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Executive compensation under scrutiny

Special to The Globe and Mail

Markets are down and inflated executive compensation packages are heading with them, according to corporate governance trend-watchers.

"We'll see more incidence of flat and declining pay levels," in keeping with corporate performance levels, says Lisa Slipp, practice leader of the Canadian executive compensation team at Mercer Human Resource Consulting in Toronto.

"Pay has been grossly out of line with shareholder experience," says Ken Hugessen, a consultant on executive compensation and related government consulting, also at Mercer. "Shareholders have complained" to directors, who are becoming more responsive to shareholders, he notes.

A Mercer study of both board and executive compensation and governance trends for 2003 found that boards of directors are increasingly tracking multiple performance measures, together with relevant business plan targets and competitive benchmarks against which they can assess business and executive performance throughout the year.

Historically, says Mr. Hugessen, executive pay levels were decided by management, with a "thin veneer" of involvement from the board's compensation committee. The scandal resulting from the collapse of Enron Corp. "put a spotlight on CEOs setting their own pay," he says, and compensation committees are now taking charge.

Low-interest loans are also disappearing. Last year's Sarbanes-Oxley Act banned them from companies listed in U.S. markets, says Ms. Slipp, and although there are no similar restrictions in Canada, "companies are moving away from them because they don't look good to shareholders."

At the same time, directors' pay is on the rise, Mercer found. Greater responsibility and heavier workloads have caused many Canadian firms to follow the lead of the United States in offering higher retainers and fees. Its study found nearly half of all companies were making changes to director compensation, and another 27 per cent were considering it.

The average annual retainer paid to directors was $17,044 in 2001, with the range running between $2,570 and $77,420, according to a joint survey of governance and director compensation in Canada by Patrick O'Callaghan & Associates and Korn/Ferry International. The retainer average was up from $16,573 in the previous year's study.

On top of the retainer, directors were paid an average board meeting fee of $1,271, up from $1,185 the year before.

Stock options are declining in popularity for both executives and directors, as many see them distancing management's interests from shareholders.

"There are strong views regarding stock options, and some say they should be banned outright," Ms. Slipp says. Although she believes "most organizations will keep [stock options] as a tool," companies are reducing them or substituting rewards such as restricted share units.

The Patrick O'Callaghan and Korn/Ferry study found that 67 per cent of companies had some form of stock-based compensation for directors in 2001. But that was down from 83 per cent the year before.

Furthermore, the use of options fell -- to 67 per cent in 2001 from 70 per cent in 2000 -- while the use of shares and especially share equivalents was up. Share compensation rose to 26 per cent from 25 per cent, while share equivalents jumped to 39 per cent from 28 per cent.

As for executives, the huge cost of stock options became apparent a couple of years ago after some exercised them at levels previously unseen in Canada. John Roth, former chief executive officer of Nortel Networks Corp., exercised options worth a whopping $135-million in 2000, before the company's spectacular downward spiral.

"What did he know? It seems fairly clear that the holding of options is less appropriate than the holding of real stock," says Jeffrey Gandz, a professor at the Richard Ivey School of Business at the University of Western Ontario.

These days, many Canadian companies are paying close attention to their industries and performance in designing compensation and incentive packages.

Rick Mahler, chief financial officer of Vancouver-based Finning International Inc., says his company offers executives three kinds of compensation: salary, short-term incentives (bonuses), and long-term incentives.

Salaries are geared toward the 50th percentile of the industry, he says, and bonuses are based on company performance, return on equity and a "safety component." If the company achieves long-term objectives, salary and bonuses will move into the 75th percentile, he says.

Finning has stopped issuing stock options to executives in favour of deferred share units, which are performance-based, vested, and held until retirement from the company, Mr. Mahler says. Directors get deferred share units as well.

TransCanada PipeLines Ltd. CEO Harold Kvisle reports that loans are given to employees relocating back to Canada but not to the senior executive team.

"Beyond that, we are absolutely committed to paying competitive compensation measured against the industry, which you get out of proxy statements and salary surveys. If one of our senior executives performs well, we would pay that person [the industry] average; if they're in the 80th percentile [of performance], we pay in the 80th percentile."

Compensation levels are entirely driven by comparable salaries in the industry, and in areas where employees are based, such as Boston or New York, he adds.

TransCanada does give stock options, "but they're not an enormous amount of the package."

The Calgary-based company also offers a cash incentive plan to everyone from entry-level staff to senior management, says spokesman Glenn Herchak. It is based on an individual's or team's performance, the company's overall performance, and the performance of the industry. Measures are determined for each performance at the beginning of each year, and payments made if target levels are reached.

Calgary-based TransAlta Corp. doesn't offer stock options for either senior management or the board, says chief financial officer Ian Bourne. "In the case of senior management, we have a performance share-ownership plan, where senior leaders are compensated in stock."

At the beginning of each year, a target grant is awarded, and the final share award is given three years later, he says, based on the company's performance on share price and total shareholder return.

The cash incentive compensation is an annual payment, based on corporate financial results and sometimes sector results. "People who are involved in our power generation business would be getting compensated on the result of corporate results and generation results."

Board members are paid in cash and deferred share units. Directors and senior management all have a prescribed amount of stock they should hold relative to their base compensation rate, Mr. Bourne said. "We have a minimum holding of company stock," driven by the performance share-ownership plan.

Canada Life Financial Corp. president Bill Acton says stock options were introduced in 1999, when Toronto-based Canada Life Financial became a public company. "As it turns out, we've earned less there than under the old long-term incentive program, he says."

Bonus payouts are based on targets and industry benchmarks, Mr. Acton says. They are also based more on company results than on share price.

© The Globe and Mail

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