Future Students, Alumni & Visitors

Archive for the ‘Significant Shareholder’ Category

Reforms to director compensation need to occur: Richard Leblanc

Activist investors in both Canada and the US recently proposed – for Hess Corporation and Agrium Inc. – that the independent director nominees they nominated to serve on both Hess’s and Agrium’s boards should be paid incentive pay directly by the activist investor that is tied to share price appreciation.

The rationale for this incentive pay – which has been termed “golden leashes” – was to incent new directors to the board to maximize share price.

There were several arguments against this proposal (see here and here for example), but the proposal itself raises a disconnect between how current independent directors on boards are paid and incented to perform, or not.

Most independent directors on public company boards are compensated in a blend of cash and company shares. The equity component is typically restricted or deferred until the director retires from the board, thus postponing taxes and enabling the director to amass a portion of equity in the company to align his or her interests with shareholders (it is believed). The equity can be a predetermined number of restricted shares, or a set monetary amount in the form of share “units.”

The problem with paying independent directors this way is that there is little incentive for personal performance or company performance. Directors get paid the cash and equity regardless. There is little if any downside, especially when directors can ride a stock market or Fed driven increase in overall share prices.

Not surprisingly, the activists noted this lack of incentive pay.

It is hardly surprising that boards do not focus on value creation, strategic planning, or maximizing company performance, survey after survey, as much as they do on compliance. Their compensation structure does not incent them to.

Compensation incentives drive behavior, both for management and for directors.

Here is what is needed to align director pay with shareholder interests:

  1. Directors should be required to issue cheques from their personal savings accounts to purchase shares in the company. Bill Ackman of Pershing Square stated that if Canadian Pacific directors were required to cut cheques for $100,000 each, the CEO would have been fired prior to Pershing Square being involved. Mr. Ackman is right. “Skin in the game” for a director does not mean shares are given to a director in lieu of service. The motivational factor to be attuned to shareholders is greater if directors are actual investors in the company. In private equity companies, non-management directors are encouraged to “buy into” the company and invest on the same terms as other investors.
  2. For Directors’ equity to vest (the portion they did not purchase), hurdles would need to be achieved that reflect personal performance and long-term value creation of the company. Assuming you have the right directors, this sets up a situation in which Directors are forced to engage in value creation and be rewarded for doing so, similar to private equity directors. The hurdle rate provides the incentive. The vesting hurdle should be based on the underlying performance of the company, commensurate with its risk and product cycle, possibly peer based, and not simply on riding a bull market.
  3. The long-term performance metrics for value creation should also apply to senior management, and the board should lead by example. The vast majority of performance incentives are short-term, financial and quantitative. We know that the majority of company value however is now based on intangibles. Long-term leading indicators such as innovation, reputation, talent, resilience and sustainability are being completely overlooked in compensation design. You get what you pay for.

Management has proposed “passive” pay for directors and short-term pay for themselves. Boards have acquiesced.

Where the activists went wrong, above, is in proposing short-term incentives tied to stock price that applied to a sub-set of directors. However their point is excellent in that independent director compensation is flawed. The correct approach is long-term value creation and incentives that apply to all directors, and to managers, and to shareholders.

Only when this shareholder-director-manager alignment occurs will the compensation issue be solved. It makes little sense to award executives on a biased short-term basis when the effects of their actions can last for years, or to award directors on the basis of time – or, as one of my students put it, “showing up.”

Compensation consultants are using the same short-term metrics as before the financial crisis. They need to be directed by their client boards to do otherwise.

The need to establish long-term value-creation metrics, in the words of one American director, “is one of the greatest challenges in establishing long-term incentive compensation plans.”

Join me in my next blog where I will address reforms to executive compensation.

Proposals to Strengthen a Board’s Role in Value Creation, Management Accountability to the Board, and Board Accountability to Shareholders

There have been a handful of activist threats to Canadian companies recently.

What these engagements have drawn focus on are defects in public company governance, including the skill sets of existing directors, the board’s focus on value creation vs compliance, and the very ways boards function and operate, particularly compared to private equity boards.

