My friend, Judy Samuelson, Executive Director of The Aspen Institute’s Business & Society Program, is onto something. In a recent LinkedIn post, she asked, “How will he be compensated?” (he being The Boeing Company’s new Independent Chairman, Steve Mollenkopf). Great question. After thinking about this, I’m also wondering how Boeing’s new CEO (a person to be named later) will be compensated and to do what. For clues, I turned to Boeing’s 2023 proxy statement to understand the company’s executive compensation program. After reading through it, I was hoping they'd rip up what's described in the 2023 CD&A and start from scratch. I received and read through Boeing’s 2024 proxy statement last month. They made some change for sure, but most of the old program is intact. And the problem with that is that they are still not going to be paying the CEO to do what is needed.
Pay For Restoring Trust
Every proxy statement I've ever read contains the phrase, “We pay for performance...,” or some variation of that. It’s one of those “It goes without saying...” phrases that the speaker or writer goes on to say anyway. What also goes without saying is what everyone wants to see from Boeing right now. You don’t need a poll to figure it out. What airlines, passengers, pilots, employees, regulators, and every other human being want to know without any doubt is that Boeing’s aircraft are airworthy. Can we trust these planes to get us and our loved ones from point A to point B safely? Taking a commercial flight, whether it be aboard an Airbus or Boeing aircraft, is still the safest mode of travel, yet people are worried about Boeing’s wide-bodies as a result of the well-publicized accidents they have had due to defects. Boeing, the icon of air travel, has lost people's trust. If trust what Boeing needs to restore, then they need to pay someone to do just that.
What Does Boeing’s CEO Get Paid to Do?
The 2024 proxy statement shows that Boeing has made significant changes in its executive compensation plan, which have been well explained by others (see AgendaWeek, CompensationStandards, and The Wall Street Journal). What I’ve tried to figure out is to what extent Boeing’s new CEO will be incentivized to do what needs to be done to regain the trust of its stakeholders, which means focusing on product safety.
First, let’s look at the the types of pay. Like pretty much every large public company, Boeing pays its executives a base salary, annual incentives (i.e., a bonus), and long-term incentives (LTI) usually in the form of equity-linked instruments.
Next, let’s look at how those types of pay make up Boeing’s CEO’s total compensation pie. From the chart in the the CD&A that I’ve copied and pasted below, we see that salary is targeted at 6% of what the board awards the CEO each year. That’s paid in cash. The bonus, also paid in cash, is targeted to make up 11% of the pie. The other 83% is the LTI part, which is awarded in Restricted Stock Units (RSUs) and Performance Restricted Stock Units (PSRUs). (Last year, they also used instruments called Premium-Priced Stock Options (PPSOs), but they've now completely done away with stock options.)
Now, let’s look what Boeing’s CEO has to do to get all of that.
Base Salary: Like all salaried employees, the CEO gets their weekly paycheck for showing up for work, either in person or remotely as may the case may be.
Annual Bonus: In 2023, for the CEO to get the bonus in full, the company had to meet pre-set performance targets based on:
Financial Performance (75% weight):
Total Company (67% weight):
Free Cash Flow (75% weight)
Revenue (12.5% weight)
Core EPS (12.5% weight)
Business Units (33% weight):
Revenue (50% weight)
Operating Earnings (50% weight)
Operational Performance (25% weight):
Product safety:
Stability (20% weight)
Quality (20% weight)
Employee Safety (20% weight)
Climate (20% weight)
DE&I (Boeing uses the acronym ED&I) (20% weight)
For 2024, they've changed the weightings of Financial Performance to be split evenly between performance of the Total Company and the Business Units. And the've changed Operational Performance to be based only on quality and safety. More on that later.
Long-Term Incentives: Once awarded, the LTI pay out based on the passage of time served (three years) for the RSUs (45% of LTI) and meeting three-year financial performance goals for the PRSUs (55% of LTI). For 2023, the metrics for the PRSU payouts were Free Cash Flow, Revenue, Core EPS, and TSR relative to a peer group plus Airbus. For 2024, the board changed the PRSUs to be paid out based solely on Free Cash Flow. Eventual payouts for PRSUs can be between 0% and 200% of the target number of units granted.
I'll pause here to see if you are feeling confused. If you are, that's normal. I'm not sure the executives themselves could walk you through their own compensation without assistance. Charlie Tharp at the Center On Executive Compensation, recently published a paper on why he thinks the entire field of executive compensation has become overly and unnecessarily complicated. I agree with him 100%.
