General Dynamics

Proxy issued:     3/20/2015 Meeting date:   5/6/2015

Pay hasn’t changed significantly since last year at General Dynamics – disclosed pay for CEO Phebe Novakavic was $19,033,073 in 2013 and $19,388,084 for 2014.  And that lack of change is the problem.  The advisory vote on pay at General Dynamics was supported by only 78% of shareholders in 2012, 58% of shareholders in 2013 and 79% of shareholders in in 2014, while the median level of support has been over 95% for companies in the S&P 500. Despite the low level of support over multiple years, the board not taken to fundamentally address shareholder concerns.

The compensation committee made some small changes to its practices, though even some of these have not yet taken effect: extending performance period for the ROIC metric from 1 to 3 years, lengthening both vesting and term of stock options to bring them closer to industry practices and getting rid of some previous loopholes in their stock ownership requirements. These changes did nothing to reduce the size of the overall pay package, or fundamentally address shareholders concern with the pay package.

The company received several red flags in our research last year, and we want to highlight one here:  the ratio of CEO pay to that of other executives was quite high. Many shareholders consider the internal pay disparity ratio – when the CEO receives an unusually disproportionate component of named executive officer (NEO) pay -- as an indicator of potential poor succession planning.

When a CEO dominates a firm to the extent that other executives seek jobs elsewhere, the turnover can be costly both in terms of lost talent and in absolute dollars. While we don’t know the internal dynamics at General Dynamics, it is a fact that there’s been considerable turnover among the NEOs. Indeed, the company has had two seniors executives “retire” in their mid-fifties, one of whom then became CEO of BAE Systems.  There is also a cost in replacing these executives, for example, when Jason Aiken became CFO in 2014, the company paid $919,885 related to relocation expenses, when he moved from Georgia to Virginia.  The company notes that $400,000 of the reported cost 2014 “represents a portion of a loss on sale of his residence.”

One of the costs of excessive CEO pay may be NEO job dissatisfaction. The solution isn’t to raise the pay of other NEOs, but rather to consider how much differential there should be in pay among the officers. Novakavic’s pay tripled when she was promoted from when she was Chief Operating Officer, and neither her talent nor her effort tripled on that day.

That is one of many concerns regarding the excessive pay at General Dynamics.