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How to lose millions and still get your bonus

Bloomberg logoBloomberg 3/17/2017 Morten Buttler, Alicia Ritcey and Joe Deaux

A couple of U.S. Steel Corp. executives had to hit a low bar to get a bonus last year. How low? Their divisions could have lost millions of dollars and they’d still get a fat payout.

Shareholders have long complained about companies that set easy compensation targets for their executives. U.S. Steel’s below-zero benchmarks are especially glaring, but they suggest that the decades-long drive in corporate governance to tie executive pay to companies’ financial performance seems to have met its Waterloo in the highly-volatile commodities sector.

When prices plunge, bosses might receive only fractions of their multi-million dollar pay packages due to factors they can’t control. But softening targets can result in excessive bonuses when prices turn, drawing ire from compensation watchdogs and investors.

“Even the best-conceived formulas fail at some point,” John Roe, head of analytics at proxy advisor Institutional Shareholder Service Inc., said. “Compensation programs are just not designed to cope with these drastic changes.”

U.S. Steel’s board adopted the negative benchmarks in response to a rocky 2015, when the price of steel slid by more than 35 percent and shares took a nosedive. So for 2016, forecasting another poor year, directors slashed performance goals that set bonus payouts -- in some instances putting earnings targets below zero.

Bonus Payout

Senior Vice Presidents Douglas Matthews and James E. Bruno would be awarded 100 percent bonus payouts if the company’s flat-rolled division, its largest operating segment, lost $15 million in 2016. That reflected the bad year the unit had in 2015, when it lost $237 million.

But as it happened, the steel market rebounded and the flat-rolled unit made $345 million before interest and taxes. Their cash payments as a result hit 175 percent of targets. Chief Executive Officer Mario Longhi got a $4.53 million bonus, his biggest ever, reflecting total company net income that was more than double the target.

“In sectors like steel, your compensation program can be completely wrong just a couple of months later,” said Brent Longnecker, CEO of compensation advisory firm Longnecker & Associates. “It’s so fluid that you have to watch it constantly.”

U.S. Steel declined to comment beyond commentary provided in the proxy statement.

BC-EXECUTIVE-PAY-BONUSES:  © Morten Buttler, Alicia Ritcey and Joe Deaux  

Many energy companies have faced a similar reality after crude prices started falling in 2014. Phillips 66, one of the largest U.S. refiners, cut the earnings target for CEO Greg Garland’s 2015 bonus by almost 40 percent, from $4.2 billion to $2.6 billion.

Still, the refiner’s profit rose 11 percent in 2015 and Garland collected a personal high $4.59 million payout, 185 percent of his target bonus. His compensation for 2016 hasn’t been disclosed yet. Phillips 66 declined to comment.

The fallout can be seen in shareholder discontent at companies’ annual meetings. U.S. Steel has received less than 80 percent shareholder support for its executive compensation program in two of the three most recent advisory votes, regulatory filings show. That’s under the 92 percent average for Russell 1000 companies, according to data compiled by Bloomberg. U.S. Steel investors have been complaining that long-term incentive awards don’t correlate with company performance, according to proxy statements.

Of course, one simple way to avoid dramatic year-on-year changes to pay targets is to get rid of bonuses and pay a flat salary. But few compensation experts advise that. They say bonuses provide a short-term incentive for executives to deliver a stronger performance than their competitors.

Payout Caps

Still, they suggest boards have tools to even out fluctuations caused by external events. Companies can put caps on payouts when they’re struggling. They can also use discretion to scale back payments even when formulas say otherwise. Hess Corp.’s compensation committee did that when it cut CEO John Hess’s bonus in 2015 from paying out 111 percent of his target to 85 percent “in light of the current commodity price environment,” a filing shows.

“Shareholders may give you a pass on negative targets for a short period of time if they are truly stretch goals, but they don’t like to see performance goals decline year after year because it can suggests more serious issues with the business or compensation program,” Dan Laddin, a partner at pay consulting firm Compensation Advisory Partners, said.

--With assistance from Anders Melin

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