Highest Paid CEOs: #4 Mel Karmazin

This is the fourth in a series of five articles, covering the top five highest paid CEOs in the U.S. Number four on the list is Mel Karmazin, former CEO of Sirius XM Radio , who made $255 million in fiscal 2012, the latest year for which figures are available. Like #3 on the list - Gregory Maffei - Karmazin's pay is simple, good old-fashioned excess. And why wouldn't it be? Greg Maffei is chairman of the board.

Karmazin became CEO of Sirius in November 2004, and left, somewhat precipitously, in December 2012. Prior to his role at Sirius, he spent most of his career at CBS until it merged with Viacom, when he became COO there. Shortly after Karmazin's resignation, three directors also resigned: Leon D. Black, Lawrence F. Gilberti, and Jack Shaw. The press release indicated that: "The decision of Messrs. Black, Gilberti and Shaw to resign were not the result of any disagreement with us on any matter relating to our operations, policies or practices."

But they always say that and I've never seen three directors resign at once for "no reason." Clearly there was a disagreement. Following these resignations, three new directors were appointed - none of whom could be considered independent - and they have since resigned to be replaced by yet more, not-very-independent directors.

Liberty Media takeover

Part of this discontent might be related to Liberty Media involvement. As I have said, Gregory Maffei is the chairman. But that isn't all. Liberty, which began 2012 with a 40% ownership of Sirius, has spent much of 2012 and 2013 buying up shares on the open market in order to facilitate its takeover of the company. Added to which, fully five of the 11-person board are also directors on Liberty company boards and/or personally known to Maffei.

Where did the millions come from?

Almost all of the millions of Karmazin's pay came from profits on the exercise of stock options - some $244 million of it. Karmazin started exercising the options in April last year and finished in October, sometimes exercising substantial tranches on successive days. In every case he sold the shares instantly, probably to Liberty Media. So much for aligning the interests of management and shareholders.

Ironically enough, these options were granted, in name at least, as part of negotiations to renew Karmazin's employment agreement - and presumably to retain him. In June 2009, at almost an all-time-low stock price and within a very depressed stock market generally, Sirius awarded Karmazin 120 million stock options at a strike price of $0.43. In reality, these options looked more like a straight swap for a prior option grant that was, at the time, miserably underwater (exercise price far in excess of stock price). The 30 million options he had before this mega-grant were priced at $4.72. That was a price that Sirius shares never saw again, so the options were worthless. Not so those granted at a strike price of $0.43.

Did Karmazin deserve these profits?

But did Karmazin deserve these profits? The company's share price hit a 10-year high of $7.50 shortly after his appointment, but after that, it fell, and fell, and fell. And probably the only reason it recovered toward the end of his career was that Liberty Media was vacuuming up any and all spare shares. So the short answer is "no."

As the compensation committee report somewhat ingenuously described the employment agreement drawn up at the time of the original award:

That no one assessed the reasonableness of the compensation arrangements does not come as much of a surprise.

Mega-grants of stock options are wrong

So what is wrong with a grant of stock options of this size, a mega-grant?

Fundamentally, like all market-priced stock option awards, executives benefit from the entire increase in the company's stock price whether it was due to market forces or the excellence of their management skills. If the option award is very large, this means that very small increases in stock price can lead to very significant rewards. A $1 increase over the exercise price of an award of 120 million stock options leads to a profit of $120 million. In other words, the award of mega-grants of stock options leads to executives benefiting from a potentially enormous upside.

If the market recovers and stock prices rebound, shareholders will "recover" most of the value of their investments, and CEOs will make potentially millions of dollars worth of profits. This does not align the interests of executives and shareholders, it divorces them. Especially if the CEO has overseen the catastrophic drop in stock price in the first place.

The award of stock options with an exercise price at a significant premium to depressed prices is the only way to align executives' interests with shareholders' in a general market downturn, but few if any, companies ever take this route.

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