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WES HALL

Compensation design isn't the problem, it's communication Add to ...

Wes Hall is the founder and chief executive officer of Kingsdale Shareholder Services

In all of the recent discussion about the shortcomings of compensation design in Canada, one fundamental fact has been overlooked: It’s not the model or the metrics that are creating the problem, it’s a disconnect between management and shareholders when it comes to how each values and defines the long term.

As someone who has helped companies win more than 100 say-on-pay votes over the past five years, I’m confident in saying it’s not compensation design that is broken. It’s the communication between directors and shareholders that has gone off the rails.

There are numerous examples of CEOs who are paid handsomely and supported by shareholders even when their stock is down. The question is, what characteristics set them apart?

In short, their shareholders believe these CEOs are doing the right things – the things they have asked them to do. There is a close alignment between the board and shareholders when it comes to understanding the long-term strategy of the company and how performance and value creation is viewed within that. If you can’t quickly complete the sentence “Here is what long-term value creation means,” how can you expect your shareholders to understand the model you’re proposing?

In any stock, there are two types of shareholders whose interests need to be balanced if the goal is to secure a high level of support for CEOs and other corporate directors on say-on-pay votes. There are shareholders who will vote based on the share price today and shareholders who will vote based on the asset. The trick is to ensure the first group understands the long-term initiatives they should be valuing now. In many cases, supporters of a company, especially one in the midst of a turnaround, will give a CEO credit for doing all the right things – but the problem is that the market does not yet value these initiatives immediately in the stock price.

When the economy is running on all cylinders, compensation models are usually seen as functional by shareholders. However, when we have years of sustained decline, as we have in the energy and resource sectors, many companies need to catalyze a turnaround or fundamentally reposition themselves to survive. In these circumstances, CEOs are responsible for making decisions that ignore the current share price and instead strive to set the company up for success in the long term. They need to be encouraged to focus on the things they can control to turn around the stock in the long run, not the things they can’t in the short term.

It’s important to realize that compensation is not set arbitrarily. It’s not even set by outside consultants and compensation committees. It’s set by the market, where an auction takes place for the few special leaders capable of providing the change shareholders demand.

In some ways, the debate around pay for performance has become more complex than it needs to be. At the end of the day, shareholders want a model that rewards tough choices that benefit the long term, rather than sweeping problems under the rug, and that shares their pain when they feel it. In our experience, shareholders generally agree that, while it may take years to see results reflected in the share price, it is fair to pay management for doing the right things today. They just need to agree on what the right things are.

As much as this is about numbers, it’s about storytelling. Rarely is a low or failing say-on-pay vote the result of one issue in a single year. It’s more the product of a few years of concerns and a feeling by shareholders that their opinions have not been valued.

The CEOs who receive supportive say-on-pay votes in challenging times are successful because they aggressively communicate their pay for performance story, realizing that if they don’t, the proxy advisers or media will tell it for them. They put themselves in the shoes of their major shareholders to understand their expectations and how their proposal will be received. “High pay” is relative, so companies should spend time thinking about their peer group, how their pay aligns with performance, and the time horizon to evaluate.

Directors who are reluctant to engage in this sort of outreach and dialogue with their shareholders should be aware that it may soon be forced upon them as their largest shareholders band together to demand that what they consider to be best practices be implemented across their portfolio.

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