A better way to change executive pay

There is a highly standardized process behind the yearly executive pay packages that combine salary, bonuses, stock options, restricted stock grants, performance share units and retirement benefits. The full assemblage will include formal contracts covering change-of-control situations, termination conditions, and other considerations. Only the amounts of the compensation package vary from firm to firm. Whenever “long-term” performance objectives are set to earn the variable compensation, “total shareholder return” (TSR) is the metric of choice (for 70 per cent of TSX 60 companies in 2015).

It now takes some 34 pages on average to explain executive compensation. In 2000, it took all of six pages.

“How much is our CEO worth?” directors ask. “Well, let’s see what other CEOs of ‘comparable’ companies are paid.” A reasonable approach? Actually, no. Assembling a large number of companies from different industries, some U.S., some Canadian, and setting a particular CEO’s compensation at the median or the 75th percentile of these “comparable” companies’ CEOs is a recipe for ever-rising compensation. The unstated assumption, a dubious one, is that any of these “comparable” companies would recruit the CEO if he or she were not paid adequately.

Then this “competitively” set compensation is made largely “at risk” so as to motivate the achievement of high performances. Right? Not really. Performance measures are set by management (or largely influenced by them) and include a broad interval giving access, commonly, to 75 to 150 per cent of the bonus or performance shares (never, or rarely, zero per cent). Furthermore, shares have now largely replaced stock options. These shares have value even if the stock price goes down (which is not the case for stock options). Stock prices depend on many uncontrollable factors, which mean luck, good or bad, will play a significant role. Actually, good luck pushes up the value of the package; bad luck pushes the stock price down but the practice of yearly grants of stock options and shares will average out the effect of “bad luck.”

The compensation package, thus set, does not really please investors but they do not know what else could be done. Proxy advisory agencies, actually the fomenters of this standardized approach, will be favourable to the compensation levels if set according to their diktats. Say-on-pay voting will overwhelmingly support the pay package and the manner of its setting. (In 2016, only four companies of the TSX 60 received 20 per cent or more of negative votes.)

The ritualized process described here is indeed reassuring by virtue of the large