A controversial salary and bonus plan for executives at Bombardier ultimately received the blessing of its shareholders this spring, but it followed protests and negative publicity that any company would hope to avoid.
Individual and institutional shareholders criticized the initial plan that would boost executive compensation by nearly 50 per cent, following significant employee layoffs last fall and the need to obtain more than $370 million in loans from the federal government.
In the end, most of the bonuses will not be paid until 2020 and are tied to company performance. As well, Pierre Beaudoin, a member of the company’s founding family, announced he would step down as executive chairman of Bombardier.
The shareholder vote, the so-called “Say on Pay” provision that many publicly traded companies in Canada have adopted, is only an advisory measure. However, the fallout for Bombardier is one of the most high-profile recent examples of the need for companies to formulate executive compensation packages that are not only reasonable but that can be properly explained and justified to shareholders.
At a time when there is greater scrutiny of these plans by shareholders and the media, it has also resulted in more attention being paid to the message, as well as the actual compensation, by human resources and in-house legal departments of companies.
Lynne Lacoursière, counsel at Torys LLP in Toronto, says good governance includes being able to explain clearly the rationale behind any executive compensation plan. “It is about engagement with shareholders,” says Lacoursière, who heads the executive compensation practice at the firm. “How are we going to describe the narrative” when it comes to total payments for senior executives at a company? she adds.
The likelihood of shareholder acceptance of compensation plans may often be more about other factors than the specific financial payouts, suggests Nadine Cote, founder of CSuite Law in Toronto. “It is not the amount per se; it is some perceived inequity,” she says. “If the company has performed well and employees are treated well with no major layoffs, executive compensation will barely make the news,” says Cote. In the case of Bombardier, the disclosure of the proposed bonuses for senior management followed layoffs and government assistance, she notes.
Overall, though, Cote agrees there is now significantly more information about executive compensation included in a circular than ever before. “Compensation disclosure is extensive. There are much greater attempts to explain it,” she says.
The most likely circumstance for a company to receive bad publicity and criticism from shareholders is if there is significant compensation despite what appears to be a poor financial performance, says Scott Sweatman, a partner at Dentons LLP in Vancouver. “You want to avoid the risk of pay for failure,” states Sweatman, who specializes in pension, benefits and executive compensation law.
The potential for negative publicity is even greater if a publicly traded company has received some form of financial assistance from government, he points out. “You will be under the microscope,” says Sweatman.
Winning over shareholders is easier if not only there is transparency about the compensation but if it can objectively be shown to link pay to performance beyond that of short-term increases in share price, says Christina Medland, a lawyer and partner in the Toronto office of Meridian Compensation Partners LLC. “It is about providing shareholders with the information they need and told in a complete and coherent way,” she says.
The Canadian Securities Administrators enacted new rules around executive compensation disclosure five years ago. Since that time, most large publicly traded companies in Canada have provided more disclosure than what is required in these rules, states Medland. As well, she says there have been increased efforts to try to develop more “metrics” for assessing performance. “Lots of companies have multi metric plans,” she explains. In the mining sector, for example, she says there might be bonuses for a good safety record or strengthening its environmental performance. “What is on the rise is a much more strategic focus on whether the incentive plans are aligned with the company’s strategy. Do the payouts make sense for the business,” says Medland.
According to Lacoursière, there is a push toward trying to devise compensation that matches performance over a longer term, such as three years, rather than quarterly results. “You may also look at other operational metrics, such as cash flow,” she says. A report issued last year by Lacoursière and two colleagues at Torys found that while “total shareholder return” is still the most significant factor for executive performance among S&P/TSX 60 index issuers, its weighting against other performance metrics is expected to decline in future years.
Percentage bonuses must also be explicitly linked to performance. “You want to be sure there are not any guaranteed amounts,” says Lacoursière.
One of the difficulties, though, says Cote, is being able to come up with indicators that accurately and fairly measure the results of the most senior employees. “There is a lot that is not within the control of the executives,” such as an unexpected downturn in a sector, she says.
The added disclosure requirements, increased scrutiny and complexity of these plans have clearly added more responsibilities to human resources and legal departments within publicly traded companies. “If you are going to make changes [to compensation], you need to ask what are the disclosure requirements,” says Lacoursière. This task is something that might need to be overseen not just before preparing the annual circular but throughout a fiscal year, she adds.
The amount of disclosure that is required and the resources it may require can appear extensive, but it is always good corporate governance, says Sweatman. “Once it is started, it is actually not so onerous,” he adds, suggesting that circumstances that ultimately result in bad publicity are usually a result of poor governance.
“You must have a good board, which is able to stand up to management. You want an independent compensation committee, which you hope has no real stake in the [compensation] game,” he states. When companies hire outside counsel or advisers, they should seek individuals who are not just telling firms what they expect to hear. “You want people to challenge the status quo and who are not worried about losing the client,” says Sweatman.
As well, an effective executive compensation plan should not just be limited to the most senior employees at the company, he adds. “You need to go further down the pay scale” in terms of incentives, says Sweatman, because that is where the future executives of a company may be found.
Measures such as Say on Pay votes by shareholders, which are not binding on boards, are still an effective tool, say lawyers in this field. “It is a real avenue for shareholders to express their views,” says Medland. The embarrassment of losing such a vote is enough of a deterrent for a board to ensure that the executive compensation plan is acceptable.
While they are not mandatory, an increasing number of publicly traded companies in Canada have instituted clawback or recoupment policies related to bonus compensation. These policies can be triggered if there is a financial restatement. They do not guarantee these funds will be recovered, yet, “it gives a company a way to protect itself,” says Medland. Litigation may still be necessary, but a clawback policy is helpful in estimating damages in any civil action, Lacoursière explains.
The rules regarding executive compensation disclosure in Canada are arguably not as strict as some of the provisions of the Dodd-Frank reforms in the United States. One example is a requirement that was supposed to take effect later this year, which would require disclosure of the ratio between chief executive compensation and that of the median employee of the company.
That disclosure is not mandatory in Canada and Lacoursière does not see it being adopted by many companies. “It is just CEO shaming,” she says. The ratio is not necessarily a meaningful figure, agrees Medland. “It tells you more about the nature of the business than about the performance of the CEO,” explaining that the ratio will be higher in a retail operation, for example, than other sectors.
However, it now appears that many of these measures, including stricter clawback rules and frequency of Say on Pay votes, are about to be rolled back. The U.S. Congress started the process this spring in legislation entitled the Financial Choice Act, aimed at rescinding many Dodd-Frank measures.
In Canada, though, whether it is mandatory or not, more transparency on executive compensation appears to be an accepted part of doing business. “This is not about any witch hunt,” says Sweatman about the increased scrutiny. “It is about being good companies.”