Coke Plan Leaves Some Dry

Donald Sagolla, a principal with Mercer Human Resources Consulting, says he has found that compensation incentives focused on stock performance make the most sense for a company's directors.

"You want to make sure the board is holding management's feet to the fire on whatever performance metrics are going to increase shareholder value over the long term, whether it is earnings per share increases or something else," Sagolla says. "Putting the emphasis on long-term stock performance puts them in the same foxhole with shareholders."

Beverly Behan, a partner in the corporate governance practice of Mercer Delta Consulting, LLC and co-author of Building Better Boards: A Blueprint for Effective Governance, says that simply requiring directors to own stock in the company does the trick.

"For a long time, we've said directors should own stock, and many companies have stock ownership guidelines for directors," Behan says.

At first blush, stock ownership appears to have worked in Buffett's case. Through Berkshire, he bought most of his Coca-Cola stake in 1987 for about $1 billion. The roughly 200 million shares are worth about $8.4 billion at current prices, making it Berkshire's most valuable holding.

On the other hand, Coca-Cola has been a sporadic performer in recent years after a number of strategic missteps. Its shares recently traded around $42, down more than 25% from its highs in 2002. Its rivals, including Pepsi (PEP Quote), have shown stronger growth and more innovation in recent years. For the first time in their intense rivalry, Pepsi actually surpassed Coke in market value in December.

Mohnish Pabrai, managing partner with Pabrai Investment Funds, says Coca-Cola is right to use profit metrics as a performance incentive for directors.

"A company's stock price is subject to all kinds of swings on a macro level depending on what the overall equity market is doing at a given period of time," Pabrai says. "If you're going to have a plan, you should have it heavily biased toward internal metrics like profit growth, sales or whatever. Management has no control over the stock price. They should be fixated on the performance measures that are more directly tied to generating cold hard cash by the business."