Governance of Executive Compensation and Pay for … · Governance of Executive ... " Selection of...

Canadian Society of Corporate Secretaries Annual Conference August 21, 2013, 10-11:30am Halifax, NS

Richard Leblanc, BSc, MBA, LLB, JD, LLM, PhD Associate Professor, Law, Governance & Ethics, York University

Governance of Executive Compensation and Pay for

Performance

Copyright © Richard Leblanc. All rights reserved.

Paper and slide deck available 2

This slidedeck is available. Email Prof Richard Leblanc at [email protected] and Richard will gladly provide you with a copy.


Agenda 3

Ø  1. Red flags and best practices; Ø  2. Shareholder engagement and activism; Ø  3. Changes to executive compensation; Ø  4. Compensation of oversight functions (Canada, FSB); Ø  5. Internal pay equity (coming in August); Ø  6. Independent director compensation: Case; Ø  7. Incorporating LT NF metrics into compensation: Case; Ø  8. CEO / Board succession planning: Case; Ø  9. Risk adjusted compensation; Ø  10. Regulation of Proxy Advisors.

Copyright © 2011 Richard Leblanc. All rights reserved.

Continuing changes in governance 4


The New Governance Normal (2013-14) 5


Say on Pay: 2.1 Billion results on Google 6


Three Important Reports 7


Research, Teaching and Practice 8


Research and Practice 9


What does governance failure look like? 9


Methodology 10

n Regulators: OSFI, AGCO, FICOM, CPAB, OSC;

n Companies: Agrium, Mason, Elliot, BHP, SNC, TD, Via Rail, other;

n Research: 40 interviews, Jan-July 2013;

n Teaching / social media: Compensation at YorkU (with Paul Gryglewicz), governance at HarvardU, Boards and Advisors on LinkedIn;

n …Interviews with activist investors, private equity leaders, hedge funds, traditional investment firms, directors (NACD 100), CEOs (Top 100) and other governance professionals: forthcoming paper;

CEO Succession planning 11


1. Red Flags / Best Practices 11

n Captured, owned compensation committee members (trips, gifts, social, office, interlocks, CEOs, donations): not objectively independent: OSC drafting issue;

n Legacy, pedigree, over-boarded, over-tenured or ‘zombie’ compensation committee members;

n Captured, beholden compensation advisors: cozy, no renewal, and no freedom to be adverse;

n Lack of compensation member expertise, industry expertise, risk expertise: overcoming defective independence legacy;


Red Flags / Best Practices 12

n Boilerplate, inadequate, complex, or gamed compensation disclosure (including charters, bios, MV);

n CEO and director biography puffery, misrepresentation vs competencies, skills;

n Complexity: intended, realizable/earned and realized pay;

n Lack of women involved in CEO compensation: “A lady”;

n Over-reliance on inflated peers: CEO compensation: peer benchmarking: 17% unrelated to performance;

n Excessive equity: mixed relationship to performance, and tendency to manipulate;


Red Flags / Best Practices 13

n Regulatory need for consensus (CSA, systemic): LCD?;

n Advocacy of trade associations resisting governance / compensation reforms: vested interests, membership, business model: disclosure (Milstein);

n Lobbying and company resistance: proxy access, pay ratio, other;

n Selection of metrics: ST and financial vs LT and non fin;

n RS/RSUs not performance based: 95%;

n CEO/Director Succession planning: 2 hours; 39%;

n Retirement: director performance appraisal;


2. Shareholder Engagement and Activism 14

n The word “engagement” is rather meaningless; it can mean whatever management wants it to mean;

n Reality: Shareholders cannot communicate with, select, or replace directors. (Bob Monks interview);

n Say on pay has been a catalyst for some engagement;

n Opaqueness of shareholder engagement and stewardship, by shareholders themselves;

n Activist concerns: It is a myth that activists are short term only or do not create long term value ---->


Shareholder Activism 15


Activist Concerns 16

n A board incapable of directing or controlling underperforming, ineffective or inefficient management;

n Undue influence of board (major shareholder, CEO);

n Weak, legacy or no independent (AND effective) Chair;

n Waste, self enrichment and conflicts of interest;

n Extraction of shareholder money to founder or family, related party transactions; no proper special committee process; complacent board;

n A board that is in charge, and an activist investor-director who can “move the room”;



n Entrenchment: pills, staggered, dual, super, restrictions, devised by incumbent management counsel and approved by board to frustrate market for corporate control;

n Conflicted and/or legacy service providers (law, audit, compensation);

n Excessive compensation, not stretch, not performance- based, and goal posts moved by board,

n Global/emerging company with only domestic directors;

n Management goes beyond pure play, runs out of options: hubris, herding, empire building; board = “enthusiastic amateurs”;



n Bloated, complacent, inexperienced board not curing governance defects: incapable, no credibility;

n Director(s) with reputation, integrity issues (baggage);

n No value maximization plan; dysfunctional board culture;

n Directors do not spend their own money on stock (given to them): Active investing in the boardroom;

n Engaged, focused, results-oriented & disciplined board and chair;

n Regular meetings with shareholders and directors, with Chair directing counsel not to interfere;