What follows is a series of recommendations that could apply to any public board: to make it more focused on value creation; to strengthen real director independence, including from management; to strengthen management accountability to the board; and, perhaps most importantly, to strengthen board accountability to shareholders.

These recommendations are expected to form a journal article I am authoring, and will be incorporated into a case on Canadian Pacific I am co-authoring. I will post the journal article once it is published, but I thought I would post the recommendations below, for commentary and criticism, particularly from my LinkedIn Group “Boards and Advisors.” (I have not included the supporting rationale/commentary for each recommendation, which will appear in the journal article; however, most of the recommendations are rather self-explanatory on their own.)

The recommendations are based on, in no particular order: interviews with activist investors, private equity leaders, directors and CEOs; advisory work with regulators; assessments of leading boards; expert-witness work; academic and practitioner literature and regulations in other countries; director conferences and webinars; lectures I have delivered to the Institute of Corporate Directors and Directors College; discussions in my LinkedIn group, Board and Advisors; and a book I am writing including with Henry D. Wolfe and Frank Feather entitled “Building High Performance Boards.”

Several recommendations may result in significant restructuring and change in how a public company board operates, functions, is composed, engages and focuses.

What follows is a listing of the recommendations, organized into three groupings, as follows:

I.           Increase Board Engagement, Expertise and Incentives to Focus on Value Creation (proposals 1-19)

II.         Increase Director Independence from Management and Management Accountability to the Board (proposals 20-30)

III.       Increase Director Accountability to Shareholders (proposals 31-38)

We will now begin with grouping I.

I.          Increase Board Engagement, Expertise and Incentives to Focus on Value Creation

1.         Reduce the size of the Board.

2.         Increase the frequency of Board meetings.

3.         Limit Director overboardedness.

4.         Limit Chair of the Board overboardedness.

5.         Increase Director work time.

6.         Increase the Board Chair’s role in the value creation process.

7.         Focus the majority of Board time on value creation and company performance.

8.         Increase Director roles and responsibilities relative to value creation.

9.         Increase Director compensation, and match incentive compensation to long-term value creation and individual performance.

10.       Enable Director access to information and reporting Management.

11.       Enable Director and Board access to expertise to inform value creation as needed.

12.       Require active investing in the Company by Directors.

13.       Select Directors who can contribute directly to value creation.

14.       Revise the Board’s committee structure to address value creation.

15.       Hold Management to account.

16.       Disclose individual Director areas of expertise directly related to value creation.

17.       Increase Board engagement focused on value creation.

18.       Establish and fund an independent Office of the Chairman.

19.       Limit Board homogeneity and groupthink.

We will now continue with grouping II.

II.        Increase Director Independence from Management and Management Accountability to the Board

20.       Increase objective Director and advisory independence.

21.       Limit Director interlocks.

22.       Limit over-tenured Directors.

23.       Limit potential Management capture and social relatedness of Directors.

24.       Decrease undue Management influence on Director selection.

25.       Decrease undue Management influence on Board Chair selection.

26.       Increase objective independence of governance assurance providers.

27.       Limit management control of board protocols.

28.       Address fully perceived conflicts of interest.

29.       Establish independent oversight functions reporting directly to Committees of the Board to support compliance oversight.

30.       Match Management compensation with longer-term value creation, corporate performance and risk management.

We will now conclude with grouping III.

Increase Director Accountability to Shareholders

31.       The Board Chair and Committee Chairs shall communicate face-to-face and visit regularly with major Shareholders.

32.       Communicate the value creation plan to Shareholders.

33.       Implement integrated, longer-term reporting focused on sustained value creation that includes non-financial performance and investment.

34.       Implement independent and transparent Director performance reviews with Shareholder input linked to re-nomination.

35.       Each Director, each year, shall receive a majority of Shareholder votes cast to continue serving as a Director.

36.       Make it easier for Shareholders to propose and replace Directors.

37.       Limit any undue Management influence on Board – Shareholder communication.

38.       Limit Shareholder barriers to the governance process that can be reasonably seen to promote Board or Management entrenchment.


