Corporate directors — once a scarcely known and faceless
breed — have in recent years become front and centre in the
ongoing public debate on the need for and the nature of
improved governance of public corporations. This debate
commenced in Canada just over eight years ago with the
plaintiff call “Where were the Directors?”, which was the
title of the December 1994 Report of The Toronto Stock
Exchange (TSE) Committee on Corporate Governance in Canada,
led by Peter Dey, and issued following the collapse of several
major Canadian corporations and financial institutions,
including Confederation Life.
Following the Dey Report, the TSE in 1995 articulated some
14 key guidelines designed to improve the governance of
Canadian public corporations. The TSE promoted the idea that
corporations and financial institutions should comply
voluntarily with the guidelines or most of them in order to
remain in the good graces of the Stock Exchange, regulators
such as the Ontario Securities Commission (OSC) and the Office
of the Superintendent of Financial Institutions (OSFI), and
with investment analysts. These guidelines were not without
controversy, especially as they failed to produce a
broad-based and deep-seated culture change in corporate
Canada. However, they did generate a very constructive public
policy debate and introduced a whole new lexicon about and
profile for corporate directors. Reference to “related”
directors, “unrelated” directors and “lead” directors became
commonplace and the virtues of and the need for board
independence from management began to come into sharper
focus.
Although it is risky and often misleading to generalize, I
believe there was more than a kernel of truth to the folklore
that up until recently, the cadre of directors of major public
companies in Canada and the United States was pretty much “an
old boys club”. Proponents of this view believe that the
directors of public companies frequently were “patsies” for
the senior managers they had a duty to be monitoring on behalf
of the shareholders. Indeed, it has been suggested by such
prominent corporate governance pundits as Graef Crystal,
author of the provocative book “In Search of Excess: The
Overcompensation of American Executives”, that the typical
American public company board of the eighties and nineties was
composed of ten friends of the Chairman/CEO, a token woman and
a token representative of a minority group. In cases where the
functions of Chairman and CEO were split, the Chairman was
generally a golfing or fishing buddy of the CEO. All too
often, the CEOs determined their own compensation arrangements
and those of their directors and the boards routinely
rubber-stamped them. In a word, a culture had developed or was
developing strongly in the USA, and to a lesser extent in
Canada, whereby boards of directors of public companies were
often not independent of management. This was particularly
serious because under prevailing corporate and securities law
and practice, the onus was on directors along with the outside
auditors to monitor and restrain management from engaging in
improper accounting devices or indulging in excessive and
selfish compensation practices.
The overriding objective of the TSE governance guidelines was
to develop a new corporate culture designed to promote systems
or processes which would encourage and enable directors of
Canadian public companies to act independently of management
in such critical areas as selection of directors, including a
non-executive Chairman; assessment of the performance of
individual directors and of the board at large, and of the CEO
and other key senior executives; establishing CEOs’ and other
senior executives’ compensation packages (including
supervision of stock option plans and other short and
long-term incentive schemes); succession planning for CEOs and
other senior executives; and last, but not least, the
establishing of fully transparent accounting and disclosure
policies; plus management of the relationship with outside
auditors to ensure their ongoing independence.
Paramount in all of this was the need to formulate governance
systems which could be conducive to aligning the interests of
both directors and management with those of the corporation’s
owners — the shareholders — and to highlight the legal status
and role of corporate directors as fiduciaries for the various
stakeholders of the corporation, especially the shareholders,
but also the corporation’s employees and customers.
Notwithstanding this heightened awareness of and sharpened
focus on the key relationship between improved corporate
governance and accountability to shareholders and investor
confidence, a culture of abuse on many corporate boards and in
many executive suites in corporate Canada and USA continued to
evolve as the nineties played out and as the Millennium came
and went. Whilst the exact reasons for this sorry phenomenon
have not been precisely articulated, the most popular
explanation is the “Raging Bull Market” — especially the
notorious “tech bubble” — coupled with poor or non-existent
governance systems and a temporary forsaking by investors of
the time-tested, traditional standards requiring earnings and
cash flow, integrity, transparency and accountability to
shareholders as prerequisites to sound investment of
hard-earned dollars.
