Saturday, March 29, 2014

Carlyle Follow Up: A Big Change in Incentives

Carlyle Follow Up:  A Big Change in Incentives

A few days ago I wrote about Michael Cavanagh’s departure from JP Morgan to become co-President of Carlyle (“Money and Culture at Carlyle [March 27, 2014]”).  The outlines of Mr. Cavanagh’s new financial arrangements have been filed with the SEC.[1] As expected, he won’t be taking home as much cash as he did at JP Morgan.   However, he will be receiving three years of guaranteed cash bonuses to smooth the transition. He’ll also be granted a couple million dollars worth of deferred restricted stock units (DRUs) each year. 

There are two aspects of his deal that are worth mentioning.  First, Mr. Cavanagh will get 933,146 DRUs to compensate him for roughly $30 million in JP Morgan equity that had not yet vested.  Second, Mr. Cavanagh’s hiring has forced Carlyle to create a new key executive incentive program, which will apply to the co-Presidents and the CFO.  As I noted in my previous post, the founders and Glenn Youngkin have been significant investors in Carlyle’s funds.   Newly hired executives have not had the financial wherewithal to make sizable investments in the funds.  Moreover, Carlyle has given carried interest to the professionals making investments, rather than to senior executives.  Thus it was difficult for senior professionals to be aligned with their investors.

Mr. Cavanagh’s arrival signals an important change.  The co-Presidents and CFO will receive a small percentage of carry that will be paid in DRUs.  Carlyle's SEC filing makes clear that this program can be expanded to other senior executives.  In other words, Carlyle will begin paying people carry even though they aren’t directly involved in sourcing, managing, and realizing investments.  This is the kind of incentive program one tends to see at banks and investment banks, where senior executives get overrides just because they can.  While this new program will probably make Mr. Cavanagh extremely wealthy, it will also help to undermine the culture and cohesiveness at Carlyle.

There’s one more amazing detail.  Mr. Cavanagh is entitled to a piece of any carried interest generated from investments in 2013 and 2014.   That’s a pretty good deal considering Mr. Cavanagh was working for JP Morgan when most of the relevant investments occurred.

Shareholders and investors at Carlyle should be asking questions, because this isn't the deal they signed up for.


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