David Zaslav and the tyranny of incentives

On April 23rd shareholders will vote on a deal that has tested shareholder capitalism to its limits. In February Paramount Skydance grasped Warner Bros Discovery, its much bigger rival, from the jaws of Netflix after months of wrangling. The takeover battle has been an epic watch. President Donald Trump has weighed in. So has Bryan Cranston, star of “Breaking Bad”. The tie-up must still be approved by regulators around the world (not easy, as reflected in Warner’s share price, which is 12% lower than Paramount’s cash offer). If it does receive their assent, the deal will create an entertainment giant, enthrone David Ellison, Paramount’s boss, as the king of Hollywood and give sovereign-wealth funds from the Gulf an unprecedented stake in popular culture.

It will also make David Zaslav, Warner’s boss, remarkably rich. Mr Zaslav is a great Hollywood survivor: he started running Discovery, a constellation of TV channels, in 2006. Mr Cranston, who has won a Golden Globe, has described him as “so boring”. Mr Zaslav, who has won perhaps the largest golden parachute in corporate history, probably doesn’t care. If Mr Ellison fires him after the deal closes, Mr Zaslav will receive $34m of severance pay.

Whatever happens to him, even if he stays on at Paramount, Mr Zaslav will collect more than $500m from stock awards and options that will vest on generous terms. His tax bill will also be settled by his employer, bringing the total bounty to more than $800m. In Tinseltown terms, selling the studio that made “Casablanca” will earn Mr Zaslav enough to personally finance two “Avengers” movies. How is that possible?

The idea that managers, as well as entrepreneurs, should earn a fortune when a company is sold took root in the 1980s. Executives naturally greet takeovers warily, since they might struggle to find another job afterwards. Paying them off thus enlivens the market for corporate control, ran the argument.

That logic never seemed quite as unassailable outside executive suites and university economics departments. “If an executive needs a multimillion-dollar contract to get his mind clear in a takeover situation, then maybe he should see a psychiatrist,” remarked Felix Rohatyn, a famous banker. Nevertheless, by the end of the decade a majority of large American firms had fitted their corner offices with parachutes and Congress had levied a special tax on them—the one that Warner’s shareholders will now, unusually, pick up on Mr Zaslav’s behalf.

Since then, boards have constructed increasingly intricate pay packages designed to align the interests of managers and shareholders. The idea that the right incentives can solve any problem has become an article of faith in corporate America. Stock awards and options, rather than cash, make up more than 70% of executive compensation at large firms. In Silicon Valley shares are doled out to employees like sweets.

One consequence is that the earnings of senior executives have become utterly unintelligible to shareholders. “Compensation actually paid”, a figure companies are now forced to disclose, does “not reflect the actual amount of compensation earned by or paid to our CEO”, reads a typical warning from Warner’s proxy statement. Another is that golden parachutes have become much bigger. According to a study by Alvarez & Marsal, an advisory firm, the average payout a CEO should expect after his firm is bought is $27m. A study by Jeffrey Gordon of Columbia University covering takeovers between 2011 and 2022 found that, for deals larger than $10bn, the average payout was $48m.

Mr Zaslav is not the first boss of Warner Bros to become fantastically wealthy. When Time bought the studio in 1990 Steve Ross earned almost $200m; when AT&T bought Time Warner in 2018 Jeff Bewkes left with a $70m golden parachute. But even by these standards Mr Zaslav has been well rewarded. Moreover, his pay illustrates just how much the interests of executives and shareholders can diverge. A good chunk of Mr Zaslav’s compensation is awarded for hitting qualitative “individual strategic goals” rather than verifiable financial measures. His parachute also continued to grow while the deal to sell Warner was negotiated. Glass Lewis, a proxy adviser, says the tax arrangements in Mr Zaslav’s exit package should be a cause of “severe concern”; ISS, its rival, has called them “problematic”.

Whether investors view Mr Zaslav’s billowing parachute as tastefully golden or garishly so may depend partly on when they bought Warner’s stock. Paramount will pay $31 for each share, more than three times what they were worth a year ago. Judged this way, Mr Zaslav has delivered extraordinary value.

Yet this merger would not have been possible without the abject failure of an earlier one he orchestrated: the tie-up between Warner Bros and Discovery in 2022. The grand promises made then have gone largely unfulfilled. Its streaming service (HBO Max, then just Max, then HBO Max again) is still dwarfed by Netflix. Warner has had just two profitable quarters since the deal closed, leaving its debt-laden balance-sheet in a precarious state.

Warner’s board is responsible for Mr Zaslav’s pay. (Curiously, the committee chair is a banker whose shop is advising on the transaction.) Yet when Warner’s shareholders do vote on the merger next week, they will also have a chance to express their disapproval, a right they have had since regulators introduced “say on pay” rules after the financial crisis. The effect of rejecting an executive’s compensation, as shareholders did to Mr Zaslav’s $52m package last year (and almost did the year before), is identical to supporting it wholeheartedly. Votes do not bind companies and are often ignored. Warner’s owners have good reason to feel short-changed by Mr Zaslav’s pay. He will float happily away. ■