Fore!! Callaway Golf — the big maker of golf clubs, balls, and other accoutrements — has hit an errant shot that may plunk its shareholders on the head. The blog Footnoted.org says Callaway is “taking a mulligan,” but that may be a little harsh. In golf, a mulligan is a do-over: if you make a lousy shot off the tee, you hit another one without losing a stroke. It’s against the rules, of course, but if the friends in your foursome don’t object, it’s okay.
What Callaway has done is hardly illegal, but shareholders attending the annual meeting May 18 at the company’s Carlsbad headquarters may ask about it. Like many companies, Callaway claims that it ties executive compensation to performance. But when performance stinks, Callaway finds another pretext to pay executives handsomely.
In its latest proxy statement, dated April 1, Callaway boasts, “Corporate governance is the system by which corporations ensure that they are managed ethically and in the best interests of the company’s shareholders. [Emphasis mine.] The company is committed to maintaining high standards of corporate governance.”
The proxy states, “A significant portion of total compensation should be related to performance,” and that’s particularly true of senior management. But also, “Compensation levels should be sufficiently competitive to attract and retain the executive talent needed.”
You can see the loophole here. The company pledges to pay its executives based on performance. But it also pledges to pay them based on retention incentives. Thus, when the performance is poor, the board can always shift focus and hand out bonuses as incentives to keep top brass on the payroll.
That’s what happened at Callaway last year. Sales plummeted from $1.1 billion in 2008 to $951 million. Earnings per share plunged from $1.04 to a loss of 33 cents. The stock, which had traded in the $30s in the late 1990s, dropped as low as $4.66.
Callaway had given the chief executive, George Fellows, along with four other officers, performance awards going back to 2006. One award was stock options that they could exercise at around $14, but that wasn’t going to happen with the stock so depressed. Last year, “All outstanding stock options were underwater and had no intrinsic value,” laments the proxy statement. Indeed, all options granted since 2006 were worthless.
That’s what performance rewards are all about: you don’t perform, you don’t get your emolument. So the board shifted its emphasis: it began focusing on incentives — paying the executives enough to retain their services.
Says the proxy, “Following a lengthy and diligent process, including numerous meetings and conference calls, the compensation committee [of the board]…ultimately determined to make a special retention incentive grant consisting of phantom stock units.” In Fellows’s case, all the board members except him joined in the decision.
Phantom stock, sometimes called “shadow stock,” really isn’t stock. It consists of cash payments that go up and down with the price of the company’s stock. Fellows was granted 254,130 units of phantom stock. He can cash half of them in after two years and the other half after three. Callaway puts a value of $2 million on that phantom stock given Fellows. The other officers were awarded from 44,473 to 69,886 units of phantom stock.
Let’s start adding this up. On January 29 of 2009, the board agreed to give Fellows 135,881 shares of Callaway stock free. The company valued those shares at $1.07 million. On the same day, Fellows got an option to buy 900,521 shares at $7.85. Those aren’t underwater; Callaway stock has rebounded and late Monday was trading at a shade under $10. The company puts a value on those shares of $2.13 million. Then there are those 254,130 phantom shares that Callaway says are worth $2 million. Fellows has a base salary of $925,000. In addition, he gets $136,105 for life insurance, travel expenses, country club dues, free golf clubs and balls, and other so-called privileges of rank.
So on page 41 of this year’s proxy, Fellows’s total compensation for 2009 — that lousy year — should turn out to be $6.26 million, says Callaway, up from $5.51 million in 2008, a good year, and $4.45 million in 2007, another good year. Of course, we don’t know exactly what that 2009 total compensation will be because we don’t know what future Callaway stock prices will be. But we have to go with the value that Callaway puts on these grants.
Eric Struik, vice president of finance, explains that the so-called incentive grants “are intended to cover what had been lost since 2006. We’re trying to compete effectively; these grants restore the retention incentive.”
Yes, but they also erase losses suffered from poor performance. Fellows’s earlier stock options may be underwater, but the so-called incentive grant should make up the difference, according to Callaway’s own valuation.
So whatever happened to compensation “related to performance,” as the proxy brags?
The Callaway proxy says that the phantom stock awards “further align the interests of the executive officers with the company’s shareholders.” Oh? What about those shareholders who are down more than 60 percent? Eyeing the phantom shares granted to Fellows, Footnoted.org comments, “Can ordinary shareholders get the same deal?” Of course not.
Callaway’s board “seems to have this orgy of self-congratulation, and for what I don’t know,” says former San Diegan Graef Crystal, now of Las Vegas, generally considered one of the world’s ranking experts on executive compensation. He is a contributor and consultant for Bloomberg News. “By any financial measurement, they had a crappy year, so they gave [Fellows] both options and free shares. I don’t know what’s going on with these guys.”
“It looks like a clever way to reprice options,” says San Diegan Bud Leedom, who heads California Equity Research and has always followed golf stocks. Incentive grants are pulled out of a hat when performance sputters, says Leedom. “Over and over, companies try to out-clever one another.”
Callaway has many things going for it: golf’s darling, Phil Mickelson, uses the company’s clubs and balls. The company says its first-quarter earnings will more than double to 25 cents a share this year. “However, a lot of golf courses are underwater. You’ll see golf courses turning fallow, the land converted to homes. People aren’t playing as much golf as they used to,” warns Leedom. Callaway stock has made an excellent run this year “but may be ahead of itself.”
Struik, Leedom, and Crystal agree that other companies use such maneuvers so that executives don’t get punished for poor performance. But that doesn’t make it right. It’s out of bounds.