Kraft CEO's 50% Pay Raise Is Wrong

2008 was a tough year for Kraft Foods (KFT), and most big food firms. On Tuesday, Kraft filed its Form 14A with the SEC, which detailed executives’ compensation for 2008, to outraged reception. As in, you’d think 2008 was a banner year for KFT, not a debacle.

Jim Cramer said he was “appalled” by what CEO Irene Rosenfeld took home for 2008. Ms. Rosenfeld’s $17 million for 2008 was +50% above her $11.3 million for 2007 (her first full year as Kraft CEO). Expect to see others “appalled” as well.

The 14A cites that Kraft’s Compensation Committee in early 2008 “approved targets for Organic Revenue Growth, Ongoing Constant Currency Operating Income Growth, and Discretionary Cash Flow” as key metrics for 2008 compensation. Per the filing, Rosenfeld hit her targets as follows:

• Organic Revenue Growth: Target +4.2%. Actual +6.6%. Performance Rating = 180%.
• Ongoing Operating Income Growth: Target +17.3%. Actual +12.2%. Rating = 65%.
• Discretionary Cash Flow: Target $2,284 million. Actual $2,774 million. Rating = 180%.

The Committee also evaluated “individual performance” (the soft factors), on which Rosenfeld also scored well, at 130% of target.

Compensation Metrics

Background: in 1995 I was promoted to Kraft HQ’s Financial Strategy dept. My first task at this job was to compute 1994 management comp statistics. My numbers didn’t smell rosy to Kraft’s new CEO, or to our Philip Morris masters. So I helped develop a metric called “Organic IFO” – income from operations without effects from forex, M&A, etc. We sold it to PM as a better metric, but it got our top dogs nice 2004 bonuses, too.

Fearing the Worst

You can read my “Kraft Earnings: The Hurt Is Organic” about Q4 2008. Its premise is that Kraft was driving revenues – albeit earnings were declining – by increasing prices to consumers… in Q4, +10% pricing, during a recession. Meanwhile Kraft was losing volumes, -6% on average. This meant Kraft was slaughtering its brands’ Market Shares.

If you fear the worst, you may be right. Since 2008 Comp was tied into Organic Revenue Growth, and since Kraft can create this “growth” just by hiking prices, a CEO may be inclined to hike prices in 2008… even to the detriment of brand health. (Note to Comp Committee: “organic” revenue growth is best driven by share and volume – not by pricing up, as volumes crater!)

The “Operating Income Growth” and “Discretionary Cash Flow” interplay is also not encouraging. In a firm hitting stride, both should soar with revenue up +6.6%. In Kraft’s 2008, while income missed target, cash flow significantly exceeded target.

Kraft’s “discretionary cash flow” is operating cash less capital expenditures. As cash flow is a “point A” to “point B” metric – 12/31 this year, minus 12/31 last year – one can work the deltas temporarily. Easy ways are to slash inventory, collect receivables, and slow vendor payments and contributions to benefit plans. One can also eliminate capex – even if that’s detrimental long-term.

Management Comp Follies

Years after I left Kraft, I met with colleagues there. They still used “Organic IFO” as one metric, but they had found ways to game it.

Consciously or not, managers will always find ways to game compensation metrics. In the end, comp committees need the ability and guts to impose the “Joey test”, no matter what the comp consultants and metrics say.

This comes from Joey on Friends: “how ya doin’?” In Kraft’s case, it hasn’t been doin’ much great. It hiked prices, regularly missed Street EPS, hit some targets and missed others. Yes, it was a tough year. Yes, it’ll get through.

But a +50% rise in CEO comp feels wrong – to market pundits, shareholders, Kraft employees (thousands now laid off) – because IT IS WRONG.

It doesn’t matter how the metrics compute. 2008 was a tough year for Kraft. That tough year should be reflected in its CEO’s rewards.

Investor Alert

KFT still has the $20 bottom limit that I cited in my earlier article. And a tide of deflationary trends likely will lift Kraft’s earnings for 2009, as predicted. So all may seem good.

But I don’t trust it, nor should “long-term investors”. There is just something wrong at Kraft – private label equivalence, lack of innovation, the need for smarter marketing, a focus on the Sales function.

