On December 17, 2012, the Canadian Coalition for Good Governance (“CCGG”) released its 2013 Executive Compensation Principles, refining and updating its previous publication released in 2009. Noting that executive compensation practices and regulatory reporting requirements have and continue to evolve, CCGG’s focus for this year’s Executive Compensation Principles is on “‘pay for performance’ and the integration of risk management functions into the executive compensation philosophy and structure”. The following is a brief synopsis of CCGG’s 2013 Executive Compensation Principles:
1. A significant component of executive compensation should be “at risk” and based on performance.
CCGG notes that a large percentage of executive compensation should be a reflection of business performance and risks taken during the relevant period. In their view, pay for performance should be truly variable (for example, through the use of Performance Share Units) and not be deferred base salary. A specific takeaway is the emphasis on the use of performance based stock options rather than equity-linked compensation that vests solely on the passage of time. CCGG notes that shareholders generally discourage the use of time-vested-only stock options on the basis that they could encourage executives to take risks that are not aligned with long-term performance and that such options permit management to participate in the upside of share performance, while foregoing any downside risk.
2. “Performance” should be based on key business metrics that are aligned with corporate strategy and the period during which risks are being assumed.
CCGG advises that performance based compensation should be based on achieving pre-identified goals over the short, medium and long term, with payment aligned to the relevant time period over which results and related risk are respectively achieved and assumed. A key takeaway is the emphasis on boards of directors playing an active role in the entire process, from setting performance goals that include both financial and non-financial measures, evaluating and “stress testing” compensation plans and having the ability to alter payouts and even “clawback” compensation in accordance with their informed judgment.
3. Executives should build equity in the company to align their interests with those of long-term shareholders.
According to CCGG, a significant portion of an executive’s net worth should be in the company’s equity (or share equivalents, excluding options) both during the executive’s employment and ideally for a period of time afterwards, in order to align the executive’s interests with that of long-term shareholders. Moreover, certain activities, such as re-pricing stock options in the event of a sustained price decrease in the underlying shares and hedging or monetizing the value of an executive’s shares held in the company, should be prohibited as these activities have the effect of circumventing the intended alignment between the executive and long-term shareholder’s interests.
4. A company may choose to offer pensions, benefits and severance and change-of-control entitlements. When such perquisites are offered, the company should ensure that the benefit entitlements are not excessive.
Key underlying themes regarding pension, termination and change of control payments are that they must be reasonable and not based upon non or sub-performance. CCGG recommends boards placing an annual limit on pension payments and not granting “bonus years worked” (except in unusual circumstances and with full disclosure), having reasonable severance and forfeiture of unvested deferred compensation on termination so as to avoid any “pay for failure” and requiring that change of control provisions contain a “double trigger”, meaning that an actual change of control has occurred and the termination of the executive has occured during a specified time period following forthwith.
5. Compensation structure should be simple and easily understood by management, the board and shareholders.
CCGG acknowledges that while a certain level of complexity is required under a company’s compensation plan, it should nevertheless be easily understood by the board and management. The plan must also be clearly explained in sufficient detail by the board to the company’s shareholders so that the latter is able to fully understand and evaluate the plan. With respect to the use of external advisors, CCGG notes that such advisors must be independent of management and that ultimately, they should not be relied upon as a means to validate the board’s approach to executive compensation or to otherwise reduce the board’s responsibilities.
6. Boards and shareholders should actively engage with each other and consider each other’s perspective on executive compensation matters.
CCGG recommends that companies annually hold a “say on pay” advisory vote as an effective means of soliciting shareholder feedback. CCGG advises that boards should review and consider the results of the vote in determining future compensation plans and gauging whether increased shareholder engagement is required. Shareholders who intend to or have voted against the “say on pay” resolution should be consulted in order to understand their concerns. Transparency is also advised, as CCGG recommends full disclosure of the voting results, a summary of significant comments from concerned shareholders and an explanation of any current or future changes (or lack thereof) to the compensation plan.