If you pick the right people and give them the opportunity to spread their wings and put compensation as a carrier behind it you almost don’t have to manage them.
- Jack Welch
Catherine McCall and Damian Yu, both principals at Hugessen Consulting , provided a lively overview of issues in executive compensation to an afternoon audience at the CFA Society Toronto offices on August 20, 2012.  The duo first outlined the current governance and market environment of compensation, then gave helpful pointers for deciphering management information, and concluded with “hot topics” in the area.

Executive compensation deserves the attention of investors. Besides being one of the largest expense items, how a company handles this agency problem is a “key indicator of the quality of the overall governance oversight,” said McCall.  The disclosure of executive compensation is regulated by rules established in 2008 and amended in 2011.  The board must now explain, in plain language, how it came to its decisions for packages awarded to the CEO, CFO, and three next highest executives.   Not only must the compensation discussion and analysis (CD&A) be present, a summary compensation table must be provided.  “There was some consternation when the table [requirement] was first introduced,” McCall noted.

On the heels of the financial crisis, compensation became a hot-button issue and it remains so today.  Much of the impetus for reform in disclosure was driven by institutional investors such as large pension funds (CPPIB, OTPP), socially responsible investors (Meritas, NEI) and “influential shareholders” such as Jarislowsky Fraser.  “Meritas and NEI tend to punch above their weight,” McCall said, because they are persistent about their proposals.  The Canadian Coalition for Good Governance (CCGG) has also played a role.  Each year they award a Governance Gavel Award, and this has raised the profile of the issue.

McCall described key regulatory and legislative developments.  There are around one hundred companies in Canada that have a Say on Pay vote, and the number is growing.  “Clawbacks,” which are a feature of the Dodd-Frank legislation States-side, are appearing in Canada.  More than half of the TSX 60 firms have clawbacks, but McCall cautioned many of them do not have much bite.

Damian Yu, CFA, walked us through the management information circular, with Sun Life Financial as the “worked example.”   (The full 96 pages for the 2012 AGM can be found here.) The Sun Life proxy illustrates many of the key compensation policy issues that a company attempts to communicate to shareholders in its circular, including peer group, target pay positioning, pay mix, and incentive plan design.

One aspect of the required disclosure that can be a touchy piece of information, Yu noted, is the disclosure of performance targets, because a company is “laying bare to the world what [it] hopes to achieve.”   Another “laying bare” came during the explication of the summary compensation table, where the entire package—paid salary, share award, option awards, non-equity annual incentive plan compensation, and pension value—is listed for top executives.

“Shareholders don’t necessarily object to level of pay,” Yu said, “but performance must be there.”  Pay for performance is the key.  The concept is simple; however, the devil lies in the details — how one defines performance and even how one defines pay can be open to debate, and a company would be well advised to thoroughly examine the alignment between its compensation and performance.  The disconnect between pay and performance is the greatest concern shareholders have about executive compensation.

Another irritant for shareholders, McCall said, is the “single trigger” change of control provision.  For example, a REIT changing its structure to a corporation instead of an income trust can be defined as a change of control under the change of control agreement.  This could trigger a lavish severance package for executives who keep their jobs.  The preferred clause is now “double trigger”:  severance is awarded on change of control and involuntary loss of job.

McCall commented on the trends over the past 20 years.  Compensation continues to increase, in part due to the overall increase in average company size on the TSX.  Options have been falling out of favour.  The generosity of pension plans is being reined in, with a move toward defined contribution.  Deferral time windows for awards have been lengthening from an average of two years to 3-4 years.

At the close of the seminar, Yu reminded attendees that compensation should not be ignored.  He cited the CP / Pershing Square showdown on executive compensation as a “watershed event” that led to the unceremonious departure of Chairman John Cleghorn.  If directors at an under performing company are unwilling or unable to ask tough questions about executive compensation, be prepared for frustrated shareholders to do the job for them.  McCall added that change is going in the right direction with the current disclosure rules.  “Sunlight is the best disinfectant.” ª

Further background can be found at the Knowledge Centre of Hugessen Consulting.