Stephen Elop’s $25M conspiracies debunked. How, why and when Nokia CEO received his equity grants. Pt2
The fierceness of the accusations directed towards Nokia board over Stephen Elop’s $25 million golden parachute last week, was nothing short of a witch-hunt.
According to the accusers- at best, independent Nokia directors were dumb incompetents for signing a contract with Elop in 2010, that created a set incentives for him to run Nokia’s mobile business into the ground and sell it cheaply to Microsoft. At worst- they colluded with American hedge funds and Microsoft on a secret, hostile and illegal Nokia takeover.
The problem is, when you look at the publicly available facts, how when and why Elop was compensated the way he was, those accusations turn out to be an absolute nonsense.
Here’s the detailed breakdown of facts that helped me arrive at conclusions I made in part 1 of this post. All the numbers are from Nokia annual reports you can find here, and from Proxy materials for shareholder meeting, found here.
There are 3 types of equity that Nokia board awards its CEO and other execs.
Stock options – a right to buy Nokia shares at a certain price, usually a market price on around the day of the grant. This is the least controversial equity grant, since if you underperform and company stock goes down, your options become worthless. There’s no point of having a right to buy stock for a certain price, when that stock trades freely in the market, below it.
Restricted shares. These are part of executive compensation package, and are awarded to company’s top officers instead of cash, as part of their salary. They are mostly meant to keep important company employees financially motivated to work for Nokia. The shares are granted, but usually not delivered to the exec for 3 years after the award, and are forfeited if he or she leaves the company, or is fired in the meantime. But if the exec stays put for those 3 years, no matter how company performed or where the stock price is, restricted shares will still be worth something. Looking at how restricted shares were awarded, it seems that the amount of the compensation Elop received in them, was part of his contract. This amount was approximately 1.2 million Euros a year, and the number of actual shares he received depended on Nokia price when they were awarded.
Performance shares. Like the name implies – these shares are awarded to company employees and execs, based on a company performance. There are some strict criteria/goals, based on combination of Nokia annual sales numbers or growth, and earnings per share. Limited amount of shares is awarded for the performance over the certain number of years. Frankly put, if company exceeds maximum goals set by the board – you get a lot of bonus performance shares. If it only meets the minimum requirements – you get some, but it is four times less. A certain number of performance shares is granted each year, but not delivered until the performance period is over, and company’s results during that period are evaluated. If company failed to perform to minimum goals– you get no shares.
To calculate the value of the performance share package awarded each year, for accounting purposes, Nokia has to make some assumptions before the actual shares are delivered (or not). For the unvested years, Nokia board assumes an average performance – somewhere between minimum and maximum criteria, and counts that Nokia employee has earned 2 times the minimum performance share allocation, or half the maximum. Which is the same number.
E.g., let’s say 2011 performance share plan assumed that Elop could get somewhere between minimum 100K and maximum 400K performance shares, depending on how Nokia did in 2011 and 2012. Before the actual results are in, and certified sometime in the first half of 2013, Nokia will assume that Elop earned 200K performance shares in 2011, and 200K- in 2012. Then, before the annual shareholder meeting, the board will check what kind of average annual sales and EPS Nokia delivered in 2011 and 2012, see whether it met or exceeded the performance criteria, and decide how many performance shares Elop (and all other Nokia employees) earned, if any.
Moving away from hypotheticals, Nokia underperformed badly during this period, and all performance shares from 2011 were cancelled in May 2013.
I believe that Nokia used the same method to calculate the number performance shares that vested early, due to the sale to Microsoft. Those shares include performance shares granted to most Nokia employees in May 2012 and 2013, measured against Nokia performance in 2012-2014, to be delivered in May 2014 and 2015.
Here’s the summary of all Nokia equity grants to Stephen Elop. When they were awarded, at what price, when they were supposed to vest, and what their value is with an accelerated vesting, at 4.2 Euro price.
- Part of the special deal Nokia made with Stephen Elop, to align his incentives with the success of strategy change. POssibility to earn additional 125-750K Nokia shares if Nokia stock price ends 2012 between 9 and 17 Euro. The number of shares – the middle of that range. Since Nokia price didn’t get there – he didn’t receive any shares.
- I believe, the number of restricted shares Elop received in 2011, was reduced by ~200K Euro as part of that same special deal
- Estimated amount of options award. It is impossible to know the actual number before 2013 report is filed next year. Nokia says in their 2012 Annual report and Proxy documents, that equity award plan for this year mirrors 2012 plan.
- My estimate of the exercise price, at which options were awarded in 2013. According to Nokia internal rules, the exercise prices are based on the trade volume weighted average price of a Nokia share on NASDAQ OMX Helsinki during the trading days of the first whole week of the second month of the respective calendar quarter (i.e., February, May, August or November). In 2013 the first whole week was May 6th to 10th.
- My estimate of a number of restricted shares awarded to Stephen Elop, based on the assumption that the value of the award is ~1.2 Million Euro a year, and is part of his contract.