There have been significant changes to corporate governance in the last few years. Most notably, boards and regulators are now dealing with a defective legacy of independent directors who do not possess the relevant expertise. The scholarship has never supported independent board or separate chairs and the causal relationship to corporate performance. Regulators and most recently shareholders are now are focusing on competencies.

Second, there has been an under-emphasis on strategy and value creation by many boards, at the expense and crowding out of compliance obligations. Shareholders are now addressing this shortcoming.

Third, there is a movement towards shareholders exerting ownership rights to effect the governance of the company and select and remove directors who can address the earlier two points: competencies and skills, and fulfillment of the strategic and value creation role of the board.

Fourth, there is the real perception that directors are beholden to management.

I have addressed in the above recommendations all four defects in the current governance model for public companies: (i) directors selected primarily with a view to formal independence; (ii) not addressing fully the strategic and value creation role of the board; (iii) shareholders having greater say on directors and value creation; and (iv) making boards more independent of management, and management more accountable to boards.

I am happy to respond to any of the above.

Richard Leblanc, PhD

Does Your Board Chair and Governance and Nominating Committee Need A Reset?

I am currently interviewing shareholder activists, hedge funds and private equity leaders on changes to public company boards to make them more focused on value creation and company performance. I am also interviewing leading directors and CEOs. My research reveals a disconnect between how many boards operate and how shareholder advocates believe they should operate.

For a board to operate effectively, it starts with an independent and effective Board Chair and Governance and Nominating Committee, which are the leadership and inner workings of a Board. It is here where governance accountability is established and good directors are selected, or not.

The focus since Sarbanes Oxley has been on the Audit Committee, and since Dodd-Frank on the Compensation Committee. But without an effective Board Chair and Governance and Nominating Committee, management accountability to the board, and board accountability to shareholders will be undermined.

If you want to make your Board more focused on company performance and value creation, ask yourself whether your Board Chair and Governance and Nominating Committee can answer “yes” to most of these questions, based on my interviews, in no particular order:

  1. Has the Board set standards for a vigorous value creation process, and does its value maximization plan clearly and simply spell out key timelines, milestones, targets, and individuals accountable for each key plan component and specific results? (Is the Board’s plan as good as or better that what an activist shareholder can provide? It should be.)
  2. Does each Director have the background into the company, the business model, the industry and markets to fully understand the value drivers and associated risks? (If not, does the Chair and Board have the backbone to replace those directors?)
  3.  Leadership goes well beyond whether the Chair is independent or not. Does the Board Chair possess the following attributes: Shareholder mindset, leadership, understanding of the value creation process and the capital markets, ability to view things holistically, an ethic of accepting personal responsibility, industry experience, and no desire for CEO role? (If not, is the Governance and Nominating Committee strong enough to recommend to the Board to replace the Chair?)
  4. Do the Board and Board Chair have the will to hold management to account for results and the courage to act decisively when needed?
  5. Does the Board ensure direct links to performance and value creation and the need to hit certain targets before any executive incentive compensation kicks in?
  6. Does each Director have a meaningful portion of his or her own savings invested in the company?
  7. Has the Governance and Nominating Committee recommended to the Board adopting shareholder accountability practices and removing entrenchment devices and other restrictions?
  8. If or when needed, does the Board and each Board Committee utilize resources and advisors independent of management who represent the interests of shareholders?
  9. Does the Board Chair and Governance and Nominating Committee look to shareholders for prospective directors, rather than to management?
  10. Does the Governance and Nominating Committee ensure that all governance terms of reference been redesigned to reflect the Board’s focus on value creation and company performance? (Many times these terms of reference written by management keep the board at bay.)
  11. Does the Board Chair and other Directors engage regularly and directly with key shareholders, without the presence of management? (The vast majority of boards do not meet with shareholders.)
  12. At these Director-Shareholder meetings, are the following matters covered off: Value creation and company performance; status of governance initiatives; board and committee composition and renewal; risk governance; and the governance of executive compensation?

