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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.

10 Questions to Determine Whether Your Board Has the Right Dynamics and Behaviors

What fascinates me is what goes on inside boardrooms. Boards can have the structures, the boxes ticked, and the protocols and policies on paper, but if they are not lead properly, if they don’t behave as a team, and if they don’t have proper oversight over the CEO, they won’t be as effective as they can otherwise be.

It’s hard to determine these factors from outside the boardroom. Indeed, a reason researchers can’t find a clear causal relationship between boards and performance – even though directors tell me emphatically that boards do matter – is because what happens inside closed doors is largely invisible to outsiders. But board dynamics – including leadership, teamwork and behavior – matter greatly even if they can’t be measured from the outside.

I am interviewing several leading directors and chairs to obtain their views on boardroom dynamics. I am also observing boards in action. The data from my research is fascinating. Here are ten focal points I am focusing on. They are modified and phrased in questions I use. They represent only a fraction of what I am looking at; however, they are also ‘favorites’ of boards I assess that are leading edge.

10 Board Dynamics Questions

1.     Our Board Chair conducts an effective decision-making process (i.e., ensures that, for crucial decisions, alternatives are generated, a thorough discussion and analysis ensues, relevant perspectives are brought to bear, the best decision is made, and the decision is supported).

→ Here, I am trying to understand how effective the Chair is, particularly in chairing meetings and shaping key decisions. This is a key weakness of ineffective chairs.

2.     Our CEO welcomes the Board’s constructive input into our Organisation’s strategy (i.e., by being sufficiently candid, open and responsive; and encourages the same from direct reports).

→ Here, I look at the behaviour of the CEO. CEOs can easily hold back, block, or try to “manage” a board.

3.     Our Non-executive Chair (or a leading or senior independent Director) has a constructive working relationship with the CEO (i.e., mentoring, supportive and collaborative, open yet independent, candid and professional).

→ Here, I look at the nature of the relationship between the Chair and CEO. I interview both, as well as other directors, trying to get a sense of whether the Chair provides a strong counterpoint or is managed by the CEO.

4.     Boardroom discussions are constructive (i.e., Directors disagree without being disagreeable, assumptions are constructively challenged, views are skillfully explored, differences of opinion are appropriately acknowledged and resolved, and consent is forged).

→ Here, I look at how debate and decisions get made within the boardroom, in real time.

5.     Our Management (including the CEO) do not inappropriately influence meetings (e.g., by filtering or managing the flow of information to predetermine an outcome, not providing independent data, not facilitating access to independent advisors, etc).

→ Here, I look at “undue influence” or the attempt to shape or funnel information, agendas or outcomes. If this happens, the board will miss something.

6.     Our Board displays at all times a culture of diversity of views and open dissent (i.e., Members sufficiently challenge one another, differences of opinion are fully aired and accepted gracefully, no topics are “off-limits” for discussion, and Members feel free to speak out openly and honestly without fear of criticism, even when voicing a minority position or asking a probing question).

→ Here, I look at “constructive dissent” and how (or whether) it happens within the boardroom, including whether “groupthink” happens.

7.     Each regular reporting member of Management has a constructive relationship (i.e., characterized by respect, responsiveness, openness, transparency, candour, professionalism and accountability) with the Board and each Committee of which I am a Member.

→ Here, I look at the interface between committees and reporting management and whether there is blockage or dysfunction. Committees are where the work gets done. If something gets missed, it often happens here.

8.    The Board reacts in an appropriate fashion towards reporting Management (i.e., predictably, constructively, confidentially and deliberatively) in order to build trust on Management’s part to come forward with their real concerns in a candid manner.

→ Here, I look at the board’s behavior in shaping trust and candor with management. Trust is a two-way street and how the board behaves also matters. If the board dominates, leaks or is unpredictable, management simply closes up. Then, something can get missed or the board does not add full strategic value as management is holding back.

9.     Our discussions (Boardroom and at each Committee of which I am a Member) significantly improve the quality of Management decisions (e.g., by engaging of Management in thorough and constructive sessions that stimulate, guide and enhance Management’s thinking and performance, impact outcomes and add value).

→ Here, I look at whether the board adds strategic value. A “360 degree” assessment that incorporates management’s views can bring a reality check to a board that thinks they add value when they may not.

