Pay up, shareholders
2015 was a rough year for many of Canada's resource companies, but that didn't stop some boards from raising the amount they pay their CEOs, even as thousands were losing their jobs. Those who defend the practice say the larger paycheques are necessary to keep top executives in the fold in difficult times – while others believe it's more important that corporate leaders share the pain being felt by their investors and employees.
By almost any measure, 2015 was a bad year for Encana Corp.
The Calgary-based energy producer was hit hard by falling oil prices and lost $5.2-billion (U.S.) as revenue tumbled. The company's share price dropped 57 per cent and Encana slashed its dividend.
Many employees also lost their jobs amid widespread cost cutting. The company announced plans to eliminate 20 per cent of its work force in 2015 – about 600 jobs – followed by a further 20 per cent in 2016. Chief executive officer Doug Suttles said earlier this year that job reductions across the energy sector "have been as severe as I've ever seen in 33 years."
But the hard times did not have a dramatic impact on one financial measure at Encana: executive pay. Mr. Suttles earned total compensation of $8.8-million in 2015, a 14-per-cent increase from $7.7-million in 2014, including a 4-per-cent increase in his base salary "to align with competitive market data from the compensation peer group," the company said, as well as $6.3-million worth of new share units and stock options.
Encana was not an isolated example. Other companies in Canada's battered resources sector also maintained or raised total CEO pay levels last year compared to 2014, saying their executives made necessary decisions in bad times to strengthen the firm, or arguing their companies did comparatively well when measured against the performance of their peer group.
Those controversial decisions have exposed a stark philosophical divide in the corporate community about executive compensation during industry downturns. Even as many boards boosted pay last year, others slashed compensation and talked about the need for leaders to share the pain faced by employees and shareholders during a time of crisis. Some shareholders are now questioning boards' decisions to raise pay despite weak financial results and hundreds of layoffs, increasingly voting "no" in say-on-pay votes where they see a disconnect with performance.
The divergent approaches have been a particular focus in Alberta's energy sector, where so many are losing their jobs. Companies filed 116 group layoff notices in 2015 – a provincial requirement when companies cut 50 or more jobs within four weeks – announcing plans to cut 17,579 workers, a 134-per-cent increase from 7,508 layoffs in 2014.
Calgary-based corporate director John Brussa, who sits on eight energy company boards and is chair of Crew Energy Inc., argues that in such an environment, "it's wrong and it's also very short-sighted" for boards to allow leaders to cash in as others see their jobs eliminated.
Mr. Brussa said it is not only bad for morale, but also encourages a strategy of relying on large-scale layoffs to control costs, which amounts to "flushing a lot of intellectual capital down the toilet."
"The one thing about a crisis is that you see the absolute best and the absolute worst in people," he said. "When the rubber hits the road, I can tell you the people who say, 'Hey, it's all for one and one for all,' and I can tell you the people who say, 'It's every man for himself.'"
Layoffs and high pay
The internal yardstick
Companies explain their pay decisions based on the performance measures they build into their CEO compensation plans, which do not always correspond to measures such as bottom-line profit or share price changes.
Many companies, for example, determine CEO bonuses based on financial factors important to the company's business, such as return on invested capital or various earnings measures adjusted to remove non-operating expenses. They also typically factor in some non-financial performance measures such as employee safety records and customer satisfaction levels.
Enbridge Inc. CEO Al Monaco, for example, saw his annual bonus climb 42 per cent to $1.75-million (Canadian) in 2015 and his total pay package grow by 50 per cent to $8.9-million because the company posted "strong financial results," according to spokesman Graham White.
The pipeline operator's share price fell 23 per cent in 2015 and it posted a loss of $37-million while cutting 600 jobs. But Mr. White said Enbridge's internally adjusted earnings per share were up 16 per cent, cash flow from operations rose 23 per cent and Enbridge completed 14 major projects worth $8-billion.
Encana did not reply to requests for comment about Mr. Suttles' pay, but said in its annual shareholder proxy circular that many of its important operational and financial objectives were met in 2015, including expense reductions and a strong employee safety record.
The board also said it used its discretion to lower Mr. Suttles' annual cash bonus from the payout level he would have received based on his performance scorecard measures, ultimately paying him a $1.37-million (U.S.) cash bonus for 2015, down 25 per cent from $1.84-million in 2014.
Oil sands giant Suncor Inc. said CEO Steve Williams earned $12.2-million (Canadian) in 2015 – a year when Suncor had a loss of $2-billion and the company cut more than 1,700 jobs – because Suncor said it had its best operating performance in its history, generated significant cash flow and reduced operating costs. Suncor said its share price also led its peer group with a relatively modest drop of 3.2 per cent in 2015.
As a result, the board awarded Mr. Williams an annual cash bonus of $2.8-million, a 33-per-cent increase from $2.1-million in 2014. While his total compensation was down 1.5 per cent from 2014 because of an adjustment to his pension valuation, his total direct pay, excluding pension valuation and other perquisites, was up 4 per cent for the year.