If you answered yes to all questions, or even almost all, you likely have a truly outstanding Board Chair and Governance and Nominating Committee. 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 discuss “What makes for a high-performance Director?” based on about 30 interviews with shareholder advocates, search firms and members of the NACD 100 and Top 100 CEO listings.

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.

Should governance lawyers be independent?

Most boards need professional advisors, such as auditors, compensation consultants and lawyers. After Enron and WorldCom frauds of 2002, regulators stepped in to ensure that auditors were hired by – and accountable to – the audit committee of the board, on behalf of shareholders, and not hired by or unduly influenced by the CFO as they once were. After the financial crisis of 2008, regulators stepped in (in 2012) to ensure that compensation consultants were hired by the compensation committee of the board and not hired by or unduly influenced by the CEO or other management. What about lawyers? Should lawyers who act for management also advise the board of directors? I don’t think so.

Now there are strict independence requirements for both auditors and compensation consultants. Their primary client is the board of directors and ultimately shareholders, whom the board is there to represent. It is entirely probable that if you do your job properly as an auditor or compensation consultant, that you will make recommendations that management will not like. You are there to act on behalf of the board and shareholders, not management. You cannot have dual masters and fulfill your fiduciary duties to only one as a professional. Indeed, auditors and compensation consultants cannot provide any additional services to management without the express consent from the board or a committee of the board. This authority is – or should be – rarely granted now.

Lawyers are equally important in the field of corporate governance. They interpret and apply legislation and offer advice to a variety of constituencies – shareholders, directors, managers and other stakeholders – who have interdependent and even adverse interests in the well being of the corporation and the competition for scarce resources. If the above reasoning is correct, so far as auditors and compensation consultants is concerned, strict independence should also apply to lawyers.

What this means is that a lawyer (or even a law firm) who has acted, or currently acts, or seeks to act, for management, should be prohibited from also acting for the board. This independence requirement is not practiced currently. There are numerous lawyers and law firms who act for both management and boards. Because most fees originate from management work, the consequences of this is a pro-management bias exhibited by lawyers who have drafted protection and entrenchment mechanisms for management such as poison pills, dual class shares, restrictions on meetings and voting, and staggered boards. Lawyers then resist pro-shareholder governance reform such as majority voting, say on pay and proxy access.

When interests between management and shareholders become adverse, even through the regular course of events, it is important for boards to have their own set of lawyers who are independent from management and seen as objective and willing to act in the interests of directors, not management, and ultimately shareholders. Management lawyers frequently exhibit an anti-shareholder bias, using words such as “attack,” “dissident,” and “proxy fight.” See here for example: Dealing With Activist Hedge Funds. Shareholders suffer when the board retains advisors who are beholden to management.

Some services this new set of “governance-only lawyers” could offer include:

  • Drafting board guidelines, committee charters and position descriptions for the board [if drafted by management lawyers, as they are now, these policies are often pro forma, management friendly, and restrict the board unnecessarily];
  • Board and committee reviews of effectiveness [typically these reviews are done by management or management lawyers currently];
  • Advising the board on activist shareholders, institutional shareholders and overall shareholder engagement [these governance lawyers would have a shareholder not a management mindset];
  • Reviewing and opining on the annual proxy circular, on behalf of the board [typically the board does not have the time to do a detailed review];
  • Review of the strategic planning process and value creation by management, on behalf of the board [again, with a shareholder mindset];
  • Negotiating and drafting the CEO contract and its terms, on behalf of the board and shareholders [typically a management lawyer drafts the agreement];
  • Assessments of risk management and oversight functions, on behalf of the board [again, the assessment would be independent of management and lawyers would work with independent auditors as necessary];
  • Ongoing coaching and development and review of implementation of policies, on behalf of the board.

All of the above activities and services are currently offered by management lawyers primarily from the point of view of management, not the board and not shareholders. This needs to change. The lawyers involved should fall into line (or camps), just like the auditors and compensation consultants have. There is room for governance lawyers who are unambiguously there to act only for directors, on behalf of shareholders.