Many investors, managers, directors and executives quite
literally — as demonstrated by their investing in and
operating companies with zero earnings, cash flow or tangible
assets — came to believe that “Yes, money does grow on trees
and yes, there is such a thing as a free lunch”!! As Paul
Volker, former Federal Reserve Bank Chairman, said recently,
“Traditional norms did not exist. You had this whole culture
where the only sign of worth was how much money you made!”.
Mr. Volker’s successor at The Fed, Alan Greenspan, talked of
“irrational exuberance” and he used many other pungent
adjectives to describe the aura of unreality that seemed to
envelope the investment world, especially during the period
including 1998 to late 2000. Such regulators as the SEC,
Congress and even members of the judiciary have had an
opportunity to make their own observations and a clear
consensus developed that we had been living through a period
where a corporate culture featuring excessive greed and abuse
of shareholders’ rights was commonplace. The stories are
legion about obscenely rich executive compensation packages,
including “over-the-top” perks, expense packages and
mega-option programs for management and directors alike in
many public corporations. In this regard, a quick reference to
the transcript of Jack Welsh’s divorce hearing is instructive.
Good corporate governance and accountability to shareholders
was often non-existent and there were numerous instances where
directors and management operated like the so-called “robber
barons” of Wall Street of the early nineteen hundreds.
Conflicts of interest, insider trading, non-objective analyst
reports — all were rife. The interests of individual
shareholders were ignored or forgotten. Last year, The
Financial Times of London wrote a series of articles on what
it called “the barons of bankruptcy — a privileged group of
top business people who made extraordinary personal fortunes,
even as their companies were heading for disaster”.
And then the “doo-doo” hit the fan! The “tech bubble” burst
with trillions of dollars of market capital vanishing in a
heartbeat! As well, both here in Canada and south of the
border, a spate of major, high-profile corporate scandals came
to light.
Many folks who thought they were set for life were suddenly
“feeling the pinch”. The less fortunate and most naïve were
wiped out. Some poor souls were even driven to suicide.
Shocking fraudulent activities were uncovered — CEOs and
senior executives were carted off to prison in handcuffs,
often in the bright and revealing glare of TV lights. The once
top accounting firm in the world, Arthur Andersen, sustained a
complete meltdown and virtually disappeared from America’s
corporate landscape. Investor confidence hit rock bottom! As
distasteful as these happenings were, they sent a salutary
message to the executives and directors of other corporations
and to the remaining major accounting firms and their
professional supervisory bodies.
Yes, Ladies and Gentlemen, this really did happen — in fact it
is still happening in some quarters — the most notorious and
tide-turning case being Enron. There are many other troubling
cases before and after Enron, but it was “the last straw” for
the Bush administration and for US legislators and regulators.
To name just a few, in Canada, we have experienced Phillip
Services, Bre-X, Cinar, Livent, Dylex — not to mention the
disastrous collapse of the shares of the likes of once
high-flyers Nortel and JDS Uniphase. In the US, the cases of
Global Crossing, Dynegy, Lucent, Cendant, Sunbeam, Waste
Management, Tyco, WorldCom and Adelphia were just the tip of
the iceberg!! It should be added, though, that the American
and Canadian economies were not and are not full of Enrons and
WorldComs. As well, it would be a gross exaggeration to
suggest the majority of senior managers and directors were
crooks. However, the scandals in these companies, and others,
did serve to once and for all illuminate the major flaws in
the governance systems prevailing in our public corporations.
Something had to be done and the US authorities were the
first to act — once again we heard the call loud and clear:
“Where were the Directors?” But now the tone was different
—as was the remedy. Guidelines and moral suasion would not be
enough! The US legislators acted, and acted swiftly, with the
tough Sarbanes-Oxley Act which was enacted in record time last
July. Some say the Americans are using a sledgehammer to kill
an ant with these onerous new legislated rules for a new
corporate governance system designed to ensure true
independence of directors from management. The law stipulates
severe penalties, huge fines and jail terms for
non-compliance. At first, there was a negative reaction in
Canada, with some experts pointing out that our economy is
dominated by small and medium-sized companies for whom strict
compliance with Sarbanes-Oxley would be very onerous. One size
does not fit all, they argued, and the Canadian corporate
environment is more suited to guidelines and principles than
to strict rules. However, the rules-based approach is
prevailing. Sarbanes-Oxley is being fine-tuned as
implementation dates approach; inter-listed Canadian public
corporations are gearing up to comply or have already made the
necessary changes. Ontario has enacted tough new rules with
onerous penalties for non-compliance with its Bill 198, soon
to be proclaimed into law. Federal Minister of Finance
Hon. John Manley, in his Budget last Tuesday, laid the
groundwork for key governance rules to be enacted federally in
amendments to the Canada Business Corporations Act.
