Many large Canadian companies are breaching the Ontario Securities Act by failing to disclose to shareholders the details of their executive compensation policies for paying bonuses and awarding stock options, a Report on Business review has found.
As part of a broad study of corporate governance practices in Canada, ROB examined the compensation statements published in the annual shareholder proxy circulars of 207 companies listed on Canada's benchmark S&P/TSX index.
The review found that 14 per cent of companies did not mention any performance features that the board of directors considers when setting executive bonuses. And only 6 per cent of the companies reviewed by ROB received full marks for offering complete compensation statements, explaining all the features that determine chief executive officers' bonuses and including a weighting of each factor as well as the details of the specific performance achievements that had to be met for a bonus payment to be made.
John Hughes, manager of continuous disclosure at the Ontario Securities Commission, said his department reviewed all aspects of compensation disclosure last year, and found that the statements of compensation practices were the weakest element.
"This is where we most often found companies to be very deficient," he said. "I think a lot of companies don't realize how much specificity is required."
The securities act requires companies to publish a statement of their executive compensation policies in their annual proxy circulars. Among the items that companies are supposed to include are the specific factors on which the CEO's compensation is based, and the relative weight assigned to each criteria. The statement is also supposed to discuss "the specific relationship of corporate performance to executive compensation," and whether a CEO got a bonus despite not having met the company's performance criteria.
But many companies fail to meet these mandatory requirements.
The OSC examined the quality of these statements for 76 large companies last year, Mr. Hughes said. He said the commission found defects in 75 of them, and sent letters to the companies asking for improvements. He said the companies pledged to make improvements in their 2003 proxy circulars, but the OSC has not yet looked at those circulars to see whether those changes are adequate.
"Those narrative requirements in Form 40 are not some kind of esoteric securities law thing," he added. "They're actually very practical in what they are trying to do."
The OSC also published a staff notice late last year to explain the requirements and give examples of good and bad disclosure, but Mr. Hughes said the commission has not taken further action since then.
Compensation consultant Ray Murrill of Watson Wyatt Worldwide said his firm also examined compensation statements and found almost half didn't even say whether the company's bottom line profitability was considered a factor in determining whether to pay a CEO's bonus.
"In 48 per cent of cases there was nothing that they said that would let any shareholder have any clue as to how incentives were determined," Mr. Murrill said. "They didn't even mention the word profit, for example, just 'financial results.' What the hell does that mean?"
Many companies give shareholders only boilerplate commentary, explaining that executive compensation is set according to "industry norms," or at "levels capable of attracting, motivating and retaining" their executives. Many companies also say that bonuses reward "corporate performance" but offer little explanation of the detailed performance factors that are considered by the board. And even fewer companies outline the specific targets that must be reached before bonuses are paid.
David Beatty, managing director of the Canadian Coalition for Good Governance, which represents 23 major institutional shareholders, says he sees "a lot of lip-speak" about compensation being linked to good performance.
"When we did our rankings, we found there were a lot of companies that had their stock price down 25 per cent and compensation up 25 per cent," Mr. Beatty said. "So what is the actual linkage? And under what conditions would an executive not get a bonus?"
He said proxy circulars contain too many lengthy compensation statements that contain little more than generic comments.
"We're asking companies to give us the next layer of the onion. You say you link pay to performance, how do you do that? And how often is pulmonary success the only standard of achievement?"
This year, shareholders have launched battles to fight several companies' compensation practices.
At Magna International Inc., shareholders protested the enormous $31.5-million (U.S.) "consulting" fee paid last year to chairman and founder Frank Stronach, who lives in Europe. The Ontario Teachers Pension Plan Board withheld its votes for all of Magna's directors this year, complaining that the company's proxy circular offers no explanation of what Mr. Stronach does to earn that much money.
At Royal Group Technologies Ltd., shareholders protested the $5.6-million bonus paid to CEO Vic de Zen because the company's share price was falling sharply and it had missed earnings targets. Royal Group agreed to set up a committee, which recommended new compensation practices.
Royal Group said in its latest proxy circular -- published before the new policy was adopted -- that Mr. de Zen's only variable compensation, beyond his base salary, "is the amount which he determines in his sole discretion (without any reference or weighting to specific factors or criteria) subject to board ratification, to award himself as a bonus."
Michel Magnan, an accounting professor at Concordia University in Montreal, said he examined the compensation statements written by Nortel Networks Corp. and found that the company has often changed its compensation criteria. For the first half of 2001, Nortel said its corporate performance criteria for paying executive bonuses were revenue, share earnings, earnings per employee and customer loyalty. In the second half of 2001, the company said the bonus criteria were operating cash flow and customer loyalty.
In the first half of 2002, Nortel said its corporate performance objectives for bonuses were "earnings, market momentum/revenue, cash flow and customer loyalty." In the second half of the year, the criteria were "earnings and revenue, cash flow and customer loyalty."
In the end, no bonuses were paid for either period in 2001or 2002. Nonetheless, Prof. Magnan said frequent adjustments make observers cynical about CEO compensation.
"It's almost like you kind of wonder if it is circular -- if they change the measure to make sure [a CEO] gets a bonus," he said.
As well, he said he believes many companies disclose only vague criteria, such as the CEO's "personal leadership," because shareholders can't easily verify these achievements.
"It can mean anything. And that means even if you don't meet any of the measures you might get a big bonus," Prof. Magnan said.
