior goes uncorrected, you better believe it will spread.
User “Peter” put the morality into better perspective:
“It’s fine and fair for a company’s founders, who in contrast to ‘professional managers’ create something of value from nothing, to make as much money as they want – IF they keep their company private. Once they take their company public and gain the associated financial benefits, they forfeit that right.”
The added insult to injury is that executives in industries that don’t require majestic intelligence—I bet anyone reading this could grow profits if they were the CEO of Coca-Cola—are the companies that are rewarding their executives particularly well. If Google has to pay some guy or gal 10,000 shares to keep him from going to Apple and building a smartphone innovation with them, I get it. The value created has a relationship to the shares issued. There is something incredibly unseemingly about people of above-average intelligence making above-average executive decisions treating the corporate treasury as a big, fat piggy bank to shake for their own enrichment, to the detriment of the actual owners of the company. I like it that shareholders are starting to stand up and fight, but the next step forward is to make their votes binding. Make it count—otherwise these advisory say-on-pay votes are like seeing your favorite football team win a game during the NFL preseason in August. It is briefly satisfying, but ultimately, empty of actionable meaning.