It has been a remarkable run for Shopify Inc. and its founder and CEO, Tobias Lütke.
Even after a large pullback that began in August, the share price of the Ottawa-based maker of e-commerce software has climbed more than 17-fold since it went public in 2015. At the peak that month, investors valued Shopify at more than $60 billion. Lütke is now a multibillionaire.
As the value of his Shopify stake crossed the $2-billion mark in February of this year, the company’s board finalized the CEO’s annual pay package. As part of his compensation, Lütke received stock options worth more than $14 million, The Globe and Mail estimates. It was the third year in a row Shopify gave Lütke stock awards, beyond his already-valuable holdings, to make sure he was “properly incentivized," company documents show. (The company did not respond to requests for comment for this story.)
Over the past two decades, many companies have jacked up their use of stock awards in CEO pay packages to try to align their executives’ interests with those of shareholders. If everyday investors get wealthier from our rising stock, the thinking goes, so should the folks who run our company.
In practice, however, the use of stock options and other share awards has led to an explosion in executive pay—so much so that many CEOs are paid hundreds of times what an average worker makes. Another criticism of stock-based pay is that it has made multimillionaires of many professional managers who had little to do with starting or building a company.
Shopify’s approach to Lütke—widely lauded for his vision in creating a Canadian global tech champion—shows that the desire of companies to pay CEOs robustly isn’t limited to the hired help. CEOs lauded as entrepreneurs, founders, job creators—however you label them—often avoid the opprobrium directed at other leaders. Investors forgive them their riches. Yet every dollar a company’s share price increases can also put millions more in the CEO’s pocket.
“It’s hard to see that if you have $2 billion, that another $10 million makes any difference," says Steven Clifford, a former CEO and director who turned against his peers when he published The CEO Pay Machine in 2017." Owning $2 billion of stock should be sufficient motivation, and it seems ridiculous to say another $10 million will make you more motivated."
Lütke's pay, combined with his accumulated wealth, stands out in our annual ranking of CEO compensation at Canada's 100 largest public companies. But other founder-CEOs collected millions more in shares in 2018.
On average, the CEOs received 62% of their 2018 pay in grants of stock or stock options, according to an analysis by Global Governance Advisors. That adds fuel to the debate about the annual “equity incentive" that makes up so much of today’s executive pay. Does it truly reward performance or just provide fat gains disconnected from what ordinary shareholders experience?
The median total pay of the CEOs was almost $6.8 million, with the median increase from 2017 coming in at just under 7%. Total compensation includes salary, bonus, stock option and other share awards, additional disclosed pay and the annual increase in pension value. The median cash compensation—just salary and bonus—was slightly over $2.8 million, with the median pay boost just 3%.
The median figure is important because a few large values can skew averages—and that's what happened in 2018. BlackBerry Ltd. gave CEO John Chen a pay package valued at $143.3 million, of which $139 million was a massive stock award designed to pay him for the next five years of his service. BlackBerry says it does not intend to give Chen any more stock awards from 2019 to 2022.
“I’ve been working on corporate governance since 2003, and over that time compensation has always been one of the top one or two issues for shareholders, and it never goes away," says Jason Milne, a principal at the Toronto-based consulting firm ESG Global Advisors Inc. “And I think for good reason, because we’ve seen pay continue to go up, and a lot of that has been driven by the stock awards."
But the form of stock-based compensation has evolved. Over the past five to eight years, Milne says, companies have moved away from using stock options as the largest component of pay packages.
Years ago, when executives were still paid largely through salaries and cash bonuses, options were seen as a way to align their interests with shareholders and give CEOs “skin in the game." An option gives the holder the right to buy a share of stock at a set price, for a set period of time. Many executive stock options had terms ranging from five to 10 years.
After the tech bubble of the 1990s, however, criticism of stock options increased. Executives whose companies' stock soared along with the broader tech market exercised their options, then quickly sold the shares and made millions. Investors in their companies would have done as well in an index fund. But after the bubble burst and stock prices plunged, executives who had cashed in before the collapse still had their millions.
Increasingly, Milne says, companies are relying on stock awards tied to outperformance—primarily by awarding shares that “vest,” or become fully sellable by executives, only when the company meets or exceeds targets. That could be measured by its shares outperforming its peers or by other metrics, like earnings growth.
“In general, having a stock [award] rather than an option does tend to align the interests of that individual with the other shareholders,” Milne says. “But what continues to worry a lot of shareholders is that very large proportion of stock that we continue to see issued.”