Michelle de Cordova, director of corporate engagement and public policy at mutual fund manager NEI Investments, said her firm voted "no" in Suncor's say-on-pay advisory vote this year, despite the company's relatively strong performance compared to peers, because NEI objected to the fact Suncor did not discuss how the board factored significant layoffs into its compensation thinking for the company.
"The [Suncor] compensation committee had the discretion to take some action to acknowledge the pain that had gone through the company," Ms. de Cordova said. "But if they did something, we didn't see it in what was disclosed to us. And that affected the decision on that particular vote."
Suncor spokeswoman Sneh Seetal said the company reduced its work force to remain competitive but tried to find ways to keep people in different jobs. "I know these decisions about people were not easy for Steve and the leadership team, which is why they looked for as many redeployment opportunities as possible," she said.
By comparison, Ms. de Cordova said NEI supported Canadian Natural Resources Ltd., which worked hard to avoid layoffs last year while president Steve Laut took a 46-per-cent pay cut for total compensation of $5.1-million in 2015, down from $9.5-million in 2014.
Canadian Natural spokeswoman Julie Woo said the company has not resorted to layoffs since the downturn began, but senior management took two 10-per-cent salary cuts, and staff salaries were also cut 10 per cent to save money.
"We believe it is important to keep the team together, so that we can continue to focus on effective and efficient operations," she said.
Peter Chapman, executive director of the Vancouver-based Shareholder Association for Research and Education (SHARE), which advises investors on voting their shares, said a growing number of institutional shareholders are paying attention to how a company manages its employees as a factor in building long-term shareholder value.
His firm's proxy voting guidelines include a sensitivity to high levels of layoffs, which was one of the factors in SHARE's decision to recommend voting against Encana's pay practices this year.
"If a company is cutting in a way that looks like it is going to lead to a long-term decline in the value of the company, that's not a good signal and it's not something you'd want to reward a CEO for," he said.
The question confronting some boards is whether they may risk losing their top executives if they slash their pay for years in a row during a downturn.
Paul Gryglewicz, senior partner at compensation consulting firm Global Governance Advisors, said CEOs know their jobs typically have a short tenure even in good times, and it is difficult to expect them to be patient with years of low pay.
In the real world, Mr. Gryglewicz said, boards take a risk when they underpay a CEO, especially if they can move to a new job where they will receive large grants of share units or stock options at the current market price, rather than remain where their old equity units are far under water.
"Part of the reality, whether shareholders like it or not, is that if the equity value is substantially down, the board has to make some hard decisions around whether they are still in a retention scenario for their executive talent," he said.
"What is the risk that person could leave the organization, and what do they leave behind if a recruiter were to try to attract them to a competitor?"
It's an argument that veteran corporate director Don Gray has heard often. But he fears boards use that concern to reward executives handsomely when performance is dismal and then pay them even more when it is good.
Mr. Gray, co-founder and former CEO of Peyto Exploration & Development Corp., who is now the company's chairman, said boards cannot be so afraid of losing a CEO that they find themselves boosting compensation to retain an executive in the worst of times. The pool of potential CEOs is not as small as some boards seem to fear, he said.
"If your team is losing and your guys aren't scoring any goals and they threaten to leave to another team, I'm like, 'here's the door,'" he said.
"I'm not afraid of losing them. … You don't want to lose people that can make you money and are really good, but you sure as hell don't want to feel like these are the only people you can possibly hire and you have no other choices, so they can hold you to ransom for whatever they want."
Concordia University accounting professor Michel Magnan, who specializes in studying corporate governance and executive compensation issues, believes the divergent approaches to pay decisions in a downturn reflect different philosophies about leadership.
Some CEOs approach their jobs as contract leaders seeking the highest possible pay – an approach he likens to mercenaries who fight for whichever side pays them the best – while others feel a deeper sense of loyalty to their company.
He said the best leaders set an example in times of crisis and do not just look out for themselves.
"Of course someone has to steer the ship when there is a storm, and that person has to be paid for his savviness, but when you are launching the escape boats into the water, I would certainly not trust a captain who thinks about his next bonus, stock option or retirement plan," he said.
The Canadian Press
Beyond the energy sector
Companies in the energy sector were not the only ones facing difficult pay decisions amid weak performance last year. Mining companies were in their third or fourth year of a commodity price slump, and many cut pay after facing years of shareholder pressure.
A Global Governance Advisors review of Canada's 100 largest companies by market value last year shows energy companies that were in the top 100 in both 2014 and 2015 reported a median increase in total CEO compensation of 0.95 per cent in 2015, while mining companies reported a median decline in CEO pay of 39 per cent.
The significant difference in pay approaches between the two sectors may reflect the different timing of the commodity cycles, said John Hammond, Vancouver-based leader of the executive compensation practice at consulting firm Willis Towers Watson.
Mr. Hammond said the drop in oil prices started later in 2014, and many of the 2015 pay decisions – including the size of equity grants – were typically made in the first quarter of 2015. That means many pay packages in the energy sector did not reflect the full depth of the oil price drop last year.
