Thought Capital

There has been a major evolution in how institutional shareholders approach executive compensation and board governance matters over the last few years. The growing acceptance of investor stewardship principles have encouraged these investors to take a more proactive approach on these matters.

The 2015 proxy season has seen noteworthy developments among Canada’s largest issuers. Overall, CEO pay levels are flat year-over-year, while design modifications for short and long term incentives continue to evolve to better align pay outcomes with performance. Finally, shareholders and proxy advisors continue to exert strong influence on executive pay decisions, with three TSX60 issuers failing their Say-on-Pay votes.

Since the summer of 2014, oil and gas equities have seen a sharp selloff that will affect 2014/2015 executive pay decisions in several ways and may influence broader compensation plans in the long term.

Total Shareholder Return has a nice ring to it. And much to recommend it as a tool to guide CEO pay decisions. But boards that use it exclusively aren’t getting a complete picture.

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.

Shareholders are taking a much more active role in overseeing their investments, scrutinizing board oversight more closely. In order to enhance governance, and to ensure independence and diversity of skills, shareholders are encouraging boards to evaluate their members, their composition and their renewal process. At the same time, as the expectations placed on directors grow, shareholders are discouraging directors from joining too many boards.

Since the financial crises of 2008, there has been a lot of media and academic attention on mitigating against excessive risk-taking and addressing the problem of “short-termism” – pressure to produce short-term results. As it relates to equity compensation and short-termism, there is an argument that we have actually taken a step backwards – albeit unintentionally.

Reflecting our firm’s continued commitment to our shareholder engagement practice, Hugessen reached out to the shareholder community in the fall of 2014 looking to discuss the key areas of focus for the upcoming 2015 proxy season. Hugessen initiated 12 conversations with large Canadian institutional shareholders, including pension funds and asset managers representing total assets under management of $2 trillion (n=9) and advisors (n=3).

Proxy advisory firms Institutional Shareholders Services (“ISS”) and Glass Lewis (“GL”) recently released updates to their 2015 voting guidelines. ISS has not changed existing or adopted any new compensation-related policies. Glass Lewis has made two compensation-related changes: i) clarified an enhanced policy regarding one- time equity. grants, and ii) expanded the list of considerations that may mitigate an ‘against’ vote recommendation when a company fails their pay-for-performance (“P4P”) test. Both ISS and GL have amended policies related to director elections.

To date, stock options have been the dominant form of equity-based compen- sation (or “equity pay”) for small and mid-size publicly-traded companies in Canada. As a result, stock options are generally very well understood, and it has become relatively simple to design and administer these types of compen- sation plans.