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Report On Business Hydro One board increases price tag for Ontario government intervention by raising CEO severance provisions

Mayo Schmidt, President and CEO of Hydro One, is pictured in Toronto on July 20, 2017.

Christopher Katsarov/The Globe and Mail

The board of directors of Hydro One Inc. approved changes to the company’s executive compensation policies last year, making it much costlier for the government to intervene in the utility.

The revisions would increase the amount of severance paid to the chief executive if he is fired after the board is replaced, or after the government passes any legislation aimed at either capping executive pay or that negatively affects Hydro One’s ability to meet its corporate performance objectives. The changes were disclosed in March in the company’s latest shareholder proxy circular, but were given the green light by the board last November.

The board’s move comes after a year in which Premier Kathleen Wynne’s Liberals intervened heavily in the province’s energy market. The government cut hydro bills by 25 per cent in an attempt to defuse anger over high prices; similar reductions were made for small businesses and farms. In rural areas, a number of fees were cancelled and bills were lowered even further. ​The government’s intervention didn’t directly affect Hydro One or its governance. The province’s two opposition parties have put forward proposals to make further changes in the energy market, some of which could impact Hydro One‘s profitability.

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The company said its recent decision was made after it launched a review of its governance policies early last year and that some of the changes addressed Hydro One’s “unique ownership structure” after it was partly privatized in November, 2015. The Ontario government still owns 47 per cent of the company.

Ontario PC Leader Doug Ford vowed last week to replace Hydro One’s board and fire CEO Mayo Schmidt, who earned $6.2-million in compensation last year, if Mr. Ford becomes premier after June’s election. He said the company has been badly mismanaged. Mr. Ford's threat to fire the board and replace Mr. Schmidt would be more costly to the company under the latest severance policy changes.

Asked about the changes to the severance provisions Wednesday, Mr. Ford criticized executive pay practices at Hydro One.

“While people across Ontario are forced to choose between heating and eating, Kathleen Wynne’s insider friends at Hydro One are getting rich on the backs of hard-working folks. It’s unbelievable,” he said in an e-mailed statement.

A spokesman for the Energy Ministry responded to news of the changes in executive compensation policies by saying that the government “recognizes executive salaries are high compared to the vast majority of Ontario salaries and we remain committed to Hydro One’s regulation, accountability and transparency through our government’s involvement as a majority shareholder.

“That said, Hydro One is now a publicly traded company, not a government entity. Decisions made regarding executive compensation are made by the Board of Hydro One,” Colin Nekolaichuk said.

The Hydro One revisions expanded the definition of what would constitute a “change of control” of the company to include a change in a majority of directors over a two-year period, as well as a move by the Ontario government to replace the entire board, except for the CEO, which is permitted under the terms of its governance agreement.

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The new definition is significant because Hydro One has different severance terms when executives are fired after a change of control, compared with being fired without cause under other circumstances.

Mr. Schmidt, for example, would be eligible to receive $10.7-million if he were terminated after a change of control of the company, based on his compensation levels as of Dec. 31, 2017, according to the latest company disclosures.

He would receive just $5.04-million − less than half as much − if he were terminated under other circumstances without a change of control, however.

The main difference in the payouts is how executives’ share units are treated under the two scenarios.

If a Hydro One executive is fired without cause, his or her share units will expire without being paid out. But if an executive is fired within two years of a majority of the board being replaced, the share units vest and become payable, and any performance goals attached to the share units are deemed to have been met at 100 per cent of the targets.

The board also added new provisions to the severance rules in November, saying a change of control would be triggered if any provincial legislation is passed that imposes limits on the amount of compensation that can be paid to Hydro One executives, or if any new legislation adversely affects the ability of Hydro One to meet its corporate performance objectives tied to compensation awards.

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Hydro One board chair David Denison said in an e-mailed statement that the board did a review of its compensation practices in early 2017 and concluded that its change-of-control provisions at that time “were not directly applicable to Hydro One’s circumstances.”

“The revision to the change-in-control terms that we identified was adopted to address Hydro One’s unique ownership structure and the provisions of the governance agreement with the province of Ontario,” Mr. Denison said.

York University associate professor Richard Leblanc, a specialist in corporate-governance issues, said there was a public-policy reason that the Ontario government negotiated a governance agreement when Hydro One became a publicly traded company in 2015. The deal gave it the right to replace the Hydro One board if there was poor management or scandal at a company that is still almost half publicly owned.

Prof. Leblanc said the recent severance policy changes undermine the impact of the governance agreement if replacing the board would now be deemed a change of control that triggers prohibitively expensive severance payments for the CEO.

“It’s almost like a poison pill, which makes it so prohibitive that you essentially insulate an excessively paid CEO − or that’s the effect it could have,” Prof. Leblanc said.

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