In emphasizing the need to restore investor confidence in the
integrity of our capital markets, Mr. Manley said:
“One of the key elements of instilling investor confidence
is good corporate governance within Canadian public companies.
Canada must aim for the highest standards. We must ensure that
our stock exchange guidelines and requirements, our securities
laws and our corporate laws provide a sound framework. Our
companies and executives must strive to implement best
practices.
This means, for example, that a board of directors must be
sufficiently independent from management to fulfill its
oversight function, that the Audit Committee of the board must
be independent to ensure a proper audit and disclosure of the
company’s financial position, and that management must be held
accountable for its actions.
The federal government has a direct role in this area. In the
coming months it will propose actions to strengthen the
corporate governance standards in the Canada Business
Corporations Act and financial institutions statutes. These
proposals will take into account what is being done elsewhere,
particularly by the provincial governments, securities
commissions and stock exchanges, as well as the ongoing work
of the Senate Committee on Banking, Trade and Commerce.”
We will await these proposals with interest.
Perhaps most important of all from a Canadian corporate
governance perspective, Peter Dey has concluded that we must
now move beyond guidelines and adopt a legislated approach. In
a presentation to the Senate Banking Committee just last week,
Mr. Dey said:
“In the current climate, making what I regard as the
principal guidelines mandatory is necessary and appropriate,
it will be a signal to institutional investors that Canadian
corporate governance is “world class”; the standard of
governance in the Canadian marketplace must be as rigorous as
the standards practiced in other developed markets.”
Mr. Dey stressed his belief that to achieve the necessary
culture of governance in the boardrooms of our public
corporations, it is key to find and strike the appropriate
balance between voluntary and mandatory legislated guidelines.
As well, he apparently believes, and I agree, that we need to
have only one basic standard of governance for all Canadian
public companies and avoid bringing in two sets of rules (e.g.
US and Canadian) which would create confusion and place an
unnecessary burden on our public corporations and their
managers and directors.
All of this makes it clear that in the post-Sarbanes-Oxley
era, the preferred role for public corporation directors is
undergoing a very significant and far-reaching transformation.
As a consequence of these changes, important issues have
arisen as to how and where to recruit directors in the future,
how to protect them reasonably from their increased liability
exposures and how to compensate them fairly for the risks and
onerous responsibilities they take on. The ongoing landscape
for directors and their role can be summarized as follows:
a) The majority of the directors on a public
corporation’s board should be independent, having no financial
ties, other than their directors’ compensation, to the
corporation or its management.
b) Directors of public corporations should be of high
integrity, possess good judgment and be prepared to make a
sufficient time commitment to enable them properly to carry
out their mandated functions.
c) The Chairs of Audit Committees should have a formal
background in accounting and corporate finance and directors
serving on Audit Committees should be financially articulate.
All Audit Committee members should be independent.
d) The Chairs and a majority of the Corporate
Governance and Human Resources and Compensation Committees
should be independent.
e) The functions of CEO and Chairman should be
separate and the board Chair should be independent of the CEO
and other senior executives and not a social “buddy” of the
CEO.
f) Directors should not accept appointments to an
excessive number of boards of public companies and a
reasonable maximum is considered to be four.
g) Independent directors should control the process
for fixing the compensation for the CEO and other senior
executives, as well as for establishing and monitoring an
effective process for assessing the performance of the CEO and
his senior management team.
h) Independent directors should control the process
for selection of new directors.
i) Independent directors should establish an
effective succession plan for the CEO and other senior
officers and should control the process for selection of the
CEO.
j) Some members of a public corporation’s board
should possess special expertise or knowledge respecting the
business or businesses of the corporation so as to be in a
better position to contribute knowledgeably to the process of
testing management’s strategic plan and establishing the
corporation’s strategic direction.
