Drug distribution company McKesson (NYSE:MCK) revealed in a June 21 regulatory filing that had CEO John Hammergren retired March 31, he would have been entitled to a $159 million pension. The largest pension in the history of corporate America; should shareholders be concerned? I'll have a look at this thorny issue.

Pros
In order to recruit a quality CEO it's vital for companies to provide a compensation package attractive enough to get that person to leave their current situation. Putting the bar as high as Mckesson has done, it likely won't be difficult attracting top flight candidates both from inside an outside the company. In fiscal 2013, John Hammergren earned $51.7 million, of which $24.2 million wasn't actual cash paid out but rather the year-over-year change in actuarial present value of his pension benefits. It's enough to get anyone's attention, even jaded, already wealthy CEOs.

SEE: A Guide To CEO Compensation

How did McKesson come up with the $159 million figure?

At the end of every fiscal year it looks at a number of actuarial assumptions in order to come up with a lump-sum payment that would be paid within seven months of retirement. In its 2013 DEF14A, it provides the following explanation of how it calculates the basic retirement benefit under the Executive Benefit Retirement Plan or EBRP for short:

"…The hypothetical annuity benefit payable under the Retirement Share Plan is calculated by first determining the value of each share credited to the participant’s account as of the date it was credited, then applying an annual 12% rate to that value from the date the share was credited to the account to the date the participant’s EBRP benefit is scheduled to begin. The aggregate value of the shares credited to the participant’s Retirement Share Plan is then converted to a straight-life annuity. The resulting annuity is converted to a lump-sum amount using the interest rate prescribed by the PBGC for purposes of determining the present value of a lump-sum distribution…"

In 2013, it reduced the lump-sum interest rate it uses to calculate its pension liability from 4.0% to 2.3% to reflect the prolonged period of low interest rates. That adjustment accounted for the majority of the $24.2 million increase with approximately $2 million for an additional year of service. Hammergren and Executive Vice President Paul Julian are the only two executives with employment agreements; once they retire that will be the end of the practice. McKesson originally created an employment agreement for Hammergren when it hired him in January 1996. The agreement, in large part, was used to induce the executive to move to the company.

Since the agreement first took effect on January 31, 1996, its stock's achieved a total return of 468% compared to 239% for the SPDR S&P 500 (NYSEARCA:SPY). It's hard to argue with this kind of performance.

Cons
According to the Wall Street Journal--Bolton Partners Inc., an actuarial firm, and Gallagher HR Consulting, an executive-compensation consultant, helped out--Hammergren's base pension is only $35.8 million. However, adding into consideration five special factors including a low interest rate and added years of service, the pension quickly balloons to the number that's got executive compensation experts apoplectic. James Reda of Gallagher HR Consulting views it as "excessive' in light of Mr. Hammergren's $89 million in total compensation (less change in Pension Value) over the past three years. Only Rupert Murdoch comes anywhere close. Add approximately $246 million in company stock, not to mention what he's sold over the years, and Hammergren's close to being a billionaire.

SEE: Evaluating Executive Compensation

Look more closely at its performance and you'll see that a good portion of McKesson's total return was achieved between January 1996 and June 1998 when Hammergren wasn't even the CEO. Over the past 15 years, McKesson's total return on an annualized basis through June 25, 2013, is 2.5%. This compares to an average of 13.9% for peers Cardinal Health (NYSE:CAH), AmerisourceBergen (NYSE:ABC) and Express Scripts (Nasdaq:ESRX). Hammergren's success has more to do with timing than it does being a good CEO.

Bottom Line
By no means am I suggesting John Hammergren is a bad CEO. However, the numbers suggest that a payday of close to a billion dollars over a 13-year period is highly unusual and entirely unearned.

Should McKesson shareholders be concerned about Hammergren's $159 million pension? You're done right they should. Unfortunately, there's not much that can be done at this point in the proceedings. All they can do now is ensure the same thing doesn't happen in the future.

Fool me once, shame on you--fool me twice, shame on me.
Tickers in this Article: MCK, CAH, ABC, ESRX,

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