Strategic Value Creation by Boards 19

n Board, led by Chair, sets standards for vigorous value creation process, establishes ambitious value creation criteria, and leads management to develop optimal value creation plan;

n Deep dives and due diligence by directors into company, business model, industry and markets to understand value drivers, innovation opportunities and associated risks;

n Board approves plan and its milestones, monitors progress regularly, calling for prompt corrective action to ensure goals are met, including increased goals as new unplanned/unanticipated opportunities arise;



n Value maximization plan clearly and simply spells out key timelines, milestones, targets, and individuals accountable for each key plan component and specific results;

n Reporting format and information flow provides frequent, timely and accurate information to board on plan progress and any variances;

n Board addresses plan variances quickly and directly: management provides concrete responses on how shortfall will be corrected, by whom and when;

n Chair adopts a primary role in foregoing;



n Maintenance of ‘day to day’ management by CEO and rest of executive team;

n Highly engaged level of functioning by board and a shift in primary focus towards value creation;

n Robust debate and review of plan execution is primary board meeting agenda item; and at least one presentation each board meeting from key personnel below the senior level, on that particular individual’s role in the value maximization plan and a full discussion of progress to date in that regard;



n Regular, robust communication between board and executive team, including open communication below the senior management level, in large part not focused on “oversight” but on engaging others in regard to their role in the company’s business and value maximization plan;

n Board links value creation plan execution to simple, straight-forward incentive performance metrics so direct link between management wealth creation and the performance and increase in equity value of company;

n Direct link to performance, value creation or the need to hit certain targets before any incentive compensation kicks in, below which management gets nothing.


3. Changes to Executive Compensation 23

n  “Independent” committees and advisors, similar to S-Ox;

n Say on pay, and mandatory say on pay (UK);

n Clawbacks (to come from SEC);

n Pay ratio of CEO to average worker (SEC expected in August);

n Pay for performance rules and guidance (SEC to come): How long will discrete pay and discrete performance take?;

n  “Hedging” (SEC to come as well);

n Proxy advisory disclosure / regulation (to come, Canada and US);


4. Compensation (Treatment) of Oversight Functions 24

n CFO, CRO, CAE, CCO, CAO;

n No CEO control any more: operational and executive management cannot interfere;

n Selection, authority, mandate, resources, accountability, independence, compensation, succession;

n Compensation cannot include revenue or operational responsibilities as metrics;

n Board and Committee chairs will need education and will comply (2013, 2014);

n RAF and limits / threshold best practices for non financial companies: current NP 58-201 defective re risk;


5. Internal Pay Equity 25

n CEO/C-suite undue influence and internal succession: talent loss, red flag beyond 2-2.5X;

n Criticism: cost, complexity, ambiguity; Overstated?

n Worker ratio: Expect ratios of 500-1,000: consultant;

n Leverage for workers? Lake Wobegon effect?

n  Income inequality and wealth disparity: society concerns?;

n Expect industry ratios to be a revenue stream for pay consultants;


6. Independent Director Compensation + Case 26

n NEDs should and want to be paid more but are loathe to do it: I recommend but subject to performance;

n Current: No connection to individual or company performance; pay for pulse?; flat fees worse?

n No skin in the game in the pure sense;

n Have hurdles to LT value creation, not bear or Fed market;

n Time pay with risk and product cycle so shareholders, directors and managers on same cycle/ aligned;

n PE Boards do it: Public boards passive and strategy gets short changed? Apply to ALL directors;


7. Incorporating LT NF Metrics into compensation + Case 27


LT NF Metrics and compensation 28


29



Case example: CSR and governance, $ - Rigor and maturity needed


Case Study 32

n Trigger and target metric changes:

n Strategic plan

n Leadership

n Regulatory compliance

n Employee engagement, culture

n Customer satisfaction

n Public confidence and reputation

n Board relations

n Succession planning


8. CEO Succession planning + Case 33

n Must get this right, even if everything else is right/wrong;

n Average board: 2hours, 39% no successor;

n  Internal less expensive, greater success rate;

n Trigger: Board and CEO evaluation (several times);

n Models: Horse, out and up; out; hybrid in/out; board;

n Typical defects:

n  Incumbent entrenchment;

n Plan vs. candidates;

n Sign of non confidence;

n Linking strategy to skill set (boards also);

n Lack of development of / exposure to hipo talent;


CEO succession case study 34

n Board agrees on strategy;

n Strategy -> Skills and type of CEO;

n Revamp internal development;

n Global search to validate;

n Board in control: structure, rigor, discipline;