In the post-Enron era, there has been an increase in the
number of lawsuits against directors of public companies,
stricter liabilities for directors have been legislated or
mandated by regulatory bodies, and the duties and workload for
directors have become significantly more onerous. The “old
boys club” is a thing of the distant past, fancy privileges
and perks for directors are no longer acceptable and going on
a public corporate board simply for public acclaim or prestige
is no longer in vogue. Additionally, directors’ and officers’
insurance has become very expensive and in some cases very
difficult if not impossible to obtain, at least to the full
extent needed and without disconcerting deductibles.
So, Ladies and Gentlemen, what does all of this mean for the
compensation of directors of Canada’s major public
corporations in today’s environment and going forward? For one
thing, it seems logical to infer that the supply of Canadian
individuals who meet the foregoing criteria of independence,
integrity and competence and who are prepared to commit the
necessary time and assume the risks may not be sufficient to
meet the demand. The jury is still out on this issue and
surveys are being conducted as we speak. One such survey just
last month by Korn/Ferry International found that 86% of its
respondents (all active public corporation directors) believe
it will be more difficult to recruit directors in the future
because of increased risks of prosecution, more stringent
selection criteria, more selective candidates, greater
responsibilities requiring more time, stricter governance, the
problems with getting adequate D&O insurance and last, but not
least — insufficient compensation.
So now, let us address specifically the issue of Directors’
Compensation Programs and the current trends which I see
emerging in Canada.
A basic prerequisite to the design of a good Directors’
Compensation Program for a public corporation is categorical
definition of what the board is expected to achieve and how
its governance system is structured. Precision of the
corporation’s governance commitment is one of the key drivers
that will determine the appropriate mix, and balance,
between the three basic compensation design components used to
achieve the objectives of a directors’ compensation strategy.
These three components are:
1.
Pay Elements:
What is the right mix and quantum for the fixed and variable
pay elements of the total compensation package?
2.
Timing:
What remuneration should be paid annually versus a one-time or
performance-triggered basis?
3.
Medium of Remuneration:
What is the right balance between cash versus equity-based or
other forms of compensation?
While there is plenty of room for creativity in the interplay
between design considerations, I believe the ultimate
effectiveness of any Directors’ Compensation Program design
today must be pragmatically tested against a corporation’s
overall strategy, the fast evolving new corporate governance
expectations and the increasingly difficult challenge of
competitively attracting, retaining and motivating what is
becoming a “new breed” of public corporation director.
There is nothing new or complicated about the mix of pay
components for directors such as the annual retainer, annual
Committee Chair retainer, meeting fees and the like. However,
the weighting of each component as a percentage of a board
member’s total annual compensation and the shift in emphasis
from cash-based to more flexible, performance-based,
equity-oriented programs is a definite trend. Also, since
Sarbanes-Oxley, the trend is sharply away from traditional
“vanilla” stock options for directors.
Prior to Sarbanes-Oxley, there was a clear trend towards
higher, more equity-based compensation, especially options,
pursuant to the recommendations of the National Association of
Corporate Directors’ (NACD) 1995 “Blue Ribbon Committee” in
the United States, which called for paying at least half of
board remuneration in stock, eliminating pensions and other
director benefits and perks, including loans, and introducing
meaningful stock ownership guidelines. The basic rationale was
to align the compensation of board members more meaningfully
with the interests of shareholders. The Blue Ribbon
Committee’s key recommendation in this regard states:
“Stock ownership
with appropriate restrictions on resale is the best method of
tying directors’ financial interests directly to those of
shareholders, while avoiding potentially damaging short-term
focus from basing compensation directly on annual company
performance. The Commission believes that substantial stock
ownership can forge the “incentive” link missing in most
director pay plans. Even though incentives are of varying
importance to different directors, and even though financial
incentives alone cannot ensure better governance, on the whole
incentives do work in the boardroom.”
So with this in mind, let me summarize some of the trends
which were evident in Directors’ Compensation Programs both in
Canada and the USA even before the Enron scandal and the
Sarbanes-Oxley legislation of last July, which for the
purposes of this discussion I see as a clear point of
departure for further changes and new trends both in the US
and here in Canada.
1.
Average
overall director year-over-year remuneration was trending
upwards in both the United States and Canada, although
compensation of directors of Canadian public corporations
continued to lag significantly behind their American
counterparts.
2. Annual retainers remained the most widely used form
of board compensation, but there was a definite trend both in
the US and Canada to pay at least part of the retainer via
some form of equity-based vehicle. (Viz. options, DSUs, SARs,
RSUs, grants and so on.)
