One of Canada's biggest pension funds is urging companies not to reprice stock options or change other types of equity-based compensation to make up for the drubbing their share prices may have taken in the global meltdown of financial markets.
Instead, executives should share the pain with their shareholders, who do not have access to such techniques, the Ontario Teachers' Pension Plan said Thursday, as, in advance of annual meeting season, corporate Canada gears up to begin disclosing how much top company officials were paid for their labours in 2008.
"This is a sort of pre-emptive move on our part," Wayne Kozun, Teachers' senior vice-president of public equities, said in a telephone interview, noting that while some companies have earlier fiscal year ends - banks and broadcasters, for example - Dec. 31 was the date for most.
"It's to say to boards of directors that, certainly, a lot of executives have done very well in the past few years, and as long as shareholders did well, we don't have a problem with that.
"But shareholders have suffered in the last year, so you shouldn't necessarily make management whole just because there was a bad year."
Teachers also has established itself as a leading advocate of shareholder rights over the past decade and more and is a founding member of the Canadian Coalition for Good Governance.
Its exhortation to boards of directors comes at a time when high executive pay has become a major target of politicians and shareholder advocates in the United States, Canada and elsewhere.
This is especially, but by no means exclusively, true of the multimillion-dollar stipends dished out to investment bankers and U.S. auto executives, even as their firms hit the skids and, in some cases collapsed, as financial markets melted down last fall.
Because it is still early in the year, the pension fund has not yet seen any cases where companies have sweetened the pill for their executives - or are proposing to - because of the equity market crash, Mr. Kozun said.
Teachers' representatives have talked about the issue to board members of some of the companies in which it is a shareholder, and has been encouraged by what it has heard so far. "Hopefully, they will take into account the feelings of shareholders such as us," he said.
Mr. Kozun added, however, that it is impossible for the pension fund to issue a blanket statement that it will necessarily vote its shares against any company proposals to sweeten the term of its equity compensation because of the market plunge. "There can be very extenuating circumstances," he said.
Toronto-based compensation consultant Ken Hugessen, meanwhile, is recommending that boards of directors should take plenty of time to evaluate how stock-based pay plans and the stocks themselves have performed.
"I think everybody feels we're still in a period of substantial economic and financial uncertainty," he said in a telephone interview.
"These programs were for the most part designed to run for a number of years, and to sort of run out and start 'fixing' them because you had one rough quarter - and at this stage, that's what it is - in our view would be a bit premature."
However, Mr. Hugessen also said that he expects "many" companies will think about how to "revamp or redo some of their equity programs" if it turns out that what has happened is "a substantial, permanent repricing of the marketplace."
He added that this is his "expectation" rather than necessarily an "endorsement."
Teachers' view is that executive compensation should be based on sustainable, long-term returns, not short-term market movements.
"We believe it is important to protect shareholder value by clearly stating we are opposed to repricings, including accelerated grants, option exchange programs or resetting of performance targets," Mr. Kozun said.
Preserving the terms of previously granted options rather than lowering the price at which they can be cashed in because a company's share price has fallen means the rules are the same for shareholders and option holders, he argued. This ensures both investors and executives are aligned to benefit proportionally when markets rebound.
Mr. Hugessen said it is "hard not to be sympathetic" to arguments against simply repricing options lower on a one-for-one basis, given that it represents a "massive, instantaneous transfer of value from shareholders to the recipients."
"I think that sort of one-for-one repricing will be relatively rare," he said.
However, he also suggested that there is a legitimate case to be made for "exchanging" options, that is, replacing existing options with a smaller number of new ones at a lower price.
Indeed, he predicted that 2009 will be "the year of the options exchange."
Mr. Hugessen provided an illustration of a company that has issued 100,000 options priced at $25 each but whose stock price has fallen to $7.
"Those 100,000 options still actually have some modest economic value, so what we'll do is give you 20,000 or 10,000 [replacement]options or what we can best estimate as an equivalent value of what you're forgoing," he said.
"Many people will say the argument still isn't good enough," he added, "but it isn't as bad [as a straight repricing]"
Teachers bills itself as the largest single-profession pension fund in Canada and invests and manages the pensions of about 278,000 active and retired teachers in the province.
Its portfolio of private and public market investments was worth more than $108-billion at the end of 2007. It has not yet published a figure for 2008, although the value is almost bound to be down by 10 per cent or 20 per cent or more.
Mr. Kozun said the pension plan is applying the same logic about compensation to its own top executives. It paid them less for 2007 than for 2006, he said, and after the market rout in 2008, "that will continue."