How Much Pay Is Based on Safety?
Let’s get back to the question of how much Boeing's CEO will be paid for safety. As outlined above, the final performance score for the annual bonus is weighted 75% on Financial Performance and 25% on Operational Performance. No change from last year. The major change for 2024 is this: The performance metrics for Operational Performance will be “focused entirely on quality and safety goals” (that's up from 40%). Great move, but even so, that means there’s still not a lot of emphasis on product safety because this only affects 25% of the annual bonus, which is only 11% of the total compensation pie. The financial performance metrics count for a lot more, especially Free Cash Flow. Why is Free Cash Flow king? According to the proxy statement, Boeing considers Free Cash Flow to be “the most significant indicator of the health of our business over both the near- and long-term, given the debt that we carry and the length of our product cycles.”
Other than the quality and safety goals that will now determine 100% of Operational Performance, does product safety show up elsewhere? That's debatable. The CD&A says that part of what drives all measures of Financial Performance (i.e., Free Cash Flow, Core and Operating Earnings, and Revenue) is “first-time quality and safety.” But being one of many drivers (six others are listed, and that's definitely not an all-inclusive list of what drives financial performance) is too indirect for me to count for very much.
LTI payouts are based on the passage of time (for RSUs) and Free Cash Flow goals (for PRSUs), so here again product safety is not really baked in. But what might address my concern here is that, new for 2024, PRSUs will incorporate a “product safety downward modifier." The way this works is that eventual PRSU payouts will be cut if two product safety operational goals are not timely completed. The two goals are:
the design and deployment of an “employee culture survey aimed at assessing how deeply and effectively our Safety Management System is inculcated in our workforce,” and
the development and implementation of “operational control limits for several programs (including the 737 program) that include measures for determining when a safety risk assessment is required before a product can move past a specified point in our production system.”
“Unless these goals are both completed by or before year-end 2024, the 2024-2026 PRSU payout will be subject to either 25% reduction (if goals are completed in 2025) or reduction to 0% (if goals are completed after 2025).”
I love the idea of applying a downward modifier to LTI payouts if product safety goals are not met. But when I think about two product safety goals that Boeing has established, the first one seems like a layup, and the second one sounds like something that should already exist. To me, completing both of these tasks should be a requirement for the CEO to keep his or her job, not merely be used as a compensation modifier.
Way Too Much LTI
The main problem I have with all executive compensation plans, not just Boeing's, is that the proportion of equity-linked LTI is way too high. When compensation is so heavily tied to things like RSUs and PRSUs, all eyes become glued to the stock ticker. And this is especially problematic at a company like Boeing where the CEO's eyes should be focused on the planes in the sky.
The target proportion of compensation awarded to Boeing's CEO in the form of LTI is normally 83%. This year, the board took a major step by reducing what would have been the LTI award target by 22%, which represents the percentage decline in Boeing’s stock price between January 5, 2024 (the day of the Alaska Airlines Flight 1282 accident) and the grant date. So, that means what would have made up 83% of the CEO’s compensation will now make up 64.7% of the pie, bringing up the proportion representing base salary to 12.4% and annual bonus to 22.8%. Going back to my discussion on the metrics that impact the annual bonus, this means that 25% of 22.8% of the CEO’s compensation will be tied directly to quality and safety, which is better but still only 5.7%.
It Goes Without Saying
I could go on to dissect this further, you could rip apart my back-on-the-napkin math, and we could argue over how much safety and quality really drive free cash flow. But I think I’ve made my point, which is that Boeing's new CEO isn't going to be paid for worrying primarily about product safety, at least not on paper. I'm not saying that Boeing's board members and executives are the kind of people who care more about free cash flow than passengers aboard planes. I'm sure they're not. But the incentive scheme they've designed doesn't scream, "Safety, of course, is our top priority," which is what Mr. Mollenkopf says in his letter to Boeing shareholders--the first thing you see when you open the 2024 proxy statement.
If Boeing's board wants to incentivize its new CEO to restore trust, shouldn't it be placing much greater weight in the CEO's compensation plan on metrics that tie directly to product safety? Because if you get that part right, the results on free cash flow, revenue, and earnings should follow. It goes without saying that product safety must be any aircraft manufacturing company executive's primary concern. If the new CEO were to read Boeing’s latest CD&A, that’s not the message they would get.
Boeing's virtual annual meeting is this Friday, May 17 at 11:00 a.m. EDT. I'll be watching.