"If it was too specific, then people could do 'one plus one equals two.' If it is fuzzy, then the board of directors has a way out. With these proxy statements, there are consultants involved, and attorneys. So the fuzziness is most of the time by design. That's the feeling I get."
Beverly Behan, a former securities lawyer who now specializes in corporate governance at Mercer Delta Consulting in New York, said it was standard advice to tell clients to keep disclosure to a legal minimum.
But she said times have changed and companies must provide far better disclosure. She said proxy circulars have become one of the most important documents a company issues and should not be treated like routine disclosure filings.
"People are reading proxies as much as annual reports. They're the fundamental disclosure document for a company, and they are the primary document people look at when assessing a company," she said.
"If you look at a proxy and there are vague statements about how you pay your CEO, people are going to wonder if there's a good process there or not. Give enough detail so people know it's real."
Quebecor Inc. has not faced a shareholder revolt over its compensation, and indeed CEO Pierre Karl Péladeau received no bonus last year, but Quebecor is a typical example of a company whose compensation statement says little about the company's performance requirements.
The statement says compensation policy "is designed to attract and retain key executives necessary for the corporation's long-term success and to motivate executives to meet the company's objectives." It also says that compensation "provides incentives tied to performance, according to overall corporate objectives and the objectives of the officers and their respective areas of responsibility."
As for Mr. Péladeau, the statement says only that his bonus is based on "predetermined financial results" and that if he exceeds them, his bonus could be as high as 160 per cent of his base salary. There is no comment on how the company's actual performance in 2002 stacked up against the company's unidentified targets.
Ms. Behan said many compensation statements are vague because the companies have vague systems for assessing CEO performance.
"Many CEO evaluation processes are shockingly informal," she said. "They are not terribly well thought through. And if you were really to hold these things up to the light, they could be very embarrassing for the board."
She said good assessment systems for a CEO include key corporate financial targets, as well as key operating targets that are relevant to the company, such as improving customer satisfaction or meeting research and development goals. She said good CEO assessments also include leadership factors, such as developing long-term strategy and fostering ethical behaviour.
Some companies' compensation systems reflect these sorts of assessment practices.
CFM Corp., for example, says in its annual proxy circular that five personal performance factors make up 50 per cent of each executive's target bonus, and says they are all specific and measurable goals. Corporate performance comprises the other 50 per cent.
CFM said its corporate performance target was to achieve share profit of $1.04 in fiscal 2002. The company said it met its share profit target, but only because of acquisitions it made during the year. As a result, the compensation committee decided to pay only 75 per cent of the maximum bonus.
Assante Corp. lists the four criteria that go into its bonus payments each year -- including operating profit, growth in assets under management and individual initiatives -- and publishes the weight each carries in setting the CEO's bonus. It also lists how the company performed against each target last year, and each target's resulting contribution to the bonus.
Some companies have bonus systems that are based on a simple percentage of corporate profits.
Stantec Inc.., for example, says CEO Anthony Franceschini receives 1.5 per cent of the company's annual pretax income, before deducting employee bonuses, as his annual bonus. International Forest Products Ltd. said that if it earned a pretax return on assets of more than 3 per cent in 2002, 10 per cent of pretax profits would be allocated to a profit-sharing pool for all salaried employees.
Shaw Communications Inc., for example, uses bottom-line performance criteria to calculate bonuses for most of its top managers. But executive chairman JR Shaw is not bound by those standards. Mr. Shaw has a separate contract that calculates his bonus as a flat percentage of the company's operating profit.
Although Shaw lost $288-million in fiscal 2002, because of huge writedowns and enormous interest costs on its debt, Mr. Shaw got a $6.3-million bonus because those charges are excluded from the calculation of operating profit.
Ms. Behan said companies must find compensation measures that adequately reflect performance.
"What we tell people to do is say: 'What are the key measures that are going to tell you that you are being successful in terms of executing your strategy? What is the bottom line? And what is taken out of some of these measures? And how important is it that that either comes out or stays?' "
A MATTER OF DISCLOSURE
Report on Business examined how well companies disclosed information to shareholders in their proxy circulars. Among the findings in the review of the 207 companies in the TSX/S&P index:
66% disclose how much they pay their auditor
37% publish director attendance figures
96% include a full statement of corporate governance
43% provide director biographies and also list other boards on which they sit
56% tell shareholders how often directors meet
3% do not have all their directors stand for re-election each year
Q. Last year, Pierre Karl Péladeau was paid $1.35-million. Frank Stronach was paid $33.2-million (U.S.). How did the boards of Quebecor Inc. and Magna International Inc. decide how much they were worth?
A. 'The company strives to offer global compensation which is competitive, taking into account compensation standards currently in force in the market, and which provide incentives tied to performance, according to overall corporate objectives and the objectives of the officers and their respective areas of responsibility. The annual bonus of the president and chief executive officer is determined based on the attainment of predetermined financial results.' - QUEBECOR PROXY CIRCULAR ON PIERRE KARL PELADEAU, CEO
A. 'Mr. Stronach's historical compensation reflects his special position as the corporation's founder and architect of Magna's unique, entrepreneurial culture. Mr. F. Stronach...provides business development and consulting services to Magna's European and other affiliates and co-ordinates global strategies.' - MAGNA PROXY CIRCULAR ON FRANK STRONACH, CHAIRMAN
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