For much of the past decade, the annual meetings of auto parts giant Magna International followed a rhythm as familiar as it was frustrating: a handful of shareholders would stand up and express outrage at founder and chairman Frank Stronach’s hefty annual pay packages; the Austrian-born Stronach, with the squinted eyes of a gunslinger at high noon, would respond by effectively telling everyone to go to hell. In 2003, for example, Stronach bluntly told reporters “I should get more” when asked whether he deserved the $58.1 million he pocketed a year earlier.
The following year he offered his personal philosophy on why company founders should continue to receive rich pay packages even if they’re no longer occupying the job of CEO—it helps foster an entrepreneurial spirit, he explained—but not because he felt the need to justify himself to critics. “I could say, ‘Look, if you don’t like it, sell your shares. It’s a free country.’ ”
That, more or less, was where the debate ended every year, much to the chagrin of corporate governance types. Stronach has been criticized for essentially milking the company he founded with the board’s acquiescence. His average annual take-home pay over the past decade was over $41 million, much of it in the form of so-called “consulting fees” calculated as a percentage of Magna’s pre-tax earnings. In 2007, at the peak of the market, he hit a personal best of $70 million. (The next best paid CEOs that year were Mike Lazaridis of Research In Motion, who earned $51.5 million in total compensation, and Royal Bank’s Gordon Nixon, at $44.2 million. Magna’s co-CEOs Siegfried Wolf and Donald Walker earned $13.4 million and $12 million, respectively.)
And it’s not just Stronach’s hefty pay that rankles investors. It’s his tendency to use his clout as controlling shareholder, made possible by the family’s ownership of a special class of multiple voting shares, to periodically grab Magna’s steering wheel as he pursued a host of risky business ideas. They included building a racetrack and casino empire, trying to buy Chrysler, the most troubled of the beleaguered Detroit Three, and selling part of Magna to a Russian tycoon with a murky background. As a result, the company’s stock trades at a significant discount to its rivals—a phenomenon known on the Street as the “Frank Factor.”
So there was a palpable sigh of shareholder relief when Magna said in May that Stronach had finally accepted a management proposal to buy out his voting control. The jubilation initially overshadowed the deal’s jaw-dropping $863-million price tag, which represents a nearly 1,800 per cent premium for Stronach’s voting shares. But even as Magna’s regular shares began to climb, a feeling of bitterness set in among several big institutional shareholders. After all, it was one thing to look past the consulting fees as long as the company was growing and making money, but quite another to allow Stronach a final egregious handout simply for agreeing to relinquish his iron grip.
Faced with mounting complaints, the Ontario Securities Commission decided to hold a hearing on the issue this week. Much of what the regulator is looking at are the technical details of the transaction, including whether the board provided sufficient information to investors before a vote on the deal, scheduled for June 28. Critics are worried that if the transaction is approved without serious changes—a likely scenario judging by the 15 per cent rise in Magna’s stock price on the day the deal was announced—it could send the wrong message to the country’s capital markets, namely that bad behaviour is rewarded. “There’s an enormous premium being paid here,” says Joseph Groia of Groia & Co., a former head of enforcement for the OSC who is now acting on behalf of shareholders’ rights group FAIR Canada in the Magna case. “And in a marketplace with a large number of two-tier share structures, that would set a terrible precedent.”
Of course, it’s not like Magna shareholders didn’t know what they were getting into. Magna and Stronach have a long history of what Richard Powers, the associate dean at the University of Toronto’s Rotman School of Management, called “non-best practices” when it comes to corporate governance. Nevertheless, Powers points the finger at Magna’s board for being too timid to offer a recommendation on how shareholders should vote. “That’s why they get paid,” he says. “The only inference you can take from that is they had questions they weren’t willing to raise in front of Frank.”
For its part, Magna has said it is doing its best to satisfy the OSC’s concerns about disclosure, raising the possibility of some sort of compromise. Last week, Magna released two internal reports about the transaction, one of which warned that the proposed deal would be “controversial.” As for why the arrangement was struck in the first place, Stronach, 77, who declined an interview request, has offered only vague references about it being time to let go of the company he started in the late 1950s. He has also said he hopes there will still be a role at Magna for his daughter Belinda Stronach, who served as CEO of the company before entering federal politics (she is currently Magna’s vice-chairman).
It’s a major about-face for a man who has long argued that family-controlled companies are desirable because they’re not as beholden to short-term goals like meeting analysts’ quarterly profit targets, and can instead focus on long-term strategies. Critics, however, say such ownership structures aren’t fair to the company’s real owners—the shareholders—and create opportunities for abuse.
Few investors are thrilled with the idea of paying a massive sum just to see Stronach go away, but not everyone agrees that the regulator should have become involved. If the OSC decides to kill the deal, it could mean the era of Stronach rule at Magna will continue indefinitely, since no one can force him to sell his shares. “I think Frank Stronach is extracting a pound of flesh,” says David Taylor, a portfolio manager at Goodman & Co., which own $5 million worth of Magna stock. “But the beauty of this deal is you get to vote on it. I can’t think of anything fairer than that.” Taylor also dismisses the idea that Magna’s board could have handled things better. “We can all do the math,” he says. “We know the price they are paying per share and it’s a ridiculous number. So the board can do all the analysis and calculations it wants, but it wouldn’t change anybody’s view whatsoever. We know it’s a stupid price.” At the end of the day, he says, the elimination of the dual-class structure should boost the stock from its current price of about $69 to around $100, based on the valuation of Magna’s rivals. “So we’re paying $800 million and change to add $3 billion in value—there’s your analysis.”
Other investors, however, say it’s time to take a stand. The Ontario Teachers’ Pension Plan was previously a big Magna shareholder, but sold off all but one share (to remain involved with Magna as it fights dual-class share structures as a matter of principle) several years ago following Stronach’s decision to sell a big piece of the company to Russian billionaire Oleg Deripaska, an industrialist with close ties to Russian Prime Minister Vladimir Putin. (Deripaska sold his shares a year later amid the global economic collapse.) “We had repeatedly spoken to them about the compensation they provide to Mr. Stronach in terms of these consulting arrangements because we didn’t think there was any justification for that,” says Wayne Kozun, the senior vice-president of public equities for Teachers’ investment arm. “We’ve had an issue with that because he’s not actively involved with running the company but he’s getting a life-long annuity of tens of millions a year. And we didn’t like the dual-class shares and the lack of independence of directors either.”
Like other critics, Teachers’ is concerned the deal to buy out Stronach will set a bad precedent, but Kozun says there’s other dangers lurking under the hood. Under the current arrangement, Stronach will get control over Magna’s new electric car division (and another four years of consulting payments) even though he would have a minority financial interest in the undertaking. At present, the project is considered to be peripheral to Magna’s core auto parts business, but if that changes, Kozun says Stronach could once again end up in the driver’s seat. “What they could be setting up here is a new dual-class Magna similar to the way it has existed in the past,” Kozun says. “And then if we wanted to buy out Mr. Stronach, we would have to pay another 1,800 per cent premium.” All of a sudden, $41 million a year is starting to look like bargain.