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Practical Investing: Beware Overpaid Executives

No set amount automatically raises alarms, but several pay practices are red flags.

Now is the time for all good investors to get in touch with their inner Robin Leach. Spring is when most publicly traded companies send out annual reports and so-called proxy statements. The latter allow investors to vote for corporate accountants and directors and on a handful of other key matters.

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But the real excitement of proxy season is in the nuggets of information about the often eye-popping pay and perks provided to senior executives. Details about the cost of joy rides on the company jet, country club memberships, enriched pensions, and corporate drivers offer voyeuristic interest, to be sure. But more important is what this data reveals about the character of a company. Proxy reports can provide the final piece of information that persuades me to invest in a stock or walk away.

Why? Executive pay is often an early warning sign that something is amiss with a company’s board. From Enron to Tyco International, runaway pay and perks told shareholders that the directors who were supposed to serve as their watchdogs had instead become the chief executive’s lap dogs. That, in turn, suggested that these firms were disasters waiting to happen.

Runaway pay is, of course, a subjective concept, and no set amount of money automatically raises alarms. But several practices should serve as red flags. Let’s look at the most recent proxy statements filed by two technology giants—Oracle (symbol ORCL) and Microsoft (MSFT). I own Microsoft in my Practical Investor portfolio, which is aimed at illustrating the basics of stock selection. This exercise will explain why I won’t buy Oracle.

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Pay disparity. The “Summary Compensation Table” spells out how much the five most highly compensated officers earned in pay, perks and stock. I consider it a warning sign when the CEO earns vastly more than all the other managers. It says that both he and his board consider him to be far more valuable than the rest of the team. In sports terms, it means the team has a weak bench. The Microsoft proxy shows that CEO Steve Ballmer earned much less—$1.4 million in the fiscal year that ended June 2011—than every other member of his team. Microsoft’s chief operating officer earned $9.3 million; the president of the Windows division pocketed $7.2 million. Nice.

Oracle CEO Larry Ellison earned almost exactly the same pay as the company’s recently named president, Mark Hurd—a close friend of Ellison’s who was hired after being ousted from Hewlett-Packard after a sexual-harassment investigation. After those two, pay to Oracle’s top dogs drops dramatically. Not so nice.

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Raw numbers. The actual compensation figures are even more egregious. Ellison earned $77 million in cash and stock in the fiscal year that ended May 2011; Hurd earned $78 million. Their combined packages could pay the entire Microsoft executive team for nearly six years. And it’s not as though Oracle is bigger or better than Microsoft; Microsoft generates twice the revenue and almost three times the profit.

Royal treatment. Does the company treat its CEO like an employee or a deity? The answer is in a column called “other,” which details what a firm paid for country club memberships, chauffeurs and other noncash benefits. The specifics of how much was spent and where are in the footnotes under the chart. In the June 2011 fiscal year, Ballmer got $11,915 in “other”—most of it matching contributions to his retirement plan (something provided to all employees). Ellison reported $1.5 million in “other”—primarily the cost of a home-security system that Oracle puts on the company tab.

Related deals. Not enough? Scan the “transactions with related persons” in Oracle’s proxy. It spells out a series of deals made with other firms owned or controlled by Ellison. Microsoft, by contrast, had no eyebrow-raising related-party deals.

Kathy Kristof is a contributing editor at Kiplinger’s Personal Finance and author of the book Investing 101. Follow her on Twitter.

ORDER NOW: Buy Kiplinger’s Mutual Funds 2012 special issue for in-depth guidance on the only investments you need.

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