I was privileged to see Irene Rosenfeld’s work at KFT divisions, and she was consistently strong. Gut-gut, her taking this payout feels different. Rosenfeld is not tone deaf. She is clued-in. Her getting what she can get, while she can get it, suggests that there’s a Charles Prince mentality in play.

Irene, I wish you success. You’ve been brilliant. But you are signaling that you are on your way out, that you have no answer to this lumbering giant, and that the old game-book will not work in the future.

A new game-plan is needed. Suggestions are aplenty, real answers will cost you. KFT is a stock that will adjust only at its beta to the market. Until we see something revolutionary, there is little alpha to be found.

Disclosure: No position in KFT.

Comments

[successfult...:]

Nice summary Patrick!

Apr 03 10:49 AM

[notsosmart:]

so whats new here. its all me & to hell with all else specially the stockholders.what is this board getting in $ & perks?

Apr 03 04:10 PM

[dren:]

As a former Kraft employee you are right on. This once was a great company. I spent 30 years there in middle management and was proud of the company in every respect.

Now it has become a purveyor of high priced junk foods and the greed mentality has infected its once great top managers.

Apr 03 06:37 PM

[dcb:]

Good article.
I warn you questioning a CEO pay or bonus on this site may cause you to get the label socialist or commie. :-)

Apr 03 08:16 PM

[Teak:]

Thanks for the analysis. As a KFT shareholder by virtue (?) of the Altria spinoff, you have my attention.

Apr 03 09:26 PM

[1rebroker:]

Nice little write-up. KFT shareholder and will remain so, but won't add any new capital in light of these developments. I don't mind a 50 % raise Ms. Rosenfeld, I just wished it occurred after a rise, in my share value. I don't think I've seen that in the last two years.

Apr 04 10:21 AM

[mansur:]

If you are former employees you must be blind. Go to your nearest super and count the "share of space" SOS in the deli and cheese sections. Do you ever remember figures like these? The share of private label is less than it was 30 years ago. Oscar Mayer products are still the best!
Sid Mansur

Apr 04 10:46 AM

[Bolton Peck:]

Kraft foods are now full of high fructose corn syrup and have become part of the reason more and more people buy items like this from the deli section, or else just shop at Trader Joe's instead.

Their quality has gone down, the price gone up. If this were my business I'd be failing-not able to give myself a fifty percent raise!

I know I'm a n00b, but as the owner of a small business, it kind of shocks me to see all these huge management pay raises, bonuses, etc. in the face of the companies involved failing financially. Didn't it used to work out like, people who performed badly and ran the company down, got demoted at the minimum, or possibly fired?

It looks to me like Kraft fired a bunch of people, raised their prices, and made the cash flow look really sweet so management could score big this year in pay increases. But it's very short sighted in my eyes-they just hurt their brand and reduce their capabilities.

Apr 04 11:10 AM

[RSAAKKS:]

Anyone who thinks market forces will control CEO pay levels to a reasonable level is dreaming. Without Govt control, the boards and CEO's will keep looting the companies as much as they can get away with.

Apr 04 11:54 AM

[ed233:]

Corporate CEO's both in the US and Canada require some method to stop this exaggerated out of control payment structure. The directors of these corporations need public flogging when they approve excessive compensation. CEO compensation should be tied in some way to a formula that is fair and reasonable which bears some resemblance as a multiple( to that of the general worker's compensation). I saw an interview of a CEO in Japan who was in charge of an airline. At the time of the interview he scoffed when he heard of the outlandish compensation paid in America for his counterpart. Maybe the shareholders of these corporations should have not only some approval power but be represented on the boards of these companies in such number as to have a significant influence of these matters.

Apr 04 04:17 PM

[HBWOW:]

Irene must be a "Superwoman" to have accomplished such greats strides by herself so it certainly seems logical that she be will rewarded. What amazes me is that the stockholders put up with this form of ego payroll excesses BUT since most of the companies' executives have and are doing this THEN it must be alrright.
MY BIG FEAR IS THAT THE MANAGEMENT OF A LOT OF COMPANIES ARE DRAINING CASH IN MASSIVE DOSES VIA EXCESSIVE SALARIES, BONUSES, STOCK OPTIONS, AND LOANS for which the companies have to increase their bank borrowings to replace this significant cash drain.

Apr 04 04:43 PM