P.F. Chang's Performance Unit Plan Tied to Stock Price Is a Wildcard - 29 Apr 2011

This week, P.F. Chang’s Bistro [(PFCB)
– $40.35] reported disappointing earnings for Q1 2011. The company’s
$0.44 fell well short of the consensus estimate and the stock price took
a hit. What was even more disappointing was the fact that Q1 2011 was
the company’s easiest 2-year profitability comparison for the year (see pages #2 and #3 in our company Data Packet here). It only gets more difficult for PFCB in the quarters ahead.

Here’s
where it gets interesting. In FY 2009, PFCB management unveiled a
3-year Performance Unit incentive for its Co-CEOs that is simply tied to
the company’s stock price relative to the Russell 2000 (IWM).
The measurement dates are February 17, 2009, and January 1, 2012. As
of today, both the Russell 2000 (861.75 today versus 428.90) and PFCB
($40.38 today versus $20.15) have almost exactly doubled since the
plan’s inception.

Which now begs the question. Why do management
teams tie a material bonus incentive to the stock price? We understand
that investors want management to have the same incentives as investors
(i.e. stock price). That’s a noble thesis. But, this bonus plan
introduces a set of perverse and conflicting managerial incentives as we
get closer to the January 1, 2012, measurement date.

For example,
PFCB will report Q3 2011, earnings in late-October 2011. PFCB
management will be heavily incentivized to shift expenses out of Q3
2011, and into Q4 2011, (e.g. shift bonus accruals into Q4 2011).

What
if a key member of the management team wants to leave the company in
early-December? Maybe this information would instead be announced in
January 2012.

What if the company’s CFO decides that its annual
EPS guidance range needs to be lowered in early-December? Well, PFCB’s
Co-CEO’s would have a MAJOR incentive to wait until January 2012 to make
that announcement.

Finally, did PFCB management artificially deflate earnings in Q1 2011, in favor of reporting stronger numbers in

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