An unusual problem is weighing on Jim Fisher's mind.
The corporate director, who sits on three companies' compensation committees, is pondering what directors should do about soaring executive pay after three years of booming stock markets have pushed the value of stock options and share units to new heights.
"It's something you just worry like hell about," he says.
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Some directors would say they don't see a problem that needs fixing. But others watching executives cash out record gains from stock options and restricted share units are debating tricky questions that only emerge in a long bull market: Should chief executive officers reap lottery-like winnings because commodity prices are high, or because stock markets are climbing steadily? Or should they be expected to outperform their peers or outstrip the upward drift of the markets? And how do directors structure pay packages to keep them from becoming excessive, while still retaining executives in a competitive environment?
Mr. Fisher, who is chairman of the compensation committee at Canadian Tire Corp. Ltd., says more companies are building extra performance hurdles into their stock options or share units - beyond share price growth - but says it hasn't slowed the huge compensation increases in recent years.
"The fact is, numbers are still getting really high. It doesn't matter what you do, the numbers are just plain enormous. And it's hard not to look at the numbers and say, 'Holy cow, did that person really earn that?'."
Investors could certainly ask that question this year. A Report on Business survey of executive compensation shows that Canada's CEOs saw their pay soar an average of 39 per cent in 2005 compared with 2004 (itself a year of huge compensation increases) as stock markets and commodity prices rocketed higher.
While salaries and bonuses climbed a modest 6 per cent last year, CEOs saw their stock option gains climb 47 per cent over 2004. CEOs on average earned $1.8-million each from exercising stock options - a number that climbs to $4.5-million if only those CEOs who cashed out options are included.
(The ROB review looked at 247 of the 279 companies that make up the S&P/TSX composite index. The others have not yet reported their compensation data for 2005.)
The pay leader for 2005 was Hank Swartout, CEO of Precision Drilling Trust, who took home almost $75-million last year, including $55-million in stock option gains. Mr. Swartout cashed out all his options when Precision Drilling converted into an income trust.
Equity-based compensation is clearly driving CEO pay these days, which is no surprise given that the S&P/TSX composite index was up a further 22 per cent last year after posting double-digit gains in the prior two years as well.
And there's every reason to think the big paydays will continue. At the end of last year, an elite group of 253 CEOs in the S&P/TSX index held a total of $2.2-billion of in-the-money stock options. That's an average of $9-million for each CEO.
With compensation plans paying out so handsomely, some directors are insisting on pay schemes plans they can justify under any conditions.
Veteran corporate director Purdy Crawford, chairman of the compensation committee of Canadian National Railway Co., says good compensation plans for CEOs leave 80 per cent to 90 per cent of their pay "at risk," or tied to performance features, so that executives only prosper if shareholders do well.
But Mr. Crawford says share price performance alone is no longer good enough evidence of superior performance by an executive. He believes stock options and share units should also have additional performance features attached - and he prefers them to be based on underlying corporate measures, such as profit growth.
He says he has even argued - unsuccessfully - that commodity companies should tie their executive pay to a "normalized" commodity price. For example, if a company's business plan assumes oil will be worth $40 (U.S.) a barrel and it climbs to $70, he says the compensation numbers should be adjusted to assume the $40 price.
"I want performance," Mr. Crawford says. "I don't want the floating tide raising all boats."
But Ted Newall, chairman of Nova Chemicals Corp., says boards can run into difficulty if they make their compensation plans too different from those of competitors.
"One big objective is not to lose your people to competitors," he says. "You can isolate yourself by putting long-term compensation too much at risk."
Many large payouts are justified, he says, because executives have earned them by all objective measures, and shareholders have also benefited.
David Beatty, managing director of the Canadian Coalition for Good Governance, says his powerful shareholder group is urging compensation committees to "stress test" executive pay plans to assess what will happen to pay levels down the road if extreme market conditions emerge - as they have recently for some energy and mining firms.
The CCGG also wants companies to "back test" their plans to check whether the compensation actually earned from long-term incentive plans was appropriate for the relative performance the company posted. "If you are trying to link pay to performance, we want to know you've looked at it before and after - how you did against a good peer group," he says.
Mr. Fisher says Canadian Tire has been stress testing its compensation plans for years now. In the late 1990s, when the company's share price was in the doldrums and employees were unhappy, the company set up a restricted share unit plan as an incentive for staff to "dig ourselves out of the hole."
But Canadian Tire's performance soared beyond all expectations, and stress testing revealed a large looming compensation liability. He said the board got so worried about the pending costs that it took out a hedging contract with a financial institution to fix the price that would have to be paid out. It has continued to hedge ever since.
"In one sense, you could say shareholders should just be happy if the share price goes way up - management will get a lot, but so will the shareholders," Mr. Fisher said. "But in fact, we worried the number was just going to get too high."
He believes pay can be excessive, even if investors also benefit. Companies don't operate in a vacuum, he argues, and have to consider what society at large thinks. There is a danger if lower-level employees at the company resent that the "suits" make all the money, and quietly protest by simply doing no more than the bare minimum.
"I think you definitely have to worry about whether the whole thing was right or too much."
Janet McFarland