10.    We (Board and Committees) are not overly reliant on (or influenced by) a particular individual (e.g., with the most relevant skills and experience or tenure, or in a particular role or reporting relationship) given the work that we undertake.

→ Here I look for pockets of undue influence. It could be a shareholder, a director or a manager that can influence debates and outcomes, acting out of self interest.

What do you think? Can your board answer an emphatic “yes” to all 10 questions above? (Most boards cannot.)

Whether a board is effective or not, for the most part, comes down to factors inside the boardroom. The above factors are uncomfortable to ask, and data is limited, but they matter. Board dynamics is known mostly by directors themselves. The regulations and guidelines focusing on having a majority of independent directors, a certain size, a separate chair, etc., are important but are inadequate to ensure effectiveness and ultimately performance of the company. For boards to succeed, and for shareholders and other stakeholders to receive returns, more of the above factors should be focused on.

Compensation Consultants Need to Professionalize

Charlie Munger, Vice-Chairman of Warren Buffett’s Berkshire Hathaway, once said “As for corporate consultants who advise [boards of directors] on salary, all I can say is that prostitution would be a step up for them.”

Compensation consultants are widely regarded as not being independent and beholden to management for the bulk of their professional services. Therein lies the problem.

Boards need professional advisors who are accountable to boards and not management. They need auditors, lawyers, compensation consultants and search firms. However, these advisors have varying degrees of professionalism and oversight of conflicts of interest. Lawyers and accountants, for example, have very detailed rules of professional conduct. So do management consultants. See here, here and here. North American compensation consultants do not appear to have an industry code of conduct or performance standards.

Enron and WorldCom – and its legislative aftermath known as “Sarbanes Oxley” – fundamentally changed the relationship between auditors and audit committees. Auditors are now accountable directly to audit committees, not management or the CFO, to recommend to shareholders approval of financial statements of the company. Auditors may not engage in what is known as “non-audit” services to management, without permission, as doing so compromises integrity of the audit and accountability by the auditor to the audit committee.

The global financial crisis – and its legislative aftermath known as “Dodd Frank” – is similarly changing the relationship between compensation consultants and compensation committees. Consultants are now accountable directly to compensation committees, not the CEO, to recommend to shareholders the approval of executive compensation. Similarly, compensation consultants should not engage in “non-compensation” services to management, without permission, as doing so compromises their accountability to the compensation committee. But many consultants do. Their firms perform services for both management and the board, and doing so compromises the ability to do the best job for both.

Lawyers and accountants cannot act for two parties whose interests have the capacity to become adverse. A husband and a wife in a divorce; a vendor and a purchaser in a sale; and yes a CEO and a board in pay negotiations – all have potentially adverse interests, particularly if the professional is doing his or her job properly.

Respecting confidentiality, managing conflicts of interests, and the ability to advocate for one’s client, are the hallmarks of a profession.

Compensation committees and boards should insist on an industry-wide rigorous code of conduct for compensation consultants ~ that is independently drafted and enforced; that is publicly accessible; and to which all compensation consultants who advise these compensation committees subscribe.

The “Code of Conduct for Compensation Consultants” should be detailed, as are codes for lawyers and auditors. It should address specifically the following areas: the organization of a professional practice; relations with other firms and members; duties and obligations to your client; conflicts of interest; confidentiality (including privacy walls); competency and quality assurance; fees and retainers; monitoring and discipline; and, most importantly, objectivity, independence and integrity.

Compensation consulting firms and the industry as a whole have a choice – indeed they have a leadership and business development opportunity. They can professionalize themselves, collectively, collegially and independently, or governments eventually may do it for them. They may not like the unintended consequences of the latter.

 

How to do a Proper External Governance Review

Several memories stand out in my mind. One was the dominant CEO who kept interrupting me to tell me how effective he and “his” board were, despite the results of my assessment (the board was in trouble with regulators and the CEO later resigned). Another was a very rich and famous director asking me to leave his office when we debriefed on the peer review, which indicated how his colleagues thought his contribution was (he too resigned). Another was a director who actually resigned from the board ahead of time when he found out I was going to do the review. Another was a chair of a governance committee who viewed my questions and then decided against the review (he was later in the news for conflicts of interest).

