Report: Home builder overpaid CEO

A major home builder is being taken to task for overpaying its top executives.

Proxy Governance Inc. of Vienna, Va., issued a scathing report this month that criticized Hovnanian Enterprises Inc. of Red Bank, N.J., for paying its chief executive about three times the amount its home building peers dished out to their chief executive during the past three years.

“The average three-year compensation paid to the CEO is 290% above the median paid to CEOs at peer companies,” the report said.

Chief executive Ara Hovnanian’s pay package included a base salary, bonus, stock awards, options and other compensation.

The firm also criticized Hovnanian for changing its rules last year to allow him to earn a bonus for reducing the company’s “net debt” instead of increasing its earnings or the value of its shares.

“They weren’t getting paid out under the old system, so they changed their performance criteria to pay out for net debt reduction, and that was just this year,” said Brad Robinson, a research analyst at Proxy Governance.

“It seems they wanted to compensate their CEO highly, and this is the only way they could do it in the current market environment,” he said.

Although Mr. Robinson isn’t opposed to companies that award bonuses to executives who can lower a company’s debt in this environment, he objects to companies that use “net-debt” declines as opposed to actual debt decreases.

For example, Hovnanian raised about $800 million in cash by selling off inventory at discount prices, but it also increased its debt by about $300 million in 2008. Therefore, on a net-debt basis, its debt level went down, but its actual debt level, with all the servicing fees, went up by $300 million.

“Is that deserving of a large bonus that was 290% above their industry peers?” asked Chris Cernich, director of mergers and acquisitions, and quantitative analysis, at Proxy Governance. “I don’t see that as a spectacular win for shareholders.”

PUNISH DIRECTORS

Proxy Governance is recommending that shareholders vote out several directors who sit on the company’s compensation committee.

Hovnanian spokesman Jeffrey O’Keefe defended the company’s CEO compensation. He noted that the Proxy Governance report showed that Mr. Hovnanian received $1.5 million in stock options that have no value due to the company’s beaten-down stock price.

“Based on our recent stock price, our stock would have to increase by about 400% for even the lowest-priced option to be worth anything to Mr. Ara Hovnanian,” Mr. O’Keefe said. “Ara did not receive a single penny of compensation from those stock options.

Mr. O’Keefe acknowledged that Mr. Hovnanian did get a bonus related to net-debt reduction, but added that the company’s compensation committee is limiting executive bonuses for 2009 to no more than 50% of the 2008 bonuses.

Another proxy advisory firm, Institutional Shareholder Services Inc. in Rockville, Md., said Hovnanian has “sustained poor total shareholder return performance” over the past three years relative to its peers, with fiscal one-year returns of -28% and fiscal three-year returns of -46.2%. Its peers averaged returns of -14% for one year and -7.4% for three years. ISS noted that the CEO’s salary was cut by about 32% between 2007 and 2008. “We will continue to monitor the company’s pay practices to ensure that there is no pay-for-performance disconnect going forward,” ISS said.

It also recommended that shareholders vote out certain directors.

Even if shareholders vote against re-election of certain directors, it would only be a symbolic gesture, as the Hovnanian family currently controls more than 70% of the votes through a dual-class structure of special shares.

MINORITY VOICE

However, Mr. Robinson said Hovnanian will not ignore its minority shareholders. He noted that the family holds only about a 21% stake in the company’s economic value. As a result, the family “depends on the rest of the minority shareholders for their economic livelihood, despite the fact that they may control which way the votes goes,” said Mr. Robinson. “So a clear message from shareholders can actually make a difference in what they perceive shareholders would be willing to put up with.”

Hovnanian is one of a growing number of companies finding themselves under the investor microscope over pay packages.

President Obama and Congress were outraged last week when they discovered that New York based American International Group Inc., which received more than $170 billion in taxpayer bailout money, forked out $165 million in executive bonuses and retention pay. AIG’s chief executive, Edward Liddy, admitted the pay was “distasteful and difficult,” but wrung his hands, claiming the retention bonuses were put in place in 2008, long before the bailout. Treasury Secretary Timothy Geithner has stepped in to try to limit the bonus payouts.

This month, the Conference Board in New York set up an Executive Compensation Task Force to study executive pay issues in general.

“You’ve seen an awful lot more institutions and government agencies speaking out, so I do think it’s something that shareholders should be concerned about,” said Mr. Cernich. “If it’s high relative to peers and performance is worse than peers, then I think they’re much more likely to be concerned about it now that the economy has turned sour.”