Coke to link pay of directors to 3-year results

Failure to meet target means they get zero


ATLANTA -- In a highly unusual move, the Coca-Cola Co. announced yesterday that its board of directors will only get paid if the company hits earnings targets.

"This is a pretty aggressive move," said John Faucher, an analyst at JPMorgan, who annually does a corporate governance report on the industry. "I've never heard of anything like it."

The plan, which takes effect this year, grants directors equity share units equal to $175,000 per year if the company meets its earnings target over three years.

The target is 8 percent compound annual growth in earnings per share. Because of the three-year period, directors won't receive payment for 2006 until February 2009. If the company doesn't hit its target, the directors will not be compensated at all for 2006.

"I think it is a marvelous way to keep directors' interests and shareholders interests as closely aligned as possible, with both an upside and a downside component," said longtime board member Warren E. Buffett, the billionaire who recently announced his retirement from the board. "Too often, people talk about interests being aligned when the directors get the upside and shareholders get the downside."

Buffett and his company, Berkshire Hathaway, control more than 200 million shares of Coke stock. Berkshire Hathaway is the largest shareholder.

Under the old policy, Coke directors received payment of $50,000 in cash and $75,000 in share units every year, as well as payment for specific roles, such as serving on committees.

Share units, also called phantom shares, are calculated like this:

When the compensation program is set at the annual meeting in a couple of weeks, $175,000 will be divided by the current share price to get the number of share units for 2006.

When the payments are actually awarded, either in cash or stock, the original number of stock units will be multiplied by whatever the stock price is at that point. Hypothetical dividends accrued during the three-year period will be added.

Coke's move is part of a larger trend of directors receiving more of their compensation in stock, instead of cash. What's so unusual is the all-or-nothing component tied to earnings, experts say.

"Is Coke a leader in this? Absolutely," said Charles M. Elson, the Woolard Professor of Corporate Governance at the University of Delaware.

Though it is too soon to know if other companies will follow, Buffett said he hopes some will.

"It wouldn't be appropriate with a company that was in real trouble," he said.

"There are some cases in which just survival is important. I wouldn't recommend it for every company, but I would say that every company that Berkshire owns stock in, I would feel very good about it if they were to adopt something like this," Buffett said.

Corporate governance experts don't all agree the system is a good one.

Faucher said the new system is much better than what many companies do, which is awarding "a lot of cash just for showing up at meetings, or not showing up at meetings, for that matter."

On the other side of the debate is John C. Coffee Jr., a professor at Columbia University's law school who focuses on corporate governance issues.

Coffee thinks some of a director's pay should be linked to performance or the stock price, but not all of it.

"There can be too much of a good thing," he said. "We want directors to be watchdogs."

Because top executives are compensated heavily with stock these days, they are motivated to be aggressive about accounting practices, Coffee said.

Boards should be watching to make sure chief executives don't cross the line into ethically questionable behavior. The Coke program might lead directors to be cheerleaders for anything that would increase the stock price or help the company meet internal earnings estimates, he said.

Buffett disagreed, contending that the three-year targets eliminate any motivation to make quick fixes. "That doesn't really hold water, when you are talking about three years of 8 percent compounded growth," he said. "You could say, `Maybe they will just cut out advertising or something like that,' but that isn't going to happen. It would be so transparent if it did. No board of directors would think or act like that. Having three-year targets just knocks that out as any kind of possibility."

Caroline Wilbert writes for the Atlanta Journal-Constitution.

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