- A total amount/value of equity compensation Stephen Elop is about to receive, as soon as Microsoft deal closes. Including all the shares that vested early due to the “change of control” clause.
As you can see, from before February 11th, Elop owns 100K shares of Nokia, worth only 420K. All other shares and options allocated to Elop between his hiring and August 2011 – 6 months after the deal was done, expired worthless. And for the whole 2011, even after Nokia shares tanked following the deal, when Symbian decline went into full swing, he only received options worth 220K Euro today.
In March 2011 Elop agreed to modify his contract, reduced his 2011/12 annual cash bonus by 30%, and his 2011 restricted share allocation by ~200K Euro. For a chance to earn additional 13 million Euro or more, if he could make Windows Phone strategy a success.
Most of the equity that makes up his current golden parachute, was allocated after the April of 2012, when Symbian sales already collapsed and it became clear that Windows 7.5 Lumias are failing. Furthermore- Nokia Board knew Windows Phone roadmap, the fact that first generation Lumias will be incompatible with Windows Phone 8, and must have had a pretty good idea of the difficulties second generation Lumias will face in the market. To put it another way – the Board knew all the bad news in Nokia’s smartphone division.
Elop, at the time, was executing the strategy initiated and approved by Nokia board. And, apart from the choice of the wrong strategy- for which Elop, Nokia Board and Nokia Leadership Team – all of them – shared equal responsibility, the Board must have thought CEO was doing a pretty good job, with the cards he was dealt. In the summer /fall 2012 they did a thorough review Nokia’s current situation, including Feb. 11th deal and management actions since then, and came to the conclusion that their smartphone division’s chances for success or even independent survival are pretty bad. Bad enough to seriously consider its sale to Microsoft. And, knowing all that- they kept Elop on board, and gave him the same equity bonus package as the year before.
So what Nokia board should have done differently in May 2012? Fired Elop? Told Elop that no more share or other bonuses are forthcoming until he turns Nokia around and gets its stock price to pre Feb. 11th levels? And told Elop to take a hike if he doesn’t agree to those terms?
All Elop critics would have rejoiced, of course. But Nokia would still have remained in the same dire straits it was in summer of 2012. With its Symbian cash cow killed by Android, failing Windows Phones, and smartphone division bleeding hundreds of millions of Euros every quarter. Its another cash cow – uber cheap dumbhones and Asha feature phones, about to experience Symbian fate in less than 9 months. With the turmoil at the top, while Nokia searches for new CEO.
Would they have been able to find a talented executive with good record to step in, in the summer/fall of 2012? With Nokia’s ability to survive in doubt? What kind of terms such a person would have demanded? What kind of guaranties/golden parachute he had demanded if Nokia situation proved unsalvageable? And what would have he done differently?
The strategy change is a Board level decision, and the Board has already decided, or was about to decide to continue with Windows Phone at least until the current contract runs its course in 2014.
The fact is, after initial erroneous strategy choice, and after the limited damage “Burning Platforms” memo caused in Q1 and Q2 2011 healed, Elop’s execution on that strategy was pretty good. He was able to significantly reduce smartphone division losses, Lumia sales are slowly picking up, and there’s at least a slim chance of Nokia smartphone division getting to break even in 2014. And, Nokia share price went from a low of 1.42 Euro in July 2012 to ~3 Euros before Mobile Division sale was announced. Of course, there still is a huge uncertainty of Nokia mobile phone unit, and I’m not sure anything can be done to save Ashas from Android. But that’s probably one of the main reasons Nokia Board decided to get out of mobile device business completely.
As for Elop’s performance, from summer 2012 onwards, when most of the currently controversial equity was granted- it was pretty good. And I am not sure anyone else would have done much better.
So was Elop’s $25 million windfall fair or justified, considering what happened to Nokia during his tenure? It certainly doesn’t look so. Especially when emotions get involved. And quite a few people I deeply respect, many Finns among them, simply can not see past that $25 million number, and the fact that Nokia – world’s biggest mobile device company– is no more.
But when you get down to details, check the “hows”, the “whens” and the “whys” of Elop’s compensation, it doesn’t seem so outrageous anymore. Even one of the chief witch-hunters of last week, Helsingin Sanomat, decided to tone down its rhetoric and did a largely positive piece about Nokia CEO this week. After they had time to check out the numbers, looked at compensation practices at similar executive level around the world, and failed to find a single trustworthy source among current and former Nokia employees to badmouth Elop’s actions as CEO, even anonymously.
Stephen Elop’s exit package was the result of Nokia board deciding to seek outsider CEO back in 2010. Once they settled on that, neither overall level CEO compensation level, nor the equity incentives they granted at the times they were granted, nor the change of control/accelerated vesting clause seem worse than at any other company of comparable size.
Of course, if Nokia board stayed with internal CEO, things might have been very different today. Impossible to say for better or worse, of course. But that’s water under the bridge anyway.
Note: The equity grant numbers/valuations might be slightly different from those in the part 1. It’s because I wrote Part 1 before I figured out how to map equity grants and their current value more precisely. However, that does not change any of the conclusions I made last week.