"Interesting" CEO bonus structure. Anyone ever seen this before?

Hi gang,

I’m reading the part of a proxy statement where it discusses how the CEO’s bonus is calculated. This seems unusual to me but basically, in this particular instance, the CEO is awared a bonus if earnings before tax exceeds some predetermined percentage of shareholder’s equity as of the beginning of the year.

Has anyone ever run into a bonus structure like this before? I’m a n00b when it comes to this sort of stuff but that struck me as unique. Or maybe it’s more common than I think? Appreciate any thoughts you guys care to share. Thanks.

That sounds like a residual income type of structure. The thought behind it is probably something like if the company doesn’t make at least enough to cover some kind of required return, the CEO doesn’t get a bonus.

What company is it and can you paste the exact statement from the proxy?

Exact statement is

“Additionally, Mr. XXXXX is entitled to bonus compensation for each fiscal year of the Company in which the Company earned pre-tax net income in such fiscal year in excess of a percentage, pre-determined by the Board, of shareholders’ equity as of the start of the fiscal year (which was 4% for the fiscal years ended March 31 2013 and 2012), as follows: 3% of all (after the 4% threshold) pre-tax net income up to $1 million, 4% of pre-tax net income from $1-$2 million, 5% of pre-tax net income from $2-$3 million, 6% of pre-tax net income from $3-$4 million, 7% of pre-tax net income over $4 million.”

It might be better if incentives were based on free cash flows instead of pre-tax net income, but in any case while I haven’t seen this before, it isn’t a bad incentive structure and seems positive in my opinion. As krazykanuck noted, it’s like a residual income-based incentive where managers do have an interest in expanding bottom-line and reinvesting money in the company prudently as opposed to growing top-line at all costs. What’s also important is that in situations where the company has negative pre-tax net income (a real possibility for this firm), then he doesn’t get any bonus compensation. Lastly, the compensation structure is such that he collects a higher bonus as pre-tax income as a % of equity goes up, so what that tells me is that there’s more of an incentive to be thoughtful about engaging in projects that yield a higher ROIC all else equal.

If I’m looking at the right company, the stock looked cheap at the beginning of the year (sort of like cigar-butt levels). However, with the YTD run, the liquidity/JV risks offset any potential upside in what seems to be a decent product. Market cap is way too small, minimal float, no return of capital to shareholders, and basically zero activity from any insiders or institutions. To me this is dead money unless someone buys them out, in which case maybe you get a 15-20% premium over the then-current price. However, there’s no catalyst for an event like that and management seems to have little interest in doing anything other than coasting along.

Thanks numi, appreciate the detailed insight. This does screen cheap and I agree with your assessment of management. It would be nice to see someone get a bit “activist” here as I think that would go a long way to unlocking some (most?) of the value.

That would be nice, but it isn’t likely to be worth an activists time. This is a true nanocap and arguably it might even be better off as a private company so they didn’t have to pay public listing fees.