Mr. Hammond said he is seeing significantly more restraint in the energy sector so far in 2016, which will show up when proxies go out in 2017 to disclose 2016 pay decisions. For example, he said grants of share units and stock options appear to be down by 10 to 15 per cent on average.
At mining giant Teck Resources Ltd., CEO Don Lindsay saw his pay rise in 2015 while many others in the mining sector cut compensation.
Mr. Lindsay was paid a total of $10.24-million in 2015, up 2.7 per cent from $9.98-million in 2014, which included a 9-per-cent increase in his 2015 annual bonus from 2014. The raise came as Teck saw its share price tumble 66 per cent in 2015 alone and it reported a loss of $2.5-billion for the year while cutting 2,000 jobs over 18 months in 2014 and 2015.
However, company spokesman Chris Stannell said 2015 was "a very strong year for Teck from an operational perspective," with all major operations achieving production targets and remaining cash flow positive.
He said Mr. Lindsay's base salary has been frozen since 2014, and the board reduced his bonus by 10 per cent to $2.1-million from the level initially calculated under the bonus criteria. Mr. Stannell said the bonus is adjusted to account for changes in commodity prices to recognize management success "in controlling the controllable."
While not operating in the resources sector, drug maker Valeant Pharmaceuticals International Inc. was the Canadian-based company whose CEO pay rose the most in 2015 even as performance cratered.
CEO Michael Pearson was paid a stratospheric $143-million (U.S.) or $183-million (Canadian) in 2015, almost all of it coming from a $179-million grant of performance-based share units awarded to him by the company's board in July last year. Valeant faced scandal and legal investigations about its drug-pricing policies last year, and saw its share price fall by 29 per cent on the New York Stock Exchange during 2015.
Mr. Pearson resigned in April of 2016 and the company paid him a $9-million (U.S.) severance deal but said his massive 2015 grant of share units will expire worthlessly because performance conditions were not met.
Valeant's new CEO, Joseph Papa, received a "new hire" award of $40-million worth of performance share units and stock options as well as a $20-million "buyout award," paid in a combination of restricted shares and cash to compensate him for equity he forfeited when he resigned as CEO of rival Perrigo Co. PLC to join Valeant.
An equity reload in 2015
Valeant's equity grant was the biggest given to a Canadian company CEO last year, but many other companies also awarded large grants of either stock options or share units in 2015, arguing that their CEOs needed to have incentives to turn their companies around.
In many cases, those equity grants were the reason companies recorded an increase in CEO pay last year, with other pay elements – such as base salaries or cash bonuses – flat or falling.
At Finning International Inc., for example, CEO Scott Thomson saw his total compensation rise 9 per cent in 2015 because of a $3.5-million (Canadian) grant of share units and stock options, an increase from an equity grant worth $2.8-million in 2014. Mr. Thomson's base salary fell slightly in 2015 and his cash bonus was down 38 per cent for the year.
Chad Hiley, Finning's head of human resources, said Mr. Thomson was in his third year as CEO in 2015 and his total equity grants have averaged $3.7-million annually over the three-year span, which means the 2015 grant was below his average.
In deciding the amount of equity awarded in 2015, Mr. Hiley said it was not a factor that Mr. Thomson's prior equity grants had no value after his 2013 share units expired without paying out and his option grants remain under water.
"Scott's a high-performing executive and we would be sad to lose him," Mr. Hiley said. "So we do certainly think about the long-term incentive glue that we have on any executive, but we don't factor in the past performance of long-term incentives into the current pay."
While equity reloads appeared to be common last year, many shareholders and directors have particular concerns about awarding large new equity grants at the low point of an industry cycle.
Large new grants can become a de facto "repricing" of options by replacing them with a lower-priced grant at the bottom of a cycle when a company's share price is at its lowest. By the time share units or options pay out, the share price could be far higher, creating a windfall return for executives, especially if their older units also become valuable as prices soar.
Shareholders are often concerned about the cost of making those payouts, and about the potential for dilution of their shares if large grants of options are exercised for shares down the road, said Ms. de Cordova of NEI Investments.
"We have been encouraging people to be extremely careful about what they might award in the current circumstances," she said.
She said the dilemma highlights the flaw in paying CEOs so extensively in equity during boom times, because those lucrative compensation vehicles become a potential problem boards feel compelled to fix when the share price falls.
"So when it's boom times, perhaps the upside shouldn't be quite so high, and in down times you still want to incentivize people to do the best for the company," she said. "So if their incentive entirely consists of options that are under water forever, it's not a very good incentive."
Mr. Gray, Peyto's chairman, said boards ultimately have to be careful they are not rewarding and reloading executives in a downturn when their past decisions have helped to contribute to the company's current woes.
Fixing errors caused by excessive debt, overly aggressive capital spending or poorly conceived acquisitions does not justify a new round of bonuses for managing those tasks.
"You've got to make sure it's not the captain of the Titanic and you're rewarding him for rowing the lifeboat when he's the guy that ran you into the iceberg. … There has to be some accountability there."