Yahoo CEO Bartz Has a Lot of Explaining to Do

September 18th, 2009
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Contributed by: Eric Jackson, Ironfire Capital
Yahoo! (YHOO) CEO Carol Bartz didn't get the "boatloads of cash" for her shareholders from Microsoft (MSFT) as she vowed in May, but she'll take home a boatload of cash herself out of Yahoo! for her work in 2009.

A review of her total compensation plan reveals that Bartz is on track to make $20 million to $30 million this year in cash and stock (depending on if the share price rises 13% by December and stays there for the rest of the year or not); and $187 million for her first four years on the job, assuming the stock can get back to $25 by then.

In last week's Activist column, we shined a spotlight on the large amount of insider selling which has occurred at Yahoo! in the past two years (based on our study of the Securities and Exchange Commission filings leading to other media reports on this topic), including Bartz dumping $2 million in shares in March and June.

Since that column appeared, Bartz, Yahoo!'s PR SWAT team and Bartz' defenders have claimed that there was "no story here," as these were "routine" share sales made to pay taxes on generous Restricted Stock Unit (RSU) grants. Bartz went so far as to say "I didn't sell anything" on television and there have also been vague references to her shares being "reacquired" again. They have not - as the actual Form 4 SEC filings show. They state only "disposals" of $2 million in Yahoo! shares, which of course immediately lower the company's earnings per share.

Contrary to what any PR flak says, these kinds of tax-related share dumps when RSUs vest may be common at lower levels of the company, but they are not at the highest level, where executives have more than ample means to pay their taxes out of their own pockets. Bartz made $45 million in 2007 alone just from exercising her Autodesk (ADSK) options, so she could have easily scratched together $2 million to pay the tax man if she'd wanted to hold on to her Yahoo! shares.

It turns out that, when you start to peel the onion around Bartz' CEO employment contract, there are many interesting details which Bartz would likely not want discussed. Prior to negotiating with Yahoo! for the top job, Bartz hired an unnamed financial advisory firm to help her. Later, when the deal was done, she got Yahoo!'s board to agree to Yahoo!'s shareholders paying "up to $150,000 for advisory fees" for her use of that savvy firm (which is outrageous and she should immediately reimburse Yahoo! shareholders for that with interest).

That negotiated agreement is a good one for Bartz, as this analysis shows. Making reasonably conservative assumptions, Bartz should get $187 million for her planned four years of work at Yahoo!.

One small part of that agreement is something Yahoo! calls the "Make-Up Grant." Because of "forfeiture of the value of equity grants and post-employment medical coverage from" leaving her old executive chairman job at AutoDesk, which has one-fourth of the market cap of Yahoo!, Yahoo!'s board said she was due $10 million.

As part of that grant, she'll get $2.5 million in cash this year and 639,386 RSUs (or shares). The cash and shares vest at a rate of 25% quarterly in 2009. By the end of this year, those shares and cash will be worth about $12.5 million (not the $10 million grant date fair value; see this breakdown for more detail.

Yahoo! states later that they are providing "post-employment medical coverage for Bartz, her spouse and eligible dependents" on top of her grant, so that should not be linked to the value of the "Make-Up Grant." Therefore, the only thing to be made up for is the value of her unexercised AutoDesk equity options.

Yet when you go back and review the unexercised options she possessed in the 2008 AutoDesk proxy statement and the ones she subsequently exercised and sold in share sales through the rest of last year, I calculate Bartz' value of her unexercised equity grants at far less than $10 million.

On the date her Yahoo! employment agreement was announced (Jan. 15, 2009), AutoDesk was trading at $16.14. That means, her remaining 250,912 $11 strike price, her 36,420 $8 strike price, and her 993,056 $14.40 strike price unexercised options had a fair value on the date she took the Yahoo! top job of $3.3 million -- not $10mm.

This major "Make-Up Grant" discrepancy between what Yahoo! chose to award Bartz and what it appears -- according to her AutoDesk SEC filings -- she was in fact walking away from should be explained to shareholders immediately.

Setting this problem aside, Bartz -- like any other employee who gets RSUs -- has to pay tax on stock grants whenever she receives them. To pay the tax, Bartz must make a choice to write a check to the government from her personal account to cover this or sell part of these Yahoo! shares from the RSUs. In the first and second quarters, Bartz sold $2 million in Yahoo! stock to pay her taxes. It's very likely she'll do this again later this month and in December, when the rest of her "Make-Up Grant" shares vest.

Which brings us to the core problem: given her leadership role at Yahoo! and given her generous Yahoo! compensation and sizable wealth she's amassed from her time at AutoDesk, why would she dump Yahoo! shares instead of paying her tax bill herself? It sends the wrong message to employees and shareholders that she wouldn't be kicking and screaming to keep every last Yahoo! share in her possession.

I think there's a simple answer to this question: Carol Bartz is used to getting generous tax gross-ups from companies she works for and likely she (or her high-priced advisors) negotiated this in as part of the deal.

A tax gross-up is when an executive wants to receive a certain amount of compensation award or benefit but knows they'll have to pay taxes on it. Rather than pay that tax bill themselves, the executive asks the company to bump up the value of the award in the amount of any taxes they would otherwise have to pay. They end up getting the amount of money they want tax-free -- with taxes paid for by the company's shareholders rather than the executive.

