Annual Meeting: May 24

Why should anyone expect a CEO who doesn’t acknowledge the basics of climate science to adhere to generally accepted accounting principles?

The pay of Southern Company CEO Thomas Fanning – who recently stated on CNBC that he is unpersuaded that carbon dioxide is a primary contributor to climate change – increased from $11.8 million in 2015 to $15.8 million in 2016. Part of the pay increase was due to what some investors have called the decoupling of pay and performance, recently covered by Russell Gold in the Wall Street Journal.

In a letter filed at the SEC April 24 shareholders opposing the pay package highlighted the ways the compensation package has been inflated by using non-GAAP exclusions. (GAAP stands for Generally Accepted Accounting Principles.) According to that letter, signed by multiple pension funds, “A driver for higher executive compensation levels in both the 2015 and 2016 fiscal years was the Compensation Committee’s decision to use an earnings per share (EPS) figure “adjusted” to exclude the negative earnings impact of the project[s] and certain other items.”

The largest exclusion related to cost overruns and the Kemper Clean Coal plant, initially forecast to cost less than $3 billion, but with delays and overruns continuing to inflate the construction cost, now at nearly $7 billion.  A 2016 New York Times expose, entitled “Piles of Dirty Secrets Behind a Model ‘Clean Coal’ Project” details deliberate concealment of cost overruns and delays and notes that, “Members of Congress have described the project as more boondoggle than boon”

The cost overruns have required the company to take pretax charges against earnings related to Kemper in 15 of the last 16 quarters. What has changed, however, is how these numbers have affected compensation.  In 2013, Southern recorded pre-tax charges of $1.14 billion related to Kemper and no adjustment was made for compensation metric purpose.  In 2015 and 2016,  however, the letter notes, “the Compensation Committee simply used adjusted EPS for all employees, including top executives, insulating them from Kemper’s negative impact on earnings.”

The letter – signed by CalSTRS, Local Authority Pension Fund Forum, Seattle City Employees Retirement System and the Nathan Cummings Foundation –  is impressively detailed and I encourage you to read it in its entirety.  It concludes: “We believe it is important to communicate that shareholders do not support the Compensation Committee using its discretion to shield senior executive pay from the negative impact of projects that are central to Southern’s strategy and failing to exercise its discretion to reduce incentive pay for executives to hold them accountable for strategy execution missteps.” In addition to urging shareholders to vote against pay they encouraged votes against the reelection of compensation committee directors Steven Specker and Dale Klein.

I have written before about the expanding use of the use of non-GAAP earnings.  In addition to making cross-company comparison more challenging, the exclusions may allow executives to make targets that would not otherwise have been achieved, as they did at Southern. Another problem is that systemic problems can be hidden by a mass of individual “non-recurring” costs or other adjustments. They muddy already confusing financial statements.

But muddying things seems standard protocol for many energy executives. When it becomes impossible to deny the climate is changing, the line moves to casting doubt on what is causing the change, raising questions on the veracity of individual statements and studies, and the appropriate response to climate change. Fanning, in his CNBC interview, said that climate change couldn’t be denied but also contended that the climate has been changing for millennia.

Another item caught my eye as I read the proxy: there were multiple peer groups listed. Anytime a company has more than one peer group it deserves particularly careful attention. One group in Southern’s Proxy is used for compensation benchmarking, the others in determining the relative TSR figure that drives bonuses.

The company states that “several of the companies in the 2016 PSP peer group do not meet the size requirement to be included in the compensation peer group (+$6 billion in revenues).”

What does that mean:  for the most part it means the CEO wants to be paid like large companies on guaranteed compensation, but is willing to include smaller companies when doing a TSR comparison. The easiest element of pay to benchmark is salary, and it is a component that has risen remarkably at Southern. In 2016, Manning’s salary was increased $1.29 million. It appears that his salary has increased significantly every year. In 2009, when Fanning was CFO at the company his salary was $690,250. In 2010, the year he became CEO, he was paid a salary of $809,892. By 2011, Fannings salary had crossed the million dollar threshold and reached $1,064,399 with increases based in part on “market data.” And his salary continues to rise.

Use of aspirational peer groups is one of many factors that has inflated compensation for years. The abuse decreased when institutional investors focused on some of the outlandish examples. A useful study published by the IRRC Institute in 2012 found that peer group benchmarking is inherently flawed and inflationary.  Misuse of peer groups is subtler now, though by the time the practice slowed the inflated executive pay was already in the system.

Climate change denial is subtler these days too. Investors at Southern’s annual meeting will also have an opportunity to vote on a proposal calling for the company to issue a report Southern’s strategy for aligning business operations with the IEA 2°C scenario, while maintaining the provision of safe, affordable, reliable energy.

CalPERS which owns nearly 3 million of the shares, has already announced its support for the proposal.   “We believe proposal #6 is of particular significance in light of the global consensus regarding climate change and emission reduction targets reflected in the Paris Agreement. The importance of the proposal’s request is also underscored by the efforts of Financial Stability Board (FSB), an international body mandated by G-20 leaders to develop efficient climate-related financial risk disclosures.”