If You Thought Starbucks Coffee was Expensive

The appointment of Brian Niccol as chair and CEO of Starbucks effective September 9, 2024, challenges several widely held beliefs about executive compensation, including that tens of millions of dollars are an egregious amount to pay a CEO for “just showing up.”

Starbucks will pay Niccol about $113 million in his first year as CEO, almost certainly placing him among the Top 10 highest-paid executives in the U.S. for 2024. His package includes $28 million in target annual pay (salary, bonus, and long-term incentives) and $85 million in cash and restricted stock to replace what he leaves behind at Chipotle. Corporate critics typically react to such sums with comments like “Wow, that’s much more than the typical sign-on!” and “Why does Starbucks need to pay for his performance at Chipotle?” and, of course, “Nobody needs that much money.”

However, the critical question from an investor’s perspective is: “Is he worth it?” That question for any given executive is ordinarily impossible to answer since their value to the company hides behind a veil of team activity that prevents distinguishing the contribution of any individual. The market sometimes partially lifts that veil for a particular executive when a public company experiences a surprise change, such as when a CEO abruptly joins or leaves a company. Upon the announcement of Niccol’s move, Starbucks stock gained 24 percent, and Chipotle dropped 8 percent. These translated into a market value gain of about $20 billion for Starbucks and a decline of about $8 billion for Chipotle.

Of course, we can’t attribute the entire Starbucks increase to Niccol’s appointment. The decision to bring him behind the counter arguably signaled a more significant strategic shift engineered by the board. However, by giving Niccol the chair and the CEO role, his leadership would appear to be a major factor in that strategy. Whatever portion of Starbucks’ gain can be attributed to Niccol’s hiring, the $113 million Starbucks spent to get him was a screaming bargain.

On the other hand, it is difficult to see Chipotle’s $8 billion decline as something other than a reaction to the loss of their established leader. Whatever portion of that decline is attributable to Niccol’s departure, the $85 million of unvested pay Chipotle gets to keep is a dismal consolation.

Like it or not, the impact of any executive on the value of their company is bound to influence their pay. If the board believes that the best person in the CEO’s chair can plausibly result in, say, a one percent higher return than with the next best person, for $80 billion companies like Starbucks or Chipotle (before Niccol’s move) that represents an impact of $800 million per year. No one comes with that performance premium stamped on their forehead. It’s the difficult job of the board to estimate that premium with imperfect information, both with respect to a CEO they would want to hire and a CEO they wish to retain.

So, Starbucks did well to pay only $113 million to bring on Niccol, despite negative reaction to that amount. Interestingly, we haven’t heard any similar questions about Niccol’s departure from Chipotle. No one is asking, “Wasn’t he making enough there?” or “Did the company do enough to keep him?” or “Isn’t it great that Chipotle is $85 million richer for Niccol having left?” This reflects keener public interest in how much money CEOs make versus what they leave behind. Boards must do the cost/benefit calculus behind comings and goings, both actual or potential.

The board’s job is more difficult when we overlay “good governance” guidelines on that calculus. Two of those guidelines are:

 

(a) that pay should be based on the market as roughly represented by peer compensation

and

(b) any above-market pay should be the result of solid performance

 

Despite the nominal concern about alignment implied by the latter guideline, these are both about keeping CEO pay from reaching levels ambiguously referred to as “problematic” or “egregious,” not paying in proportion to the value that a CEO brings to their company.

By emphasizing peer pay data, these guidelines commodify CEOs, assuming their cost can be reasonably determined by looking at comparable companies, like how one would value a house. At the same time, there has been criticism of using peers as a proxy for competitive pay because CEOs don’t move between companies—i.e., there is no real competition. The lack of movement alone doesn’t mean that competition doesn’t exist. Just as houses have values absent a transaction, even in neighborhoods with little or no turnover, executives have a value to their firm and, potentially, other firms even when they don’t move across firms.

For better or worse, we are likely entering a period where big companies with big problems create highly leverageable opportunities with the right leaders.

The standard pay-for-performance justification for above-market pay doesn’t hold in this new world. Starbucks’ $20 billion market value gain precedes Niccol taking the reins. Going forward, if Starbucks disappoints shareholders so that they only realize a $10- or $15-billion net gain from the change of leadership, Niccol may realize well-below-market pay from his incentive plans.

On the other hand, Niccol earned a lot at Chipotle, including $75 million in unvested equity awards. Those awards clearly proved insufficient to keep him, as Starbucks readily matched them in a sign-on grant. If Chipotle could see the future knowing that losing Niccol would have cost its shareholders $8 billion, how much could it have plausibly offered him to keep him from leaving? It’s hard to imagine Chipotle exposing itself to the criticism associated with either a retention grant or materially higher target pay, especially with Niccol already making the list of most overpaid CEOs. Now that the market has temporarily lifted the veil on his value, everyone has a clearer idea of Niccol’s true negotiating leverage. If he comes close to delivering on his promise, it may well be Starbucks’ turn to be constrained by governance standards.

While Niccol’s move was unusually high profile, companies of all sizes are increasingly facing a similar dilemma. Investors will keep pushing for constraints on executive pay based on “good governance” guidelines while bidding up the stock prices of companies challenging those guidelines to pay for the executives they want. Boards will be caught in the middle, dealing with difficult choices about how to make their investors happy.

 

By Marc Hodak

Marc Hodak is a partner at Farient Advisors.