There is no greater darling stock on the ASX than Cochlear, the fabulous Australian success story which has brought hearing to more than 250,000 profoundly deaf people globally through the bionic ear technology which was developed by Professor Graeme Clark at Melbourne University in the 1970s.
And for investors who paid just $2.50 a share when the panic-stricken Pacific Dunlop floated the business in 1994, Cochlear has been a magnificent investment, jumping another 50c to $72.32 in morning trade today.
But having a feel-good story that delivers for shareholders doesn’t mean the basics around executive pay, good corporate governance and disclosure should be ignored.
And so it was yesterday with the shareholder revolt against Cochlear’s remuneration report and the proposal to issue long-serving CEO, Dr Chris Roberts, 231,161 options to buy shares at $62.78 a pop in August 2015.
At the 2010 Cochlear AGM, shareholders overwhelmingly approved Roberts being issued 86,272 options to buy shares at $69.69. If all hurdles are satisfied, he’ll pay $6 million to exercise these options in August next year. At the 2011 AGM, there were no complaints about Roberts being issued 117,620 three-year options over shares at $68.56. If all hurdles are satisfied, he’ll pay $8 million to exercise these options in August 2014.
Seeing as the formula for the annual allocation was pretty much the same?—?that Roberts is entitled to an options grant valued at 75% of his fixed pay?—?the obvious question to ask was why was the 2012 allocation so much larger than the previous two years?
Never before had the annual options play being so big, as it will require a hefty cheque of $14.5 million if Roberts takes up the shares in August 2015. It didn’t help the board that Cochlear shares had rallied in the weeks after the options were priced, because it never looks good to be issuing a CEO options which are already “in the money”. This is especially so when you have a CEO who has already ridden this long-standing options play to a lucrative position of owning 715,803 fully paid ordinary shares which are today worth $51.7 million.
This is a greater equity position than any other non-founder CEO in the ASX50, including Nicholas Moore at Macquarie Group and Marius Kloppers at BHP-Billiton, who both own about $40 million worth of ordinary shares.
The obvious defence against claims that Roberts was about to get options which were already $2 million “in-the-money”, would be to look at the strict performance hurdles which are put in place. And this is where Cochlear ran into trouble. Because the one-off product recall smashed 2011-12 earnings, it created a very low base for the “Earnings Per Share” hurdle.
Indeed, underlying EPS would have to fall by more than 37% by 2015 for Roberts not to satisfy this particular hurdle, which applied to 50% of the allocation. The other half has a hurdle based around total shareholder returns which is genuinely challenging.
That ridiculously low EPS hurdle may have been defensible if Cochlear was only issuing 100,000 options, but this is where the real controversy kicks in. Under the controversial Black-Scholes pricing formula, you have to make a series of assumptions to come up with the value of each option.
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