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Some major shareholders are growing frustrated with the way companies are doling out share units as a major part of CEO pay, voting against pay packages at several large companies this year over concerns about equity grants that are oversized or poorly linked to performance.
While large investors have demanded that companies make more use of share units to ensure pay for chief executive officers is tied to performance, voting trends suggest they are also more willing to push back when share grants give CEOs big raises without a link to strong performance.
The Ontario Teachers' Pension Plan, for example, voted against pay practices at Valeant Pharmaceuticals International Inc. this spring over concerns about the $63-million (U.S.) pay package awarded to new CEO Joseph Papa, which included a $42-million grant of share units and $10-million in stock options. He also received a $9.1-million bonus for 2016 performance.
Mr. Papa was hired in 2016 to replace CEO Michael Pearson, who was awarded $140-million in new share units in 2015, which ended up expiring worthlessly after he was replaced last May during an investigation into Valeant's drug pricing policies.
"We have significant concerns over compensation arrangements at the company," Teachers said in a statement about its Valeant vote decision.
"While we continue to acknowledge the challenges that the company faces, we believe a number of the decisions taken by the compensation committee, particularly in relation to [equity] granting practices and continued one-time awards, raise questions over the alignment with long-term shareholder interests."
Teachers was not alone. The company received 68-per-cent support for its pay practices at its annual meeting in May, with the Canada Pension Plan Investment Board among other big investors who voted against the plan.
Valeant spokeswoman Lainie Keller said the company has designed a new equity pay program that launched in 2017 after consulting with 23 shareholders about their concerns. Mr. Papa received no share-unit grant in 2017 under the new program.
His 2016 compensation reflected "appropriate and customary terms" for recruiting a sitting CEO at another major company, Ms. Keller said, and a large part of his 2016 bonus was required to replace compensation he lost when he left Perrigo Co. PLC. He was also required to purchase $5-million of Valeant shares when he was hired.
"Valeant's board is fully supportive of Mr. Papa as the company executes its turnaround plan in 2017-2018," Ms. Keller said.
Shareholder concerns are mounting as share units have exploded in popularity, becoming the largest single component of compensation for many CEOs. Investors have touted share units because they are similar to common shares, tracking a company's share price both up and down for several years. They normally pay out in cash, typically over a three-year period.
But their wide acceptance has allowed companies to increase pay by piling various types of restricted share units and performance share units on top of stock options. The result is that equity grants have become a major reason why CEO pay is climbing in Canada, according to new data compiled by Global Governance Advisors.
In 2016, median total pay for CEOs rose 10.8 per cent to $6.3-million (Canadian), driven by a 25.6-per-cent median increase in grants of share units to CEOs, according to data for Canada's 100 largest companies by market value as of Dec. 31, 2016.
The median grant-date value of share units hit $2.1-million last year – well exceeding the $918,000 median value of stock-option grants. Stock-option grants also rose 13 per cent last year.
Global Governance Advisors senior partner Paul Gryglewicz said a modest increase in the number of companies granting options in 2016 accounted for some of the rise in the median option-grant rate.
He said there is still a clear trend of companies favouring grants of performance share units as their key equity pay feature because of shareholder demands for a shift away from stock options.
Some shareholders, however, are drawing a line.
Michelle de Cordova, director of corporate engagement and public policy at ethical mutual-fund manager NEI Investments, said her fund is voting against excessive pay packages, even if a company has posted strong performance.
Ms. de Cordova said NEI wants to see compensation grants that are aligned with performance, but doesn't accept that strong performance justifies extraordinary levels of share grants – or any other compensation element.
"If we're seeing equity-based pay that is increasing the level of pay, then clearly that's a problem for us if it's pulling the experience of the executives further and further away from that of folks in the rest of the economy," she said. "Anything that tends to increase the sticker shock of executives' total compensation is a concern."
Some equity grants are known as performance share units (PSUs) because they have performance conditions that must be met before they pay out, such as achieving a certain level of profitability or return on capital, as well as requiring the share price to rise. They are favoured by many investors because there is not a payout for below-average performance, especially if the performance measures are relative compared to peers.
Ms. de Cordova said she disagrees with the automatic assumption that PSUs are by definition performance pay. Some programs have easily achieved targets that practically guaranteed pay.
"If the targets aren't very taxing, you can have pay that is theoretically performance-based because there are targets there, but it's a concern if those targets are very easily achievable," she said.