9. Risk adjusted compensation 35

n Pockets of acute enterprise risk – derivatives, rate setting, emerging markets – with opaque controls and management override: Risk takers;

n  Immature RM, lack of controls, IT: RAF now;

n CAE restricted from compensation: Basel = full scope;

n  Deferral and explicit ex post adjustment;

n Compensation Committee has discretion;

n Risk adjusted metrics with denominators;

n RM and ethics in LTIP and Clawbacks or Malus;


Oversight of Risk Management 36 36

Strategic

Financial

Information Technology

Human Resources

Accounting & Reporting

Integrity Operations

• Strategic Planning • Capital Investment • Corp. Organization

• R&D

• Acquisitions • Divestitures/Closures

• Manufacturing Strategy • Functional Location • Financial Planning &

Modeling

• Risk Management - Insurance • Risk Management - Interest Rates

• Investments • Financing

• Liquidity/Cash Flow • Credit/Bad Debts

• Performance Management

• SEC Reporting

• Financial Forecasts • Tax Accounting & Reporting

• Management Reporting

• Reputation

• Management Fraud • Employee/Theft/Fraud • Illegal Acts • Resource Misuse • Ethics

• Brand Image

• Tone At The Top

• SG&A • Capital Projects

• Quality • Customer Credits/Rebates

• Inventory Management • Procurement

• Training

• Perf/Rewards Alignment • Availability of Skilled Staff

• Communications • Morale and Job Satisfaction

• Leadership • Salary Inflation

• Knowledge Assets • Empowerment

• Access • Availability

• Information Relevance • Continuity

• System Integrity • Technology Infrastructure

• Tech Development & Integration • IT & Business Strategic Alignment

• Outsourcer Management • Cost Control

• Safety • Environmental Compliance

• Govt. Compliance • Reliability

• Operating Costs • Sales and Marketing

• Contract Compliance • Capacity Planning

• Engineering • Repair Services

Environment • Political • Legal

• Regulatory • Business Interruption • ExternalTheft/Fraud/

Illegal Acts • Business Practices

• Innovation

Customers • Customers’ sales

• Planning • Reliability

• Relationships • Contracts

• Standards and Expectations

• Customer viability

Suppliers • Supply • Pricing • Quality

• Relationships • Billing

• Logistics

• Risk Management – Foreign Exchange

Rating Agencies • Maxtor credit • Vendor terms (guarantees,

advance payments)

• Workforce management

Technology • Product

Obsolescence

• Tax Strategies • Debt Compliance

• Lease Compliance

• Statutory Reporting

• Analyst Communications

Competitors

• IP Protection

Source: N. Marks

“We missed it.”


Governance of Executive Compensation 37


Risk Governance: No RAC without Risk part 38

n  Formal board approved risk appetite framework, with explicit limits, assured controls, and accountabilities;

n  ERM that is integrated, dynamic and culturally embedded;

n  Risk function has informs performance metrics and compensation decisions of senior management;

n  Third party reviews of risk, oversight functions;

n  Crisis, contingency, scenario planning to Board;

n  Risk consistently ranks last in my board reviews; recent example of “risk” not mentioned in majority of charters;

n  OSC at fault: NP 3.4 risk two lines long, vs ASX (16 August 2013);


10. Regulation of Proxy Advisory Firms 39

n Concerns:

n Lack of disclosure of methodology, weightings;

n Governance quality vs qualitative, context;

n Predictive validity;

n Lack of convergence of scores and methods;

n Market concentration;

n Conflicts of interest;


“Comply or Explain” Regime 40

Source: Basel (May 10), Europe (Dec 10) and FDIC (Feb 11)

n CSA Staff Notice 58-306 (Dec10): “unacceptable”;

n EU Submission


Thank you! 40


Contact Information

Professor Richard Leblanc Faculty of Liberal Arts & Professional Studies York University tel: (416) 736-2100 x 33744 Email: [email protected]

Twitter: http://twitter.com/DrRLeblanc

Blog: http://www.canadianbusiness.com/author/richardleblanc

http://ca.linkedin.com/in/rwleblanc

LinkedIn Group: Board Advisors

41


Short bio 42

Professor Richard Leblanc (http://www.yorku.ca/rleblanc/) is an award-winning teacher and researcher, consultant, lawyer and specialist on corporate governance and accountability. He is a former recipient of

Canada’s Top 40 Under 40™award, was named as part of the NACD’s D100 “people to watch,” received a teaching award as one of the top five university

teachers in Ontario, and was named to Canadian Who’s Who. Professor Leblanc’s research expertise is in corporate governance,

specifically in the effectiveness of boards of directors. He blogs on these issues for Canadian Business, Huffington Post Canada, and founded the discussion group on LinkedIn, Boards and Advisors, which is one of the

largest and most active corporate governance groups on LinkedIn (> 5,000 members). He will provide hands on examples of how to maneuver the

challenges directors could face in 2013 based on his extensive service as an external advisor to boards that have won national awards and peer

endorsement from institutional shareholders for their corporate governance practices.

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