3. The widely used pay vehicle of meeting fees in
corporations of all sizes was diminishing as a percentage of
total annual remuneration. This may be due in part to the
competitive emphasis placed on increasing the value of
Committee retainers as well as the trend towards increasing
the use of full or partial equity-based retainer pay.
4. The quantum of Committee Chair retainers was noted
to be growing rapidly, as were Committee attendance fees.
While this reflected the growing need to compensate for the
heightened time demands and accountabilities in corporations
where an improved governance culture was already taking hold
(particularly for the Audit and Human Resources and
Compensation Committees), it has recently become a competitive
response to the current scarcity of competent, experienced and
independent directors within the North American market.
5. The use of pensions and other benefits and perks,
including loans to directors, had virtually disappeared
following the recognition that seniority/entitlement driven
pay components tend to align director interests more
with management than the shareholder and compromise a
director’s independence.
6. The need for a corporation’s directors’
compensation package to be more competitive and attractive to
outside directors was being addressed by the introduction of a
greater degree of individual flexibility through the
customization of director pay. Many corporations are today
enabling individual directors to choose the form and/or the
timing of their compensation by offering various creative
compensation deferral arrangements and the option of
exchanging all, or a portion, of their cash retainer into an
appropriate equity-based program. Tax consequences for both
the corporations and their directors are getting very special
attention.
7.
Approximately 25% of North American firms surveyed had already
introduced stock ownership guidelines requiring directors to
achieve a set minimum level of ownership in the corporation’s
stock (often as a multiple of the annual retainer) over a
defined period of time. I expect this trend will become a
significant element of Directors’ Compensation Programs in the
post Sarbanes-Oxley era where it has become pretty much the
rule that shareholders expect directors’ compensation to be
aligned with their own interests.
While the NACD’s Blue Ribbon Committee’s recommendations to
substitute equity for cash can be credited with initiating
and/or driving the trend towards more equity-based director
pay, it was also prophetic in its recommendation as to what
form of stock-based compensation would be preferable. The Blue
Ribbon Committee was quite correctly concerned that stock
options had the potential to bias judgment in favour of
short-term financial performance by placing an undue focus on
marginal stock price growth rather than longer term corporate
strategy and ultimate total return, and recommended two
alternate, but tax-effective forms of stock-deferred stock
units and restricted stock. (The use of the latter is not a
popular practice in Canada due to onerous tax rules here.)
The foregoing is a snapshot of North American directors’
compensation trends prior to the Sarbanes-Oxley Act of last
July and it is interesting to note how they presaged the new
direction that is now being taken as US and Canadian
corporations actively strive to renew their corporate
governance ethics and systems.
In a presentation to the Senate Committee on Banking, Trade
and Commerce early this month (the Committee is conducting a
study on the lessons to be learned for Canadians from the
Enron debacle), Mr. William Dimma, a well-known Canadian
corporate governance expert, prefaced his comments about
directors’ compensation by stating:
“No board can
manage, but all management must be overseen by an active and
committed board that is not only ultimately in charge but
genuinely in charge. That ultimate board control must be real
and not merely governance jargon, which is too concerned with
form and not function.”
The words
“active”, “committed” and “in charge” succinctly reflect the
nature of change in board governance and the directors’ role
that will also shape the future direction of directors’
compensation. On the current state of directors’ compensation
in Canada, Mr. Dimma offered the view that “Directors in
Canada are “quite underpaid”. They may not be vastly underpaid
for what they used to do”, he said, “ but they are
underpaid for what they should be doing.”
He added that a
director should play just as important a role as the CEO if he
is doing what he or she should be doing and should be paid
roughly the same amount per the amount of time. He then stated
that “I would go so far as to say that today’s fees ought to
be roughly doubled in Canadian dollar terms for Canadian
directors. How you divide it up is another matter. Directors
playing the same role should be paid exactly the same. If the
role is different because you have assumed extra
responsibility then you should be paid more. However you
should not be paid more per hour devoted. You might have a fee
at the front end that is incremental but for the amount of
time it should probably be at the same rate.”