Eldorado Gold Corp. lost its say-on-pay vote this spring – receiving just 43-per-cent shareholder support for its pay practices – after facing criticisms that total compensation of $7.8-million for then-CEO Paul Wright was larger than his peers.
Even though Mr. Wright's cash salary was cut more than 30 per cent last year and he opted to cut his equity awards by 25 per cent, investors raised red flags about the pay total and about the formula used to calculate the payout for his remaining share units.
Institutional Shareholder Services Inc., which advises major shareholders on how to vote at companies' annual meetings, said performance share units granted to Mr. Wright – who retired in April – could pay out at a comparatively high-maximum level equal to 6.5 times his $902,800 base salary in 2016.
ISS said the high 6.5-times multiplier has "the effect of paying out overly large awards even in years of mediocre company performance."
Eldorado has recorded several years of underperformance, with revenue falling in 2016 as the company posted a loss of $347-million (U.S.). A spokeswoman said no one was available to comment on the CEO compensation program.
Companies in the mining sector were responsible for much of the increase in equity pay last year as share prices rebounded amid an increase in commodity prices. Mining firms within the top-100 companies in Canada posted an average total shareholder return of 102 per cent in 2016.
Pay levels climbed in tandem, with median total compensation rising 32 per cent for the same group of mining companies, according to Global Governance Advisors. The median share award rose 17 per cent last year while stock-option awards soared by 187 per cent to a median grant-date value of $1,005,446 (Canadian) from $349,941 in 2015.
Large equity grants can be a particular concern in cyclical industries such as mining and energy, however, because shares granted at a low point can lead to huge payouts if the share price rebounds quickly.
Encana Corp., for example, granted CEO Doug Suttles $2-million (U.S.) in restricted share units in March, 2016, that were already worth $5.8-million by Dec. 31 after a surge in the company's share price. His $4-million grant of performance share units was valued at $11.6-million by Dec. 31.
ISS said share grants may lead to a "windfall" for Mr. Suttles, "yet long-term shareholder returns are negative and lagging peers."
Encana's shares fell each year from 2013 to 2015, hitting a low of $4.15 (Canadian) by February, 2016. But they bounced back sharply in 2016 to $15.76 by Dec. 31 for a one-year gain of 124 per cent, although longer-term shareholders were still not back in the black.
ISS recommended voting against Encana's pay practices this year, saying Mr. Suttles's equity grant alone was "well in excess" of the total median pay for his peers.
His total pay climbed 57 per cent in 2016 to $13.3-million (U.S.), largely due to his $6.1-million share grant and $3.4-million in new stock options.
The proxy advisory firm said Encana provided no rationale for the increase in the value of the share grant, and said new performance metrics for Mr. Suttles's PSUs "are opaque in their description and without disclosed target goals."
Encana received 62-per-cent support this year on its say-on-pay vote, including a "no" vote from Dutch investment giant PGGM. The pension fund said Mr. Suttles's pay rose more than 50 per cent even though the share price fell in the three prior years, and said the payout formula for his equity grant was a particular concern.
"Disclosure of long-term goals is lacking and the TSR [total shareholder return] metric uses a non-rigorous goal," PGGM said in a written explanation for its vote decision.
Encana, however, said its CEO pay is correlated to total shareholder return, which climbed 131 per cent last year, placing Encana in the top-10 per cent of more than 25 North American peers.
"The company completed its strategic transformation two years ahead of schedule and is on track with its five-year plan to deliver on one of the industry's best value-creation plans," spokesman Jay Averill said.
"A clear majority of our shareholders have expressed support for our pay-for-performance philosophy."
Compensation consultant Ken Hugessen, who helps companies develop pay plans for executives, said many firms have stopped the practice of giving out the same dollar value of equity grants to the CEO each year and counting on future performance to determine their ultimate worth. Instead, many companies now give more share units in better years and fewer in bad years to ensure that the reported annual compensation total for the year looks more aligned with immediate performance.
But over all, Mr. Hugessen doesn't believe total compensation is rising at the top tier of Canada's largest companies.
He said compensation was down 2 per cent last year, based on data for 56 companies in the TSX 60 index. And he argues most of those companies have taken a conservative approach for the past five years.
"Among the TSX 60, total compensation is pretty much a flat line," he said.