I have seen all kinds of data – directors who fall asleep at meetings. CEOs who pound tables. CEOs who funnel information. Directors who are out of their depth. Directors who despise other directors. Bullying, cliques, factions, sexism, conflicts and denial. The most fascinating to see is the body language, process, relationships and dynamics – this can make or break a board regardless of structure and protocols. An intransigent CRO or ineffective risk committee chair can take a company down. I have also assessed some of the best performing boards – led by terrific leaders who spend enormous effort at getting the directors and process just right. Some have won national awards over the years they are this good.

So I have learned a thing or two.

First, why would any board do an “external” board review to begin with? Simple. Self interest. Boards assessing themselves are analogous to students marking their own exams. It’s an inherent conflict to assess your own work. It’s even worse if management facilitates (which happens most of the time a “self” review occurs) as they have the most to gain by a soft review.

Mainly, however, external board reviews are often poorly done. Why? What makes for a good external board review? Four key elements.

Who is your client?

Your client is not the CEO. Your client is not the general counsel, nor the corporate secretary, nor any manager for that matter. Management should not unduly influence you. If you conduct a governance review properly, the board’s interests could – and sometimes should and will – be adverse to those of management, whom the board controls. So you cannot act for simultaneously opposing interests. If you or your firm does business with management, or seeks to, or has done in the past, you are conflicted and should not do the review, no matter how you try and justify it.

Your client is also not the chair of the board. A good board review will assess the chair’s performance and he or she is likely the problem if the board is poor.

Your client is the chair of the governance committee (or its equivalent) and the committee as a whole, who ultimately reports to shareholders, similar to the auditors being accountable to the audit committee. If you do not work directly with and for the governance committee, the review will likely suffer or fail.

Garbage in, garbage out

Next, the review itself. The vast majority of approaches are superficial, do not reflect best practice, use the wrong scale, and are heavily biased. Unfortunately, these “surveys” get perpetuated and become the lowest common denominator. They are highly imprecise and lead to misleading results. There is a false sense of reality when the board “agrees” or “strongly agrees” to a majority of ill-defined performance metrics. The analogy to “happy-face” questionnaires is “pat-on-the-back” interviews. The tough questions are not asked. Garbage in, garbage out.

The review becomes a one-sized-fits-all, check-the-box pain, no better than those of external proxy advisory firms and rating agencies. Directors are skeptical, rightly so because what really matters is not being measured and what doesn’t, is.

The board of a bank is not the same as the board of a hospital or high tech start up. Reviews need to be best practice, highly customized and rigorous. They need to span silos. Lawyers, accountants and HR advisors don’t have competencies and market permission in cross-silos and default professionally to their own. The result is even more compliance box ticking.

Importance of 360 feedback

If a board is stale, management knows. If a director is not performing, directors know. Each director and reporting management should opine on other directors. The learning and self-development here is tremendous and counteracts a board or director thinking it, he or she is better than others do. It is very difficult if not impossible to do a peer assessment internally. Directors default into collective group-think (read: denial) because their responses will be seen internally. A good peer review will include self, peer and board assessment, so each director knows how he or she performs relative to his or her own perception, other directors and the board as a whole. The peer review becomes a developmental and recruitment tool.

Reporting and debriefing

The vast majority of reporting to shareholders by listed companies on the results of board reviews is superficial, wholly inadequate and boilerplate. Companies have a vested interest in making it this way. This will not change without greater prescription and enforcement by market regulators and shareholders.

Perhaps the weakest link for a board review however is internal reporting, implementation and action taken based on the review. Feedback should be provided to each individual director and debriefings should occur to discuss development, priorities, committee and board reform, and tough discussions – such as leadership and behavioural change and director retirement. A good review effects behavior. Some of the areas include knowledge of the business, judgment, communication, integrity, constructive challenge, willingness to act, thinking skills, financial acumen, interpersonal/teamwork and commitment. These are very specific skills that each director needs to possess for the board to be effective. One director can unduly effect an entire board dynamic and decision. Governance committee chairs and I have had tough but candid discussions and coaching with directors based on these outputs. It is not easy, but without proper data and leadership, directors on the receiving end either refuse to acknowledge or do anything about it.

Conclusion: Canada ahead of US and UK but they are catching up

To Canada’s credit, we have had to explicitly recruit and assess individual directors on the basis of competencies and skills since 2005. We have also not had enormous financial failures or bailouts. The US and UK have. Imagine that – up until the financial crisis, you could sit on a risk committee of a US bank and not know anything about risk or banking. The US changed its rules since then, mandating that directors need to disclose their qualifications, which is not quite the same as directors being assessed. (Lawyers will skillfully list bullet points about past job titles.) In the UK, their Code has changed stating that for all listed companies, external board reviews have to occur at least every two or three years. This is a step in the right direction.

