Executive compensation.
With corporate executives facing unprecedented scrutiny of their pay packages, Canadian companies are drafting an array of complex new compensation plans for CEOs aimed at addressing shareholder demands for reform.
A Report on Business review of compensation practices at Canada's 100 largest companies reveals that many companies are adopting new formulas and payment methods to try to ensure compensation is better aligned to corporate performance.
But even as these efforts emerge, the review found little evidence that chief executive officers' pay was closely linked to performance last year, despite devastating economic and market conditions.
The survey found that total pay of CEOs at Canada's 100 largest companies fell 5 per cent on average in 2008, with base salaries up 10 per cent but cash bonuses falling 20 per cent.
An average CEO took home $5.1-million last year (compared with $5.4-million in 2007), including a salary of $863,000, a cash bonus of $1.2-million, share units and stock options of $2.4-million, as well as other benefits and pension contributions worth about $600,000.
Compensation experts note many of last year's gains came from compensation elements set up or paid out before the market downturn, and forecast a greater impact in 2009.
But the results still call into question whether significant compensation reform is under way in Canada.
While other aspects of corporate governance - such as board independence - have shown clear improvement over the past decade, moves on pay reform have not kept pace, said Wayne Kozun, senior vice-president of public equities at the Ontario Teachers' Pension Plan.
"I don't know that I can point to situations where compensation is necessarily getting much better aligned [with performance]" Mr. Kozun said. "There are isolated cases that have improved, but some have gone the other way, as well."
While the impact is not yet clear, there is ample evidence that many companies are at least attempting to change.
Many recent amendments involve adding new types of performance conditions to stock options or share units - including innovative moves to discourage excessive risk taking by CEOs.
At Manulife Financial Corp., for example, a recent amendment will tie the value of executives' share units to the company's required regulatory capital levels, a move aimed at ensuring excess capital is maintained at certain thresholds. The revision came after a year in which the insurer had to raise funds numerous times to bolster its capital ratios.
Other companies have introduced changes to curb pensions, impose tougher severance terms, or encourage more long-term share ownership by CEOs.
"We're watching people try all kind of things I never would have seen them try before," said Christopher Chen, a compensation consultant at Hay Group in Toronto who designs CEO pay packages for major companies. "It is more complicated now - people are trying all kinds of things, all kinds of performance things, and stress testing."
The influential Canadian Coalition for Good Governance, which represents Canada's largest institutional shareholders, is staging an all-out campaign to improve the compensation track record. CCGG executive director Stephen Griggs said the coalition is sending major companies a new report outlining its preferred features for compensation plans, and is meeting almost weekly with different major companies to review their pay practices. He plans to do 30 more meetings over the next year.
"It really all revolves around the obvious statement that if you say you have a large part of executive compensation being pay for performance, it really does have to be pay for performance - and not disguised additional salary, or performance that has really nothing to do with achieving corporate goals," Mr. Griggs said.
David Beatty, a member of the compensation committees at Bank of Montreal and Inmet Mining Corp., said directors now want compensation to be specifically tailored to the features of each industry and company to ensure it provides incentives to meet the most important performance goals of the firm. This has spurred far greater diversity of program designs, he said.
"Everything is designer - it's a designer industry, like Louis Vuitton for comp," Mr. Beatty said.
It also means the environment is also far more difficult for directors, who are facing public pressure to reform.
Earlier this year, the Ontario Teachers' Pension Plan revealed it voted against all of the directors on BMO's compensation committee, including Mr. Beatty. Teachers argued the bank has been the worst performer among its peers under CEO Bill Downe, yet the board planned to use its discretion to boost his pay last year. Even though Mr. Downe did not accept the increase, Teachers said its awarding sent the wrong message about pay for performance.
The voting decision was a public blow for Mr. Beatty, who is the former managing director of the CCGG and serves as director of the Clarkson Centre for Business Ethics and Board Effectiveness at the University of Toronto. He said investors' unwillingness to grant boards any leeway in setting pay makes the boardroom environment far more difficult. "I absolutely do feel that I am being very closely monitored and I am responsible to an external third party, as opposed to just my own conscience and my colleagues," Mr. Beatty said. "It is very stressful, definitely."
To avoid backlash, many companies are targeting commonly criticized elements of compensation, such as pensions and severance payments, for reform. BCE Inc., for example, revealed that its new CEO, George Cope, will not receive a traditional defined-benefit pension after former CEO Michael Sabia earned a huge pension entitlement during his six years at the helm of the phone company. Toronto-Dominion Bank revealed this year that CEO Ed Clark has agreed to give up all right to severance payments - worth $10.1-million under his old contract - as part of a new employment agreement.
Mr. Chen of Hay Group said he has recently seen companies base CEO bonuses on improvement in cash flows, rather than on more traditional profit measures. He calls the change an emergency measure for firms "hanging on by their fingernails."
Ken Hugessen, whose independent Toronto firm advises many of Canada's largest companies about pay design, said he knows of companies that are planning to introduce rules requiring CEOs to hold until they leave the company 50 per cent of the shares they reap from exercising stock options - a U.S. trend to encourage greater CEO share ownership that is now moving to Canada.
Another common change involves adding greater performance conditions to stock options and share units so they will pay out only if various targets are met. One of the most popular moves is to link payouts to total shareholder returns compared with a peer group of other companies, an amendment many in the compensation world warn can be extremely complicated to structure.
Mr. Hugessen said many of the common new compensation ideas are destined to boost complexity. And while he supports the trend, he notes the amendments clash with another common shareholder demand for simpler plans they can more easily understand.
At least 12 large companies have agreed this year to begin giving shareholders a non-binding advisory vote on executive compensation at their annual meetings next year, and directors fear investors may not be able to easily understand - much less critically evaluate - increasingly complex pay models.
"I hear these calls for more alignment, more performance sensitivity and then I hear, 'Make it more simple,'" Mr. Hugessen said. "And I say, 'Which one do you want?'"
Janet McFarland