The language of finance is endlessly creative. First it gave us "golden handcuffs," and then "golden parachutes," and now we have the most evocative term yet: "Golden leashes."
If you follow this stuff, you might be familiar with the golden leash from such proxy contests as Jana Partners' messy attempt to oust Agrium Corp.'s board last year. The golden leash is a deferred payment from activist hedge funds to directors that they nominate during a proxy fight. While funds often give nominees cash compensation to run during a proxy contest, on some recent occasions, nominees have been offered additional rewards if they win, and if the company meets certain stock-price based benchmarks over a multi-year period.
These arrangements are controversial. In his harmoniously named paper "Special compensation arrangements for dissent directors in proxy contests: A policy analysis," University of Toronto professor Edward Iacobucci offers a pretty thorough and even-handed assessment of the debate surrounding golden leashes.
As I discussed last week, one of the core debates in corporate law is over the principle of shareholder value maximization. Those who are supportive of activist investors, and skeptical of boards of directors, tend to view a corporation's share price as a mostly accurate bellwether of a corporation's success. Their opponents tend to view corporate value in a more holistic way, and suggest that a corporation's short term share price may not reflect a corporation's long term health.
If you're following along, you can probably preempt Prof. Iacobucci and predict where the two sides stand on golden leashes. The pro-activism crowd views these earn-out payments as an incentive for boards to improve share prices, which are an efficient measure of the company's overall value. They also argue that the payments help to attract nominees who are willing to "walk the talk" by linking some portion of their compensation payment to company performance. Their opponents see golden leashes as encouraging boards to focus on high risk, share-value-maximizing activities, like increasing leverage, as well as making boards beholden to their hedge fund masters' business plan.
The response to this from the pro-activist crowd is, of course, that the boards are responsive to share price, not hedge funds, because that is what compensation is already linked to. The anti-activists respond that these strategies don't improve overall corporate health, just short-term share price.
If all of this sounds to you like a snake eating its own tail, I sympathize.
For all the sound and fury, however, the policy choices that regulators face when dealing with golden leashes are fairly straightforward – either ban them, or don't. Boards and shareholders are faced with a similarly binary choice, to either enact corporate bylaws banning directors from entering into such arrangements, or alternatively, to just evaluate nominees who have entered into such arrangements during a proxy fight.
Prof. Iacobucci comes down on the side of the market, arguing that regulators shouldn't regulate golden leashes and that shareholders should evaluate such proposals as they come, in the context of proxy fights, rather than enacting bylaws to block such arrangements altogether.
Of course, Prof. Iacobucci recognizes that there's a small contradiction in promoting a case-by-case assessment of such packages while objecting to a bylaw-based approach. Corporate bylaws are subject to market pressures as much as anything else. If we trust that shareholders can assess the value of bylaws, and that markets can adequately incorporate information about a company's bylaws into the market price, then if anti-golden leash bylaws start appearing, we have reason to assume that such by-laws are good for companies.
This is the same problem that the pro-activism crowd runs into in the debate surrounding shareholder rights plans, or "poison pills." While advocating that corporations should have minimal takeover defenses, under the premise that most takeovers are value maximizing, they offer little in the way of an explanation for why shareholders continue to approve pills outside of the takeover context, albeit pills that contain limits on directorial authority. In some cases, it looks like the pro-activists are picking and choosing some markets over others.
So, while Prof. Iacobucci advocates for a market-based approach, he is not Dr. Pangloss. Prof. Iacobucci recognizes that markets can't function without information, and that it's unclear whether Canadian disclosure rules require that this kind of compensation be disclosed to a sufficient degree for shareholders to make an informed decision, or even be disclosed at all. Current regulations only require prospective directors to disclose share ownership, and only require companies to disclose compensation from the company itself or its subsidiaries, not third parties. A somewhat ambiguous catch-all requires that directors disclose if they were elected under "any arrangements or understanding…[with] any other person," which may catch golden leash arrangements, but also may not.
For example, the catch-all does not seem to compel disclosure in the case of Celestica director Gerald Schwartz, who is also president and CEO of Celestica's controlling shareholder Onex, even though his compensation at Onex is presumably related to Celestica's performance and his position at Celestica is related to his job as Onex CEO.
This ambiguous state of affairs isn't a surprise. Innovation always tends to outpace regulation. So, whether you're pro-activism or anti-activism, the first step in dealing with golden leashes is simple; Canadian securities regulators should beef up securities laws to require that all such compensation arrangements be fully disclosed. In other words, make companies disclose, and let shareholders decide.
Adrian Myers