Government-controlled AIG recently implemented a plan to reduce the impact of its volatile share price on the pay of top employees by basing most of their non-cash compensation instead on the price of its debt, which is seen as a more-stable investment. The plan was devised by AIG's management and board and approved by the company's government overseers.
Last month, AIG executives who must receive a portion of their annual pay in the form of stock—as mandated by the U.S. compensation czar—began receiving new "long-term performance units" that derive 80% of their value from AIG's junior debt and 20% of their value from AIG's common stock. The combination "is designed to serve as a proxy for AIG's long-term value," the government-controlled company said in a filing at the end of May, when the change to how its top employees are paid kicked in.
Typically, executives receiving non-cash compensation get stock or stock options, grants designed to motivate the employee to expand the company. Tying compensation to the value of debt is unusual, executive compensation experts say, because companies are generally expected to repay their debt. But AIG isn't a typical situation, they say.
The value of AIG's shares depends largely on whether the U.S. government, which owns nearly 80% of the company and is owed $102 billion by AIG and its units, is eventually repaid. If the company can't generate enough cash from asset sales and earnings to pay off Washington, its shares would be worth little or nothing.
"AIG is operating under a lot of pay constraints, so this is one way in which they can deliver more value to their management," said Marc Hodak, managing director of Hodak Value Advisors, a New York research and consulting firm that advises executives and directors. He adds that "just being able to repay their debt would be a very significant achievement for AIG, so this is a rare instance where the interests of debt holders are aligned with shareholders."
AIG for months said it has struggled to keep compensation for its employees competitive while complying with federal pay curbs aimed at limiting compensation for executives at rescued companies. Individuals who are among AIG's 100 highest paid employees are required to receive a significant portion of their compensation in the form of stock, and their annual cash salary generally can't exceed $500,000.
Stake in the Future
Last year, AIG considered paying employees in this group with stock units linked to the value of several key subsidiaries, but ended up basing their pay on AIG's common stock so employees would have a stake in the entire company's future. The company then decided on the new long-term performance units. Starting in May, employees who received common stock in the first half of 2010 were allowed to exchange that for the new units, which they will receive from now on and can redeem for cash from AIG over time.
"AIG is committed to compensation practices that allow the company to attract and retain capable and experienced professionals and motivate them to achieve strong business results in both the short- and long-term," a company spokesman said. He added that the grants of long-term performance units "allow us to achieve these goals."
Executives who recently received these units include David Herzog, AIG's chief financial officer; Kristian Moor, head of AIG's global property and casualty insurance business, Chartis Inc.; and Mark Wilson, chief executive of AIA Group Ltd., AIG's largest overseas life-insurance business that is slated for a sale or an initial public offering.
In contrast, AIG's junior debt, which ranks higher than Treasury's preferred shares, is seen by many analysts as having significant value. The performance units that AIG executives receive are linked to a set of securities that pay annual interest of 8.175% and currently trade at about 80 cents for every dollar. These securities, known as "hybrids," are expected to move closer to their maximum value of 100 cents as AIG makes progress in repaying taxpayers.
About $5 billion in AIG common shares are owned by investors other than the government, while the Treasury holds $49 billion in preferred shares. The preferred shares rank higher in AIG's capital structure, meaning their owners would get paid before the common shareholders in the event of bankruptcy. The Treasury is expected to convert its preferred shares into common shares and sell them in the future, which may dilute holdings of private shareholders.
The hybrids AIG executives effectively hold would be converted into common shares 90 days after at least 75% of the Treasury's preferred shares are converted into common shares, or after AIG's market capitalization rises to more than 10% of the company's total assets, according to company filings. As of March 31 this year, AIG had $864 billion in total assets and is expected to sell off some large businesses and assets to repay the government.
Feinberg's Call
Treasury pay czar Kenneth Feinberg earlier signed off on AIG's decision to pay its senior employees in the form of long-term performance units.
Mr. Feinberg, who is winding down his work at the Treasury after taking on a new role overseeing an oil-spill compensation fund, has also mapped out how top AIG executives can cash out of their stock salary. His pay determinations allow individuals among AIG's 25 most highly paid to redeem their stock or performance units for cash in three annual installments beginning on the second anniversary of their grant.
But the schedule was subject to acceleration by one year if AIG began to repay its federal obligations.