Executive payouts break records every year, the wage gap between CEOs and average workers grows constantly more vast, and both the U.S. and Canada are reworking the rules on how companies pay the brass. It’s time to big bucks.
Executive compensation has become a tricky beast, laden with elaborate stock schemes whose windfalls make million-dollar salaries look like chump change. It’s all led to confounded directors, irritated shareholders and nervous regulators.
To delve into the thorny issueof executive pay, BCBusiness brought together a group of B.C. experts. Doug Pearce is the CEO of the B.C. Investment Management Corp., an organization that handles $83.4 billion in investments for the provincial government and other public groups. He is also the chair of the Canadian Coalition for Good Governance, a national association that advises companies on governance issues. Bryon Hodges is an 18-year veteran with the Hay Group Ltd., an international HR firm, and has worked as an executive-compensation consultant in Vancouver and the U.K. Laura O’Neill is the director of law and policy with the Shareholder Association for Research and Education, a Vancouver-based non-profit organization created out of the labour movement that advocates for responsible investment practices. BCB: Bryon, give us an idea about some of the attitudes behind executive compensation today. How much of a priority is this for the companies you work with? Bryon Hodges: Companies are very concerned about compensation for executives on two levels. For the companies, the most important thing is attraction and retention of good talent at the top. But on the other hand, they are also concerned about being seen to be doing the right thing. I think that there’s a lot of change taking place, and I think just trying to keep up with that change has been quite difficult for them. I think the whole area of performance criteria for executives is key: how to link their pay to the performance of the organization, doing it in a way that is going to help the organization move forward, but at the same time in that acceptable area for investors. Trying to align the interests of executives with the shareholders is paramount. BCB: Doug, on the investment-management side, how big a part does compensation play in the decisions that you make? Doug Pearce: Investors are increasingly more concerned about the excessive-compensation issues and disclosure. Investors typically don’t like surprises, and we have had some surprises. We believe that proper disclosure of the full compensation picture is important. We like to link compensation with performance, with qualitative and quantitative performance measures. BCB: One of the things that can get controversial is the sheer amount of compensation and how this changes over time. Do you see this as an issue? DP: Yes, because it’s actually shareholders’ wealth that is being paid off. In our view, there have been numerous examples of excessive compensation. We’ve seen cases where there have been a couple of years of declining shareholder value and yet the executive has had increases in compensation. Some of this may be warranted, but typically this is not the case. BCB: Laura, you work with a pretty broad scope of shareholders and different groups. What kinds of attitudes have you heard from them on these topics? Laura O’Neill: What it comes down to for most of our clients is the performance issue. We don’t hear as much about excess; we hear about excess in relation to performance. We are real supporters of an advisory say on pay. We would like to see something that deals front and centre with compensation so that shareholders can weigh in on that with a ballot. I think what shareholders are looking for is an opportunity to get a lot closer to the conversation that the compensation committee of the board has when it talks about how it’s going to pay the executives. That’s where we want to see the link to performance. It’s also important to note that performance for us is not just a financial matter. For many of our clients it also has to do with environmental, social and ethical matters. So we want to see the board really grapple with how it is they are assessing executives on those non-financial matters, and we’re not seeing enough of it now. BCB: All of you brought up the issue of tying compensation to performance, but I understand this can be quite complicated. What makes it difficult? BH: Laura mentioned a number of various performers. If I could add another one to the list, it’s really about some of the softer issues that senior executives face in their organizations around putting the top team together, motivating individuals, succession planning, managing the next generation of managers for the business. If you think performance is difficult to judge in terms of financial areas, what about in some of these other softer areas around people management? I think that any good system of measuring performance really does have to address those. DP: I think it’s really important for the chief executive to set the tone in the corporation. Even on financial matters such as internal controls, national controls or how risk-averse the company is. Investors have a lot of time for that type of executive. It lessens the burden on questioning whether you’ve got an Enron situation with an executive who is prepared to take on a lot of risk. BCB: So it’s partially setting out what the requirements are, what the expectations are in the package. DP: Absolutely, full disclosure of fact. Putting that forward and actually doing a look back too, which means: as the executives set up these compensation programs, did it turn out the way they anticipated? BCB: Who does the evaluating of the CEO? If pay should be performance-based, who sits down and assesses whether the executives have performed well? BH: In most organizations, the compensation committee. Part of their mandate is to set the plan to determine what the measures are and what the targets are and then, at various points during the year, to actually assess the chief executive. In a lot of cases of excessive compensation, a lot of that can be traced back to the work that the compensation committee has done or has not done. DP: I would add two more things. I think it’s important that the compensation committee be independent members of the board. I would also suggest – Bryon can’t say this, but I can say this – that they hire experts in compensation that are reporting directly to the committee and don’t have a conflict with the management’s requirement for compensation advice. I think we also have to understand that this is an evolving art form; it’s not really a science. LO: But we come back to disclosure yet again. We’re dealing with the compensation committee and its work and its outside advisers. They can’t be doing a bunch of other work for the corporation for which they make much more money than they do advising the comp committee. BCB: Bryon, the Hay Group works in all kinds of human-resource areas, and I’m sure that some of your clients also have contracts for some of your company’s other services. So when you are doing executive-compensation work, what can you do to ensure you maintain independence?
