Management Incentives at Gramercy Capital (GKK)

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.
Non-executive
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)
Executive
	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?