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Archive for the ‘Executive Compensation’ Category

CEO to Worker Pay Ratio Coming to a Company Near You ~ And Some Numbers May be Eye-Popping

A compensation consultant who spoke to my corporate governance class at Harvard University last week said that the ratio of total CEO pay to the pay of the average worker at a company may not be what you think. Ratios of 500 or even a 1,000 to one may occur, this Boston pay advisor predicted. Embarrassment and tough questions will follow.

Next month, the Securities and Exchange Commission (SEC) is expected – at long last – to issue a draft rule outlining how US listed companies are expected to calculate this CEO to worker pay ratio. There has been fierce resistance to the ratio by corporate management, lawyers and lobbyists against the calculation and disclosure of this ratio, which was mandated in the Dodd-Frank Act of 2010.

Resistance centers on the complexity of calculation, the cost, and the usefulness, according to companies.

For example: Is total CEO compensation intended, realizable, or realized? (These numbers are all different, and is part of a larger pay debate. The regulator focuses on intended pay, which may not be what the CEO actually receives, or is entitled to receive.)

For the average employee pay, what if the company has 1000s or 10s of 1000s of employees? What about part-time employees? Contractors? People who are hired or quit during a given year? Different countries? Are bonuses, long-term incentives, and pensions and benefits calculated as well, for each employee? You would like to think that the average employee wage is easily calculated and companies should already know this information, but this is not the case. Nevertheless, the SEC should be clever enough to issue guidance in the new rule so that the average employee wage can be calculated in as cost effective a manner as possible.

Next, what is the usefulness of such a ratio, companies ask? A CEO to worker pay ratio, for example, would be very different for a bank (think Bank of America), as compared to the retail sector (think Wal-Mart), where average worker pay is different. Therefore how can there be meaningful comparison?

Likely what will happen are different ratios for different sectors, and the ratio will be relative to a company’s peers. This will be useful to corporate boards and shareholders.

For senior management and boards, a CEO to senior management ratio above 2 or 3 times can signal succession or talent management red flags (a CEO earning five times the next highest executive means there may be no internal successor). A CEO to worker ratio that is too high relative to peers within an industry could signal CEO entrenchment, a complacent board, or even low employee wage relative to the norm.

Taken as a whole, very high CEO to worker pay ratios can signal systemic wealth disparity. CEO pay has been outstripping executive and worker pay year over year by a wide margin because of structural issues related to “peer group benchmarking” (the very way CEOs are paid). This structural pay inequity is unrelated to CEO performance. There are societal costs to wealth disparity as well. Having CEO to worker pay ratio data may change the way CEOs are paid. Or not. But one thing for certain, there will be surprises.

Canada has its first Say on Pay Failure: Barrick Gold

This 85% of votes cast against executive compensation could have been predicted. A $17M pay package, including a $11.9M signing bonus, was awarded to Barrick senior executive John Thornton, in advance of performance, in spite of a 20-year low in Barrick’s share price. Institutional shareholders gave a strong condemnation of this payment and the director votes soon followed in Barrick Gold’s annual shareholder meeting yesterday:

Compensation Committee Chair, J. Brett Harvey: 28% withhold;

Compensation Committee Member, Gustavo Cisneros: 27% withhold;

Compensation Committee Member, Steven J. Shapiro: 28% withhold;

Director Hon. Brian Mulroney (non-independent: received $2.5M as an advisor): 24% withhold;

Chairman Peter Munk (non-independent: controlling shareholder and part of management): 17.5% withhold;

Director Anthony Munk (non-independent: familial relationship): 24% withhold.

Barrick CEO Jamie Sokalsky said the board would “carefully consider” shareholder perspectives. Founder and Chairman Peter Munk deadpanned, “Bad times bring out more people.”

I spoke out against the quantum of the above pay package for Mr. Thornton, but there are two sides to every argument. Let me make the case for Barrick Gold and what it should have done from a governance perspective.

Chairman Peter Munk said “we had to secure him” [John Thornton] “because of the competitive environment.” Munk went on to say “It is hard to have someone paid on performance if he would not have been able to join to perform.”

There is merit to Peter Munk’s position. If shareholders truly believe in pay for performance, then it is equally important to attract and motivate executive talent in a downturn as it is in an upturn. This means, paradoxically, that a compensation committee will pay out more, in spite of low stock price, and rein in executive pay during an upturn. Mr. Thornton is motivated, as his shares have declined in price.

