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Management Incentives at Gramercy Capital (GKK)

February 11, 2012

I was reading this wonderful post at Distressed Debt Investing that focuses on what I consider one of the most important factors on my investing checklist, management incentives. It reminded me that in my initial analysis of Gramercy Capital I didn’t really look closely enough at this factor. If I want to increase my position in GKK, which I am considering, I really need to get a better handle on what the management incentives are and therefore what I should expect strategically from management. Lets start with the Board of Directors.

Board of Director Compensation and Ownership

There are 7 Board members, of which 6 are non-executive directors, though only 5 appear to be independent as one is affiliated with SL Green, the former owner of GKK. Of the 6 non-executive Board Members, one, Bill Lenehan, has just been elected to represent the preferred shareholders at the special meeting last month. The others have been around since GKK was controlled by SL Green.  The single executive Director is Rodger Cozzi, CEO of Gramercy Capital. You can review the backgrounds of the older Directors in the most recent proxy statement. As for the new director, Craigatk did a little background writeup over at the Corner of Berkshire and Fairfax. Table 1. below shows director compensation for 2010 and share ownership as of December 2011.

Table 1. Board Compensation and Ownership (in thousands)
Stock Ownership
Since Comp. Total Com. Restr. Phant Opt.
1 Baum Aug-04 $165.9 156.5 2.5 115.5 38.5
2 Holliday Aug-04 $149.4 335.6 201.8  –  – 133.9
3 Kelter Aug-04 $164.4 165.5 2.5 124.5 38.5
4 Konigsberg Sep-04 $171.4 156.3  – 2.5 115.3 38.5
5 Laven Aug-04 $181.4 153.8  – 2.5 112.8 38.5
subtotal 967.7 (just under 2% of total shares outstanding)
Cozzi Oct-08 N/A 704.4 504.4 200.0

From the table above, it is clear to me that non-executive directors have little ‘skin in the game’ and receive modest compensation for what I would consider a rather complex corporate situation. Director fees (comp.) are primarily in the form of cash, with less than 10% paid as restricted stock and options. And though most directors have been in place since 2004 only one, Holliday, owns common shares outright and that is because he was the CEO prior to 2008; I assume these shares are connected with previous grants or options associated with his tenure. That means most likely no Directors have acquired shares in the open market, which is rather disappointing if not even distressing. Don’t they think GKK is a good investment? [the corollary is ‘maybe we shouldn’t either’] On the other hand, as a group they do appear to have the appropriate background and expertise to run the business. (you would be surprised how many Boards do not!)

Management Compensation and Ownership

Management compensation is skewed towards cash (salary and bonus) with only a very small portion paid in the form of restricted stock and options. Table 2 below details 2010 compensation by component.

Table 2. 2010 Mgmt. Compensation (in thousands)
Name Position  Total_  Salary Bonus Stock Options Other
Roger M. Cozzi CEO $1,910 500 1,300 105 5
Timothy O’Connor Pres $975 400 575
Robert R. Foley COO $725 400 325
Jon W. Clark CFO $550 250 300
Michael Kavourias EVPLegal $860 385 475

This lack of long-term compensation is reflected in the minimal share ownership of the top 5 executives; only the CEO (who was hired in a second moment) has any kind of substantial equity exposure (approx. 1%), and even that is insignificant compared to the ongoing cash flow from his regular cash compensation. I was unable to determine how or when Cozzi’s shareholdings were acquired but will speculate that it was in the form of a grant when he was hired in 2008. My conclusion is that for management, salary and bonus are the primary concerns, and their interests are thus poorly aligned with those of shareholders from this perspective.

As might be expected, the top 5 executives have protection from termination in case of change of control, approximately 1 year of salary and benefits plus early vesting of options. Standard fare which, alas, does not go a long way to realigning their interests with us simple shareholders who might like a share price ‘bump’ from a tender offer.

In sum, I would expect management to try to right the ship at GKK (so that they can continue to receive their cash compensation) but not necessarily focus exclusively on building shareholder value. I think they may want to grow the company (and thus their salaries) rather than ‘prettying up’ the company for a potential suitor or returning value to shareholders in the form of dividends or liquidation distributions. If Plan Maestro is right, with all their NOL carryforwards they won’t have to pay dividends on the common for a while even though they are a REIT, and certainly won’t be paying dividends on the preferred (sorry Whopper).

As long as we recognize it, this lack of allignment between shareholder and management interests doesn’t make GKK a bad investment. We just have to factor it in when evaluating GKK shares for their investment attractiveness. From my perspective it means that the share price has to be especially attractive as I expect underlying value to be revealed only after a long and perhaps quite difficult turnaround which Mr. Market may take some time to acknowledge.

Any thoughts from readers on what I might have missed?


From → Positions Closed

  1. Olmsted permalink

    Good article. Only thing I’d add is that it is hard to interpret the lack of insider buying here. For the better part of the last two years management and the board has had material non-public information while they have worked out a solution for Realty.

    • Thanks for the comment. Yes I agree it hard to judge lack of insider buying because of the non-public info. Now that Realty’s put back is public, let’s see if management plunks a few of their own dollars on the line. This would be a perfect time unless something else is brewing.


  2. craigatk permalink

    Nice analysis of management’s interests. I like the preferreds because of the margin of safety but agree management is a big risk and as a result this could take quite a while for the investment to play out. I’m trying to think long-term here and size the position correctly for the risk that something will change during the time that I’m waiting. The new director is certainly a good change, but it’s not enough to force a catalyst in my view.

  3. Craig,
    Thanks for the comment. I hear you on the preferreds but because the upside is limited and the timining is unclear I prefer a smaller position in the common. To each his own.

    I think you’re right that this will take longer to play out than we all anticipate. Perhaps they need two or three preferred directors to tip the balance on the board… that’s at least a couple of years away.


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