Microsoft Corporation (MSFT): Is CEO Satya Nadella Overpaid?


It’s a question you don’t hear much anymore, given the performance of Microsoft Corporation (NASDAQ:MSFT) and MSFT stock over the last three years — up 22.2% including dividends through July 14 — but back in 2014, the controversy over CEO Satya Nadella’s pay was front page news.

Microsoft Corporation (MSFT): Is CEO Satya Nadella Overpaid?

Let me refresh your memory.

Nadella Gets $91 Million

Institutional Shareholder Services (ISS) recommended two weeks before Microsoft’s fiscal 2014 annual meeting that shareholders reject the CEO’s pay package of $90.8 million, arguing that it was unreasonable.

Nadella’s pay included:

  • $919,000 in salary
  • A cash bonus of $3.6 million
  • $13.5 million in MSFT stock awards as a retention bonus during the CEO search to replace Steve Ballmer
  • $7.1 million in Microsoft stock awards for 2014 performance
  • $59.2 million in stock awards for long-term performance incentives
  • $5.8 million in stock awards vested in 2014
  • $800,000 in additional compensation

At the time, Chairman of the Board John Thompson defended the payout, stating: 

“To attract and motivate a world-class CEO that could lead Microsoft through its strategic transformation, the Board designed a compensation structure comprising competitive annual compensation and a one-time long-term equity grant that motivates our CEO to create sustainable long term shareholder value by providing him with the opportunity to share in those gains and build ownership in the company over the next seven years,”

Ultimately, 72.6% of shareholders voted to approve Nadella’s compensation.

The Cost to Shareholders

If Nadella hits the bare minimum on his long-term performance incentive — 5-year total shareholder return in the bottom third of the S&P 500 — he gets 150,000 shares of MSFT stock, another 150,000 in 2020, and a final 150,000 in 2021.

At the July 14 closing share price of $72.78, we’re talking about $32.7 million just for showing up to work until June 2021, a seven-year stretch.

However, Microsoft’s annual total return over the past three years has been 22.2%, compared to 9.8% for the S&P 500. If the good times continue through June 2021, there’s a good chance Nadella will hit the maximum award of 2.7 million shares. Today, those shares would be worth $196.5 million.

At a 10% annual return (half the past three years) over the next four years, Nadella will receive approximately $287.7 million, which means he’s going to be awfully tempted to avoid doing anything outside the box for fear of risking some $300 million in found money.

Shareholders could potentially see reduced returns over the next four years as the company slides into neutral and Nadella plays it safe. In other words, the board did what it thought it had to do to incentivize Nadella over the long-term and, human nature being what it is, that could now backfire in a big way.

I’m not saying Nadella’s going to take his foot off the gas as he transforms Microsoft into a leader in the cloud, but it is a possibility to keep an eye on.

Bottom Line on MSFT Stock

I’m currently reading a book by Steven Clifford called The CEO Pay Machine, which highlights what’s wrong with CEO compensation. A former chief executive and board member himself, Clifford concluded that the system is all messed up, but could be easily fixed.

“Mr. Clifford recommends keeping CEO compensation to salary and restricted stock — stock that might only become available in chunks over a five-year period and that they can only cash in on retirement,” wrote Harvey Schachter in the Globe and Mail in May. “But he figures boards won’t do that so governments must act: For every dollar a company pays a CEO over $6-million, it should pay $1 in tax. It can still pay the CEO $40-million but then owes the government $34-million.”

Under Clifford’s plan, Microsoft would have to pay the IRS a lot of money to keep Nadella in the top job. While Nadella has done well as CEO, he’s just a cog in the wheel. It’s the Microsoft staffers in the trenches who are getting the job done and paying for his lavish compensation.

“Most of a CEO’s success is blind luck, being in the right place at the right time, or fit, having the skills needed now,” Clifford says.

I couldn’t agree more.

Microsoft shareholders have done well since Nadella took over in February 2014. However, MSFT could have done equally as well paying Nadella and the rest of the management team a fraction of their annual compensation.

Is Satya Nadella overpaid? You better believe it.

As of this writing, Will Ashworth did not hold a position in any of the aforementioned securities.

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