BH: I think we are not in the same league as some of our competitors who do a large amount of work in the area of pension and benefits consulting. But clearly it is a concern. Advisers want to be seen as being independent, and there are all sorts of ways that they will try to justify their independence. But when it comes right down to it, I think there will be a lot of groups moving away from the big names and setting up on their own, as we already see happening in Canada, to establish this goal of being independent. There’s a congressional committee at the moment in the U.S. which is also looking at this, and they’ve actually asked at least one of our competitors to produce information about the work they do on executive pay as a percentage of the total amount of work they do for any particular organization. Of course they are being dragged kicking and screaming to this committee, but eventually they’ll get the information from them, so that is a big issue at the moment, one of great concern. [pagebreak] LO: In the U.S., something called compensation disclosure and analysis – which we’ll soon have here – is supposed to be the narrative where the committee ties performance to pay and explains why they’re doing what they’re doing, why this is the stock-option plan arrangement and so forth. If they do a lousy job of that, that’s going to be a problem. I know that in the U.S. there have been a lot of concerns about compensation disclosure that muddies the waters. The lawyers get involved – I am one, so I can say that [laughter] – and they are more worried about protecting the company against any potential legal liabilities than laying it all out clearly. The hope is that, over time, companies will get better at this and that in Canada they’ll be pretty good at it from the beginning, we hope. BCB: That raises an interesting point: most of the news stories we’ve heard about wildly excessive compensation have been U.S. examples. How big of a problem is that locally here in B.C.? BH: The trial in the States with Conrad Black is one example of where it’s starting to catch up with the Canadian situation. DP: I don’t think it’s as bad in Canada by a long shot. I can’t think of any local examples that really fit the excessive end of the scale. I think there have been disclosure issues in Canada where possibly the shareholders should have known a little bit earlier and there should have been more disclosure on the performance measures. It was important for us to create coalitions like the Canadian Coalition for Good Governance to do the proper research, to really get in front of boards and compensation chairs and have some engagement and dialogue. In the majority of the cases, there’s no resistance either. They want to know what shareholders want, and they want some reason as to an approach. That engagement is really important. BCB: It seems that companies can’t really deal with this stuff in isolation. Your compensation has to be competitive with other companies to attract talent, and your practices have to be comparable with everyone else’s. DP: Yes. And I think there are a lot of escalation-type issues going on. I think some comparison is warranted in trying to establish what the market is. People often speak about the high end of the market at first, and then that gets the headlines. Anybody digging deeper will find that it’s usually quite a range of compensation. BH: Yes. I think that’s the downside of all this disclosure, that companies do see what other companies are doing in detail, and they then say, “Why aren’t we doing that? And how did we miss out?” So it perhaps does start to lead to some escalation.
LO: And again, if you link your compensation to the performance of the corporation properly, you’ll have much less trouble with excess because the pay is not going to run into staggering amounts when the performance is poor, and shareholders will be much more willing to accept the high pay in the years when the company does fabulously well. But in terms of the corporation’s health generally, which has to do with compensation too, we like to see companies focus much farther ahead than the next quarter. So performance targets are important; it’s important that they also be long term enough that we know that the people making these decisions are thinking years down the line. BCB: That seems to echo a lot what you were saying before about not really wanting any surprises, wanting to have a bit of a road map into the future. BH: Yeah, and just echoing Laura’s point, this long-term horizon is critical. One of the things in our industry that we’re afflicted with is this short-term, quarter-to-quarter mentality, and we’ve got to get beyond that. We like companies that have more depth in management so that it can promote from within. BCB: If Canada hasn’t seen quite the level of excess that we see down in the States, why is that? Is it because we have better regulations? Or is it because we’re just generally less greedy? DP: I think we’re probably closer to the European situation in Canada, where Europe and Canada have been slower to catch on to the whole area of stock options and the variable portion of pay. So in Europe, the fixed base salary tends to be higher and the incentive portion tends to be a smaller percentage, whereas in the U.S. it’s really the reverse. BCB: So having worked both in the U.K. and North America, do the differences in practices actually have a very significant effect in the end pay-out or the culture of the governing sect? BH: Yes. Certainly Europe is catching up to North America. There are a lot of companies now who are operating across the ocean and a lot of executives moving back and forth as well. So I think that’s bringing Europe up to the same level and the same sorts of standards that you find in North America. Whether it’s created any changes in the culture is a good question. I think it’s probably putting more emphasis on a larger part of the package being in incentives as opposed to being in base pay. That’s probably different. But the problem in Europe is that there hasn’t been sufficient amount of pay at risk with that group. BCB: With all these issues, what we’re getting is a net increase in complexity. How big of a problem is this for investment managers and boards of directors? DP: I think it’s a huge issue for boards these days; not only do you have this whole notion of a compliance board for regulation purposes but you’ve got this compensation issue you need expertise on. Being a board director these days is quite different than it was a decade ago, when it might have been a nice social gathering. I’m probably overstating that, but it is far more complex today than it was a decade ago, partly because of what’s happened in the U.S.; it’s had ripple effects in every other economy. Globalism, corporate social responsibility is at the board table too, so you’ve got a lot of issues that historically you did not have to deal with. They obviously dealt with compensation, but the nature of the discussion’s changed. Main article photograph is of Doug Pearce by Perry Zavitz. Click here to listen to a clip of this discussion.