Why CEOs earn 400 Times Average Employee Salaries

I attended an American Bar Association seminar last week by telephone that was very informative. It was a presentation by an American colleague, Professor Charles Elson, and his graduate student, Craig Ferrere, on executive pay and the use of peer groups.

Background to Executive Compensation Reforms

Dodd-Frank (which is a significant piece of legislation in the US) is requiring that compensation committees that approve executive pay be composed of independent directors and that compensation consultants, when retained, also be independent. Sarbanes-Oxley (a similar piece of legislation enacted after WorldCom and Enron) adopted a similar approach mandating independent audit committee members and independent external auditors.

Dodd-Frank also will require (in regulation yet to come by the Securities and Exchange Commission in Washington) the disclosure, for each listed US company, of a ratio comparing CEO pay to that of the median (meaning, middle) pay of an employee of the company, and greater demonstration of pay-to-performance linkages. Dodd-Frank has also mandated that pay plans be put up for an advisory (meaning, non-mandatory) shareholder vote at least once every three years, otherwise known as “say-on-pay” votes.  The vast majority of say-on-pay votes have been approved.

Skeptics argue, however, that making compensation committees more independent, and mandating greater pay disclosure for shareholder approval, will not constrain pay, but may actually compound the problem, otherwise known as “the law of unintended consequences.” This means that with greater and greater pay disclosure, CEOs become competitive and greedy, saying to compensation committees, in effect, that they are worth more than another CEO, for example, and exert greater upward negotiating pressure on the committee.

Having a more independent compensation committee members may not, in and of itself, be adequate to respond to this pressure in the competition for executive talent. Nor will say-on-pay votes, as shareholders want the best CEO leading the company so that they will maximize their investment.

The skeptics may have been largely correct over the years, given that even with many of the above reforms beginning to be enacted and the global recession, CEO pay has continued to rise, at a 10-20 percent level.

The Structural Reason CEO Pay Continues To Rise Despite Reforms

A very important reason CEO pay continues to rise in spite of all these reforms over the years is related to the “Lake Wobegon” effect, which is a natural human tendency to overestimate one’s capabilities, and this means that the water continues to rise for all CEOs.

A problem is the way pay is actually calculated and compared.

Executive pay is calculated by comparing executive pay within similar companies, otherwise known as “peer groups.”  When the pay is compared, compensation committees decide whether they should pay their CEO at 50th, 75th or 90th %’ile when compared to the peer group. The peer group is a basket of companies that is very important, and executives will cherry-pick or favor certain companies that may not entirely compare to their company in terms of size, complexity or industry. Companies are compared using peer groups of similar companies, in other words, not individuals.

In addition, the vast majority of compensation committees will select either the50th, 75th or 90th percentile for their CEO, for the simple reason that they do not want to signal to the market that their CEO, whom they have chosen, ranks in the 25th percentile, for example, or even below the 50th.

The implication of peer groups and percentile selection, combined, which constitute the primary tool of comparing and setting pay, therefore means that CEOs have a “built-in” increase of between 10 and 20% every year (or an average of 17%), which is compounded each year. This increase results from repeatedly choosing 50th, 75th or 90th percentile comparison of peer groups of companies rather than individuals.

The difficulty with peer groups is that they are predicated on the characteristics of the company, rather than the individual. Performance metrics of companies are compared and then the individual pay is “back-doored” based on the company’s performance. In addition, if a company within a peer group has a very successful year, all CEOs who use that company within their peer groupings will benefit regardless of their performance, which is unjust enrichment.

There are no widely accepted individual performance metrics, to complement or counter-act the systemic bias of peer groups and percentile rankings.  Imagine if you will that there was a CEO ranking based on a metric that was shown to correlate to corporate performance, and among individual CEOs so CEOs could be compared, such as “stewardship of assets,” for example.  CEOs could be ranked within an index, say Fortune 500, for Fortune 50, much the same way that mutual fund managers or even hockey players are (the number of goals, assists, etc.) are compared, over a 5 year period to counter act the effect of an anomalously good or bad year.

Professor Elson and his graduate student are working on a such a metric and index.  If they successful, this will begin to address the structural bias inherent in setting CEO pay.


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