This pay philosophy is at odds with the more common approach to pay, which is “profit sharing.” This means executives are paid higher in peaks and lower in valleys, to “share the profit” with shareholders. Many pay metrics are aligned with shareholder returns. This could hamstring a company in attracting talent when it needs it most and paying talent during a bull market, where executives get unjustly enriched.

It is quite possible Mr. Thornton had to leave unvested equity on the table somewhere else and needed to be made whole. This is the rationale for a “golden handshake” and is completely reasonable.

It is important that Barrick explain the need at this time for this executive, with these qualities, to large shareholders and receive their support. A plan for asset sales and addressing Barrick’s problematic Pascua-Lama mine, and Mr. Thornton’s role, could have been laid out better. There is a rational argument for the payment that could have been better communicated by Barrick in advance of the vote. Other corporate boards are meeting directly with institutional shareholders in advance of meetings, to explain pay and make necessary changes.

What else could or should Barrick have done, from a governance perspective?

The board is in dire need of renewal. There are directors who have served on the board for 20 and almost 30 years (Messrs. Mulroney, Beck and Birchall). Some regulators are moving to caps of 9 years on directorships. There is also no indication of outside responsibilities of directors, on Barrick’s website. There is evidence that over-boarded directors lack oversight effectiveness. Governance disclosure is rather opaque, including which directors are independent and on what basis.

Lastly, and perhaps most importantly, Mr. Munk owns less than 1% of the total equity of Barrick, yet controls the board appointments. The best governance reform would be for minority voting shareholders to have the right to nominate directors of their choosing. Canada has a large number of similar control-block companies, with dual share structures, whereby a dominant shareholder who may own a minority of total equity, has a majority of voting power. A good reform would be to have a “say on directors” that is commensurate and fair. Minority shareholders should have a say on directors.

Does Your Compensation Committee Need A Reset?

Executive pay practices are in the news on a regular basis. Just in the past few weeks, after meeting with investors, the performance metrics for Citigroup were changed following a failed say on pay vote a year ago. Yesterday, it was reported that Apple has required executives to hold triple their salary in stock.

The heat is now on Compensation Committees – who approve and set executive pay – more than ever before. Academic institutions are also keeping up, training our next generation of executives and directors on the rapidly changing terrain of best compensation governance practices and shareholder accountability. See the new course I developed for York University in this area, here.

What are the top pay practices for Compensation Committees? There are fifteen, listed below.

But before you read, ask yourself if you are a Compensation Committee member (or even a Board member not on the Committee), how many questions you can answer “yes” to.

If you are an investor, who will have a say on pay this upcoming proxy season, ask yourself if Compensation Committees at your investee companies conform to the practices below. The more questions that can be answered “yes,” the greater the likelihood there will be pay for performance that is directly aligned with value creation for you as a shareholder.

  1. Does each Compensation Committee member fully understand the company’s business model, the key value drivers, and the performance metrics arising from achieving the company’s strategy?
  2. Does the Compensation Committee precisely calibrate these metrics such that there is a direct line of sight and sufficient stretch for short-term bonuses and long-term performance-based equity?
  3. Has the Committee or an expert third party independent of management benchmarked your Compensation Committee Charter to best practices?
  4. Have you approved, and can you defend, the compensation of oversight functions (e.g., internal audit, risk, compliance) and key risk-takers within the organization? (Assume compliance failure occurs and these pay practices receive expert scrutiny.)
  5. Would a third party, after diligent checks into Compensation Committee member backgrounds and relationships to management, reasonably conclude that all Committee members are fully independent? (There are several red flags that may not be captured by formal independence standards – e.g., interlocks, reciprocity and social relatedness.)
  6. Do you have one female non-CEO on your Compensation Committee? Do you disclose the competencies and skills for each Compensation Committee member on your website?
  7. If you use a Compensation Consultant to assure compensation, has the entire firm or the person never done work for management before, and would otherwise be objectively viewed as fully independent?
  8. If you retain a lawyer to advise, negotiate or draft compensation agreements or pay plans under the Committee’s direction, has that lawyer never done work for the management before, and would otherwise be objectively viewed as fully independent?
  9. Do you have bonus deferral and equity vesting and hold requirements that are performance-based and risk-adjusted by the Committee?
  10. Would your compensation disclosure satisfy an investor as being fully transparent, understandable, clear, and absent of obfuscation or gaming? Do all Committee members fully review the disclosure, or have an independent advisor do so under the Committee’s direction?
  11. Whenever CEO compensation is discussed, the CEO leaves the room.
  12. Does each Committee member issue a cheque from their own savings to satisfy stock ownership requirements? (In other words, the stock is not given in lieu of board service, but they must pay for it.)
  13. Does your Compensation Committee meet directly with key investors to hear their views, without Management in the room?
  14. Does every Compensation Committee member have tenure on the board not exceeding nine years?
  15. Are key contractual provisions, such as a “clawback” or “malus,” and pay practices drafted by the Committee or an advisor independent of management who reports to the Committee, incorporating best practices?