For an example, let's go back to the 2008 AutoDesk proxy statement : "During fiscal 2007, Ms. Bartz's other compensation included post-employment health and dental benefits with an actuarially determined present value of $631,986 plus a $421,324 tax gross-up, and a Company gift for appreciation of years of service as CEO costing $67,500 plus an associated $33,889 tax gross-up." Have you ever heard of a gross-up on a gift for years of service?

Tax gross-ups are completely unacceptable and any well-governed company doesn't allow them. If you make money or a benefit of some kind, you should pay tax on that -- not the shareholders who gave you the benefit in the first place. To use one of Bartz' favorite words, tax gross-ups are stupid.

Bartz has clearly become used to tax gross-ups at AutoDesk and likely she or her high-priced advisors were thinking of this "Make-Up Grant" in the same way. They might have negotiated her $3.3mm fair value (as of mid-January 2009) unexercised AutoDesk options into a $10mm make-whole grant from Yahoo! That's a tax gross-up and then some.

Yahoo!'s compensation committee is to blame here. First, they pay Terry Semel over $570 million for his six years as CEO; then, they award Bartz a four-year $187 million pay package with up to $30 million in year one; then, they see their ineffective incentive plans lead to Yahoo! insiders selling $233 million in stock over the past two years versus insider purchases of only $103,000. Now, we learn of these discrepancies in the reasoning for different elements of Bartz' pay.

Where is Carl Icahn in all this? It turns out he was right at the negotiating table when all this went down. His colleague, Frank Biondi, has served on Yahoo!'s compensation committee since joining the board in September 2008. He directly oversaw the design and approval of Bartz' pay plan, which, in my view, wasn't in the shareholders' interests.

Of course, Bartz is at fault here too. She's gotten too used to high pay and tax gross-ups over the past few years -- both for herself and for CEOs she has socializes with.

Examine this table below for a comparison between the average annual total compensation for several popular tech CEOs vs. ones in Bartz' social network. Bartz doesn't suffer fools -- or CEOs who don't bank a lot of coin.

Popular Tech CEOs
CEO Most Recent Avg. Annual Total Compensation
Eric Schmidt, Google (GOOG) $500,000
Jeff Bezos, Amazon.com (AMZN) $1.3mm
Steve Ballmer, Microsoft $1.3mm
Steve Jobs, Apple (AAPL) $1

Carol Bartz' Network of CEOs by Employment or Directorship
CEO Most Recent Avg. Annual Total Compensation
John Chambers, Cisco (CSCO) $11mm
Paul Otellini, Intel (INTC) $12mm
Dan Warmenhoven (Ex-CEO), NetApp (NTAP) $5.7mm
Carl Bass, AutoDesk $7mm
Carol Bartz (when Executive Chairman), AutoDesk $4.5mm
Source: Company proxy statement SEC filings

Several things should be done to fix this mess:
* To avoid these questions about her commitment, Bartz should put some skin in the game. I think she should buy stock in Yahoo! that represents a significant chunk of her net worth. I would suggest at least half the value of her 2007 exercised options from AutoDesk or $23.5 million. This is not that large relative to the upside she should make from her 4 years at Yahoo!
* Bartz should immediately pay back the $150,000 to Yahoo! shareholders for her financial advisors who helped her negotiate a $187 million four-year deal for her.
* The Comp Committee (Art Kern, Ron Burkle, and Frank Biondi) should all resign off the board. Enough is enough.
* Someone else from Yahoo!'s board should explain why Bartz' $3.3 million in unexercised AutoDesk options had to be "made up" for by Yahoo! shareholders to the tune of $10 million.
* Yahoo!'s board should also provide much more transparency on Bartz' employment contract. For example, what cash flow and total shareholder returns targets does she exactly need to hit in order to receive her 4 times base salary annual bonus and other equity grants and options? If shareholders can't trust the details around the "Make-Up Grant," why should they trust the board's decisions on these other compensation matters?
* Yahoo! should change their comp plans going forward for all executives and directors so that base and target bonuses are quite low -- even lower than the often cited "peer group." How will they attract people? Load up the incentives on the back-end. And, instead of having those incentives be triggered by 20 consecutive trading days at a certain stock price level (as Bartz' are), require that the stock stay there for two years (with clawbacks in case it drops back done). This will eliminate short-termist thinking.
* Finally, Bartz should refrain from going on TV in the future saying she "didn't sell anything" after she has sold $2 million in shares.

At the time of publication, Jackson had a net long position in Microsoft.
For Detailed Investor Profiles on these Investors, click below:
Ironfire Capital
Icahn Associates (Carl Icahn)
Related People: Alexander J. Denner; Brett Icahn; Carl Icahn; Eric Jackson; Jackson Leadership Systems, Inc; Keith A. Meister*
Related Entities: High River Limited Partnership; Icahn Partners; Icahn & Co Inc; Icahn Associates; Icahn Enterprises (formerly American Real Estate Partners); Icahn Fund Ltd; Icahn Partners LP; Ironfire Capital US Fund LP
Related Article Tags: Shareholder Activists, Corporate Raiders and Proxy Battles; Hedge Fund Resources and Featured Partner News


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