How One Company Got its Executives to Forfeit Bonuses

For boards anxious about the level of scrutiny their executives’ compensation packages are likely to undergo this proxy season, the events that unfolded at American Reprographics last year might provide some comfort: The document management services company got two of its executives to voluntarily give up a portion of their 2006 performance bonuses.
If they hadn’t given up a chunk of their year-end extras, the executives — Chairman and CEO Mohan Chandramohan and President and COO Suri Suriyakumar— would have collected significantly more than the compensation committee intended when they entered into the executives’ employment agreements. The reason they would have earned more than anticipated is primarily the result of two events. First, according to Manuel Perez de la Mesa, the board’s comp committee chair, the company was able to renegotiate its loans, an unanticipated stroke of luck that saved the company an estimated $8 million annually on a pre-tax basis. Furthermore, the company deleveraged as part of its 2005 initial public offering.
Each of those unanticipated events increased American Reprographics’ earnings per share, the metric upon which the executives’ bonuses were based pursuant to the terms of their employment agreements. Chandramohan and Suriyakumar were set to collect $60,000 for every 1% the EPS increased by more than 10% from its previous year, according to Paul Dorf, managing director at Compensation Resources.
“The CEO suggested that we just skip that benefit and skip the bonus in ’06,” Perez de la Mesa says. “From a comp committee standpoint, our goal was to balance fairness to the shareholders and fairness to the executives for their operating performance contributions. [The executives’] response to that was genuine and extremely admirable, by every measure.”
Dorf, however, is more cynical about the situation. The bonuses the executives collected — which amounted to 35% of their salaries of $1 million apiece  — were less than they were entitled to under their employment agreements. But, by accepting lower bonuses, the executives probably wound up saving money for both the company and themselves, Dorf says. That’s because, between the two of them, Chandramohan and Suriyakumar own 52% of the company.
“Every dollar of bonus they don’t take flows right to the bottom line. It’s not a compensation expense, so it’s not something they’re deducting. Therefore the profitability will be greater and the EPS goes up,” Dorf explains. “By not taking their bonus, there’s a good chance [the executives’] ownership value will be increased far greater than the $1 million each they forfeited.”
Indeed, Perez de la Mesa says Chandramohan’s significant holdings factored into the CEO’s decision.
“His thought process is that, from a shareholder standpoint, he — as a significant shareholder — is a beneficiary of those transactions and therefore is already receiving an inherent benefit much more significant than the bonus would be by the appreciation of the value of the shares,” says the comp committee chair.
Of course, not all boards will be able to so easily convince their executives to forfeit a portion of their bonuses when unforeseen events arise.
“When you see companies with executives that have a small percentage of ownership — 5%, 10%, 15% — you’re probably not going to find that they’d be as willing to give up their bonus,” Dorf says.
In those instances, Dorf recommends protecting against unforeseen executive windfalls by including a provision preventing such occurrences in their contracts.
“There should be a provision in any plan that says any extraordinary circumstances will be adjudicated by the compensation committee or the board in its entirety,” he says. “We can’t foresee everything that could possibly happen.”
“That’s so the board can sleep at night in case there are unexpected windfalls or extraordinary circumstances that come into play,” he says.