If you answered yes to all questions, or even almost all, you likely have a truly outstanding Compensation Committee and pay for performance. You may even wish to apply for a governance award, here.

If you cannot answer yes to the majority of these questions, you have work to do.

Join me in my next blog where I will ask if your Nominating and Governance Committee needs a reset.

The Governance of Executive Compensation: A Counterpoint for Compensation Committees

For those compensation committees and their advisors who wish to get ahead of current and emerging requirements and meet best practices in this area, here are ten suggestions, independently and constructively offered:

1.         Independent Members

Committee independence should exceed black-letter requirements, i.e., members should be reasonably seen to be independent from the outside, and assessed anonymously by fellow directors from the inside. Interlocks, prolonged tenure, personal relations, service provider associations, perks and subtle conflicts should all be addressed.

2.         Compensation Literacy and Closed Shop Pay-Setting

A skills and diversity matrix should be used for the Committee. Compensation literacy, expertise and industry knowledge should be defined and met by members. The Committee should not be homogenous. At least one member should be a woman. Non-CEOs and first time directors should also sit on the Committee.

3.         Independent Advisors & Resources

The Committee should have explicit access to unconflicted qualified advisors who work for the Committee. If an advisor’s colleague seeks to do, or has done, work for the company, that advisor should not be retained. The consulting industry has not done an adequate job of addressing conflicts and professional standards and further regulation is coming. There should be no undue funneling by management in advisor retention.

4.         Risk-Adjusted Metrics

Compensation consultants, if used, should be instructed by the Committee to incorporate explicitly risk-adjustment into proposed metrics and adjustments ex post (after the fact) prior to vesting of deferred cash and instruments. The Committee should understand how to do this, consistent with best practice. If not, it should get independent advice, per item 3.

5.         Proper Clawbacks and Malus

If these clauses cannot be drafted by the Committee itself, they should not be drafted by management or internal or external counsel (who are conflicted by being self interested or assessing their own work), but by an independent advisor (see item 3) consistent with best practice and industry standards.

6.         Pay-for-performance Linkage

Management prefer short-term, quantitative, formulaic pay plans. Regulators explicitly want compensation committees now to incorporate qualitative, longer-term metrics, pay periods and discretion. More rules are forthcoming but compensation committees need to be able to understand the business model, the key strategic drivers and get this right so pay equals performance. This has not happened in several instances. Re-cutting pay plans is emotional and adverse so compensation committees need courage and resources at least equal to that of management.

7.         Meaningful Shareholder Engagement and Binding Votes

The Committee should meet directly with key shareholders without management present on a regular basis. Binding votes on pay are forthcoming. Conflicts of interest among institutional investors and asset managers and other barriers to engagement will likely be addressed. Boards should prepare for direct shareholder engagement and voting on a broad basis using technology in the future.

8.         Pay Equity and Disparity

The use of peer groups (vs. CEO rankings) and at the 50th, 75th or 90th percentile have resulted in a perpetual compounded 17% increase in CEO pay overall. This increase results in a significant disparity not only in the C-suite (depending) but also with the average worker. When ratios emerge, committees should scrutinize and act as appropriate. This disparity is part of public and regulatory parlance now. Inaction is resulting in regulation.

9.         Succession Beyond CEO

Boards increasingly should want to see a deep talent bench for key units and functions, beyond the CEO. CEOs resist, including in their own succession but boards should persist. Succession should be part of the pay package for intransigent CEOs. Proper CEO succession mitigates excessive executive compensation payouts.

10.       Director Pay

Management has an interest in paying directors beyond what is required for a part-time job, including for non-executive chairs. Committees need to push back on exorbitant pay that can be reasonably seen to compromise their own independence. In the US, for example, the NACD had recommended a 15-16% premium for Lead Directors, specifically to guard against compromising of independence. This premium is much lower than 2X or 3X seen for non-executive chairs, and the spirit of director pay overall.


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