When executive operational performance and market returns are out of sync, what’s a compensation committee to do? Check and recheck the pay-for-performance rationale and share it with shareholders.

As with all commodity players, mining companies are largely price takers, subject to price swings reflecting global macroeconomics, geopolitical forces and changes in underlying supply and demand over which management have no control. Moreover, absolute share-price performance among the miners is influenced by global fund flows and asset allocations as much, and possibly more, than a company’s actual performance. This was evident once again in 2014, another difficult year for the sector. Slowing demand growth from emerging markets, together with a “risk off” trade during the year made for weak sector performance, with the S&P TSX Global Mining Index falling 21.8% in 2014.

Once again directors are in a tough spot, particularly those on the boards of companies that, by virtue of their capital/operating cost discipline and business strategy, outperformed peers but still suffered negative returns. In these situations, results under a short-term incentive program, capturing annual financial and operating performance, may indicate target or above target performance, seemingly at odds with the shareholder’s recent experience. How then can a board justify to themselves and to shareholders that incentive programs are working and that pay and performance are aligned, when operational measures and shareholder returns are so badly out of sync?

Getting it right under these circumstances takes hard work and thoughtful judgment. The theory behind building the best incentive programs is simple. They should contain those measures most correlated to long-term value creation, that are easily measured, difficult to manipulate and over which senior management has a clear line of sight. In practice, of course, this is extremely difficult, especially in a commoditydriven business. “Controllables” are mostly limited to capital efficiency, achievement of strategic milestones and cost minimization. Standard accounting return measures (such as ROE and ROA) are easily influenced by less than shareholder friendly situations such as high debt and large asset write-offs. Furthermore, given the long capital expenditure lead times characteristic of many mining projects, the “right” metrics can be elusive. In reality, ascertaining whether value is being created is always difficult, and most performance measures are only approximations for underlying returns and value.

Consequently, boards need to be involved and informed throughout the performance setting and assessment process, digging into the numbers to develop a clear understanding of performance, and whether pay outcomes are aligned, so as to apply their informed judgmentjudgment on their results and implications for management incentives. Once a board is satisfied that incentive programs are driving longterm value creation, this needs to be clearly conveyed to shareholders. Increasingly, boards engage directly with major shareholders and proxy advisers to explain the company’s compensation approach. Furthermore, compensation committees will craft a “Letter to Shareholders” to articulate highlights of the pay-for-performance narrative; the company’s strategy, its performance and how this informed pay decisions. A clearly written letter can be very useful, as it sets the tone for the rest of the CD&A. During the busy proxy season, proxy advisory firms will rarely look beyond the contents of the circular. While clear and convincing rationale behind pay decisions may not affect quantitative tests, it can certainly

Getting pay and performance right in a commodity-driven business is tough. Ascertaining whether value is being created is always difficult, and most performance measures are only approximations for underlying returns and value.

influence how shareholders and their advisers respond to the results. In challenging markets, when operational performance appears out of sync with share price and commodity price movement, the board’s role in monitoring the outcomes of pay programs, assessing performance and articulating the rationale behind incentive programs to shareholders is even more critical. There are no simple answers. The best a board can do is to confirm that incentive programs and outcomes have sound rationale and that management is being rewarded appropriately for achieving goals that drive long-term value—and then thoughtfully articulate to shareholders in the CD&A the board’s decision and its pay-for-performance rationale.