The challenge is to reward CEOs who build lasting value, rather than those who engineer a quick bonanza. “A company should never give stock options, because you’re not aligned,” says Steven Clifford, the former CEO. “If you have a stock option, you have a one-way bet, whereas the shareholder always has a two-way bet. So, the CEO would be incented to take much more risk than the shareholder might want.”
“It is not just the holding of the stock, it's how you get the stock,” Clifford adds. “If you get the stock bonus based on completing a merger, well, you get the merger completed, but you may overpay.”
The trick of crafting a package that properly pays a CEO gets more complex when the top executive is also a founder with large share ownership, says Ken Hugessen, a veteran Canadian compensation consultant. Companies may not want to give a founder-CEO a large block of new stock. But if they don’t, they end up paying their CEO a fraction of what a professional manager would get. Or, they could make the pay cash-only, which removes any performance incentive.
“It's difficult to say to someone, 'Well, we think you ought to accept pay that's half or one-third of what others do, no matter what the reason is,” Hugessen says.
Several Canadian companies have taken that approach, however. Mark Leonard founded Constellation Software, a relentless acquirer of small tech companies, in 1995. His 2.1% stake is worth just under $580 million, as of Sept. 30. He previously transferred one million shares, now worth about $1.3 billion, to his children.
In 2015, Leonard announced he would no longer take a salary or cash bonus. The company has reported no compensation at all for him in the past three years.
In his 2015 letter to shareholders, Leonard said he did that partly because he wanted to cut back on the “weekends, all-nighters and a constant grind of 60-hour-plus weeks that characterized my earlier career.” But he added, “One of the results of this compensation change is that I get to side-step the agent-principal problem. My compensation for being president is now tied solely to my current ownership of CSI shares. In essence, I'm your partner in CSI, not your employee. I like the feel of the partner relationship a whole lot better.” (When asked about the company's compensation system, Constellation pointed to that letter.)
“We have found that, generally speaking, founders have more rational pay plans because they’re already so invested in the stock. They don’t really need any more stock awards and generally have lower cash [compensation] as well, because they’re already making money from their original investment,” says Nell Minow, vice-chair of ValueEdge Advisors, a corporate-governance consultancy.
Prem Watsa founded Fairfax Financial Holdings Inc. in 1985. He has taken $600,000 a year in salary since 2000, with no cash bonus or executive pension, and he has never received stock awards as part of his pay, the company says. His stake in Fairfax is worth about $1.1 billion as of Sept. 30.
“Mr. Watsa’s compensation arrangements reflect his belief that as a controlling shareholder involved in the management of the company, his compensation should be closely linked to all shareholders,” the company said in its annual proxy statement. “This close link is achieved by his ‘compensation,’ beyond a fixed salary, coming only from his share ownership.”
Other CEOs with major shareholdings who received no equity awards in 2018 include Gerald Schwartz of Onex Corp., whose stake in the company is worth just over $1 billion as of Sept. 30. However, Onex granted him 3.95 million stock options in January 2014, then valued at nearly US$60 million.
Schwartz had exercised all of a 2004 option grant in 2013, leaving him with no more options. Onex said in 2014 that its board believed "stock options are an integral part of executive compensation and are fundamental to the alignment of interests and the incentivization of future performance.”
Onex said it would grant no more options for the next five years, and the options it gave Schwartz required the stock rise at least 25% before they could be used. Emilie Blouin, Onex's director of investor relations, declined to comment for this article.
It's important to note that Watsa and Schwartz have super-voting shares that allow them control of their companies greater than their economic stakes. That's quite common in Canada, where many large public companies have family or founder ownership, and special voting rights designed to perpetuate it.
“I think the biggest challenge to deal with founders and the board is to have the board truly demonstrate that they are independent and that they’re not being controlled by a founder’s request, and making sure that a lot of these awards that are granted are still at risk and have forfeiture components,” says Paul Gryglewicz of Global Governance Advisors.
Many other companies also have CEOs with large shareholdings and face the same challenge. At Brookfield Asset Management, CEO Bruce Flatt’s stake is worth $2.8 billion as of Sept. 30. He is one of 38 Brookfield partners who have the right to nominate half the company’s board of directors. The company gave him a stock award valued at $5.4 million in 2018.
Company spokeswoman Claire Holland says Flatt’s pay and the size of his stake owes to nearly 30 years of ownership and an 18% annualized return over that time. “Virtually all of Mr. Flatt’s compensation is paid in long-term share awards, which are only of value if the corporation performs on behalf of all shareholders,” she says.
That’s the art of the deal in Canadian executive compensation: providing value to shareholders and to executives—sometimes in balance, sometimes not.