Mr. Dimma also indicated that he has come around to the
British view that stock options for directors are not
appropriate unless they are clearly performance-based and
structured to pay off for directors only when shareholders
benefit too. He believes, and I agree, that it would be better
if we paid directors properly and stopped giving them any
options. Deferred stock units that put off taxation until
retirement is a popular and effective way of doing so.
Based on the fairly thorough research I have conducted of
corporations in the North American market, there appears to be
no question that Canadian public corporation directors are in
fact for the most part underpaid both as to what they are
expected to do and the risks involved, and vis-à-vis their US
counterparts. Various current surveys have found that
directors of US public companies, on the average, are paid
almost 50% more, on a per dollar basis, than Canadian
directors.
To attract and retain the “new breed” of director within the
North American and global market, we must ensure that our
directors’ compensation is globally benchmarked and
competitive. It will likely become popular to recruit
directors for Canadian public corporations outside of Canada,
either in the USA or elsewhere. It is clear that supply side
pressure on competitive directors’ compensation levels is
being and will continue to be exacerbated by the post
Sarbanes-Oxley demand for increased director competence,
independence and accountability.
At Air Canada, the directors are paid in traditional fashion,
basically at the “mid-point” of Canadian industry practice as
determined by surveys conducted by director and executive
compensation experts. Each director receives a fixed annual
retainer fee of $37,000, paid $17,000 in cash and $20,000 in
stock. The payments are made quarterly and the stock portion
is calculated on the basis of market price following issuance
of the corporation’s quarterly financial results. The Board
has five basic Committees — the Audit Committee, the Corporate
Governance Committee, the Human Resources and Compensation
Committee, the Strategic Planning Committee and the Investment
Policy Committee. Until very recently, all Committee Chairs
received an annual retainer fee of $4,000 and all Committee
members, including the Chair, a fee of $1,000 per meeting. In
recognition of the now increased responsibilities for Audit
Committee members, especially the Chairman, plus the need for
special financial expertise, the retainer fee for Air Canada’s
Audit Committee Chair will shortly be increased to $8,000 and
the meeting fee for Audit Committee members increased to
$1,500. All Air Canada directors receive $1,000 for attending
board meetings, either in person or by conference call.
The responsibility for recommending to the Board the amount
and nature of directors’ compensation at Air Canada rests with
the Corporate Governance Committee. This Committee has noted
the view that Canadian corporations are not remunerating their
directors sufficiently given the new nature of their role and
responsibilities, and is reviewing the matter in depth,
consistent with the current trends I have referred to in this
presentation.
By contrast, some of Canada’s other major corporations,
including the big banks and BCE Inc., have already taken
definitive action in this regard. Let us take BCE as an
example. It appears from recent corporate filings that BCE
undertook late 2002 a comprehensive review of compensation
arrangements for outside directors. The result was that cash
compensation for BCE’s outside directors, starting January 1,
2003, was increased substantially to reflect the increased
role and responsibilities of directors under new governance
standards applicable to BCE, such as those prescribed by
Sarbanes-Oxley. The new compensation program involves:
1. For all outside directors — a flat fee of $150,000
per year, payable quarterly.
2. For the Chair of the Audit Committee — a flat fee
of $225,000 per year, payable quarterly.
3. For the non-executive Chair of the Board — a flat
fee of $300,000 per year, payable quarterly.
4. Outside directors are expected to own at least
10,000 BCE common shares and/or share units under the
Directors’ Share Unit Plan. The directors have five years to
reach such threshold. BCE’s Board believes this share
ownership guideline serves to further align the interests of
outside directors with those of the shareholders.
5. Until the minimum share ownership level is
attained, the annual fee will be paid in the form of share
units under BCE’s Directors’ Share Unit Plan. Afterwards,
directors can elect to receive their compensation in share
units or in cash.
6. In view of these new arrangements, BCE’s previous
Outside Directors’ Stock Option Program was terminated and all
outstanding options, whether vested or unvested, were
forfeited.
(I am submitting Attachment I as further evidence of the
current trends at major Canadian public corporations, as
determined from their most recent proxy circulars.)
In conclusion, let us consider these trends in the context of
the questions which public corporation boards now need to
resolve concerning their Directors’ Compensation Programs.
1.
Is the Directors’ Compensation Program structured as to
attract, retain and motivate independent directors of top
quality?
