Pay CEOs for performance, not failure

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Last year was a tough one for Canadian Tire CTC-A-T. An unseasonably warm winter led to fewer sales of outdoor gear and a softening economy meant consumers spent less in general.

The retailer, one of Canada’s largest, saw its revenue tumble. Retail sales fell 3.9 per cent in 2023 and profits, measured by net income attributable to shareholders, were $585-million, down by almost half from the year before.

Given the poor results, Canadian Tire did something very rare for a major public company: it did not pay cash bonuses to its executives, even though there was the ready excuse of poor weather.

This is unusual, but it shouldn’t be. Withholding bonuses in a bad year is good corporate governance and a worthwhile example for other companies to follow. Boards owe it to their shareholders and employees to ensure that executive pay is actually aligned with performance.

It’s a core principle of executive compensation that salary is only a small part of how a chief executive officer is paid. The rest is usually a combination of cash bonuses, shares and stock options, which is called “at risk.” That is, at risk of going up or down based on the performance of the company. The idea is a CEO will do their job to the best of their ability if they have a personal financial stake in the company’s future.

But if that is so, the risk has to be there. Unfortunately, it too often isn’t, and this is a problem that can affect many of Canada’s largest companies.

For example, there is BCE BCE-T, which paid CEO Mirko Bibic a nearly full bonus of $3-million as part of a $13.4-million compensation package last year, despite missing financial targets and slowing the growth of its dividend. Or there is Bank of Montreal, which has often missed its financial targets in recent years (including 2023), and yet graded CEO Darryl White a 95 per cent on its scoring for incentive pay, which earned him a total of $11.2-million in compensation last year.

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On the extreme end is First Quantum Minerals, where CEO Tristan Pascall’s compensation increased 30 per cent last year to US$4.5-million, despite the company shuttering the Panamanian mine that accounted for half its revenue and the share price tumbling 62 per cent.

While there is no research that quantifies the trend, boards rewarding executives after weaker results has stood out for long-term observers. “That’s consistent with our experience,” said Catherine McCall, CEO of the Canadian Coalition for Good Governance, which advises corporate boards on behalf of institutional investors.

The first solution is perhaps the most obvious: boards should grade their CEOs more honestly. Target ranges should not be so broad that an executive earns an A for effort. And the CEO shouldn’t get extra credit if a company does poorly because of external factors, such as weather or war; it may not be in their control, but it’s not like shareholders see value increase on poor results, whatever the reason.

Investors should play a role in demanding more accountability and honesty by voicing concerns during “say on pay” votes. Consulting firm Kingsdale Advisors noted in a review of last year’s proxy season that investors expressed more opposition to high compensation. Average support declined to 90.9 per cent from 92 per cent the year before, which, while still high, was the lowest support in five years.

There is also a larger issue at play. As executive compensation has grown more complex over the years, it has tended to obscure – rather than to illuminate – the link between performance and pay. Management proxy circulars can grow to dozens of pages and include multivariable formulas to explain bonus schemes. “You need an army of consultants to create the plan, then you need an army of consultants to analyze the plan and figure out what you do with it,” said Kevin Thomas, CEO of the Shareholder Association for Research and Education, an investor advocacy group.

Simplicity would be better. For example, the Coalition for Good Governance has suggested many stock option plans could be replaced by a mandate that a CEO use part of their annual cash bonuses to buy common shares. This would still let a CEO accrue equity and align their interests with shareholders – a core tenet of executive compensation – but be easier to both administer and understand.

Because if CEOs are going to share in the upside of a company’s performance, sometimes they need to share in the downside, too.