This question should really be expanded to state “Does the
Directors’ Compensation Program attract, retain and motivate
top directors, consistent with the board of directors’ defined
corporate governance mandate?” This clarification leads to
some pointed questions against which to test the viability of
a program. For example:
·
Has the corporation developed categorical standards of
“independence” applicable to members of the board and its
Committees lately?
·
When was the last time the board reviewed and clearly
articulated its key functions and the expected background,
qualities, diversity, skills and experience in light of its
evolving corporate governance guidelines?
·
Has the corporation recently revalidated or re-written its
board’s Committee charters? Has the board increased and
recognized the time commitment and responsibility expected of
its Committee Chairs, especially the Audit and HRC Committees?
·
Does the Corporation have a properly paid non-executive Chair
and does it expect or require a full-time commitment of the
Chair?
·
Has the corporation taken cognizance of the new North American
and global market benchmarks that the corporation must compete
with for the recruitment of top, independent director talent?
Is the Directors’ Compensation Program competitive with this
market group?
If a corporation is only just starting the process of revising
its corporate governance system, then its Directors’
Compensation Program is most likely not competitive and it too
should be updated to reinforce the board’s governance
objectives.
By taking the lead from some of these recent trends in
directors’ compensation, change will be imperative if a public
corporation is to remain competitive, and effective, in the
following areas:
1.
Annual retainers at all levels may need to be competitively
adjusted, perhaps on an annual basis, based on the expertise
and time commitment expected of the directors and having a
view to the corporation’s industry peer group. In Canada, I
believe in most cases this will mean adjusted upwards.
2.
The ability for directors to individually customize their
compensation should be enhanced to provide them with the
flexibility to choose both the form and the timing of their
compensation. The appropriate alternatives may vary by
industry sector but should transparently align director and
shareholder interests.
This will likely mean first ensuring an overall market
competitive total Directors’ Compensation Program and:
·
Increasing the percentage of directors’ pay delivered as
equity or equity-based programs such as deferred share units (DSUs)
— but not restricted share units (RSUs), performance shares or
stock appreciation rights (SARs) which are all prevalent in
the USA, principally because of better tax treatment there.
·
Providing for a director elected exchange of cash for
equity-based alternatives.
·
Ensuring all equity alternatives can be flexibly deferred
and/or applied against stock ownership targets.
3.
Just prior to the Sarbanes-Oxley Act, US surveys confirmed
that large firms were paying, on average, 60% of their
directors’ total annual compensation in equity (mostly stock
options) versus cash and were moving in the direction of even
more equity. In Canada, there was a lesser but still important
percentage of directors’ total annual compensation being paid
in equity, although the same momentum towards more equity was
not yet as prevalent.
4.
Today, because of the need to align directors’ compensation
closely with shareholder interests, alternate instruments such
as stock grants or deferred share units (DSUs) could well be
the logical next step for emphasis in directors’ compensation.
A detailed summary of these alternatives and their advantages
and disadvantages is set forth in Attachments II and III.
As the new corporate governance environment takes hold and as
the “new breed” of public corporation director becomes
commonplace in Canada, I predict there will be a new landscape
for directors’ compensation. The directors will be paid much
more in line with their worth and with global competitive
standards. Corporations will no longer be relying on stock
option programs and will have changed their compensation mix
for directors by adding long-term equity (and cash) based
performance vehicles clearly linked with the creation of
genuine shareholder value.
In directors’ compensation packages, we can expect to see more
creativity in the development of vehicles such as deferred
share units that will provide for flexible and tax-effective
directors’ compensation. I also think we can expect to see a
fundamental repositioning, and increase, of the fixed and
variable cash commitments within our programs, with the
programs’ design emphasizing flexible director choice in
determining the cash/equity ratio of their pay and strategic
stock ownership guidelines driving the shift towards the use
of more equity.
With the new governance paradigms that are emerging,
corporations must seriously attempt to introduce compensation
packages for directors which faithfully reflect the
shareholders longer-term interests.
In my view, now is the time to introduce the appropriate
changes, all as part of the drive to restore investor
confidence. Shareholders’ new expectations of corporate CEOs,
senior management and boards of directors is clear. Only the
demonstrated achievement of strategic and financial business
objectives, aligned with value creation for the investor
should be rewarded. This does not however preclude fair,
equitable and competitive compensation of the time and effort
put in by the “new breed” of directors as they endeavour to
diligently represent shareholder interests.
