Canadian HR Reporter

Canadian HR RepoRteR december 15, 2014 FeAtures 19 executive comPenSation Say on pay – or say on corporate performance? Shareholder perceptions, proxy advisory firms and director voting play a part in votes By Sarah Dobson s ay on pay (soP) has be- come an established prac- tice in canada, with many companies voluntarily allowing shareholders to vote on their ex- ecutive compensation packages. Over the past few years, 80 per cent of TSX 60 companies have adopted this policy and 120 held the vote in 2013, with support av- eraging about 90 per cent, accord- ing to Mercer. But are they really a reflection of C-suite compensation or are they more about corporate perfor- mance? And what kind of impact are these non-binding votes hav- ing on executive compensation? Linking votes e factors that lead to a negative vote tend to tie, in some respects, more to the shareholders' per- ception of company performance as opposed to the relation of the comp to company performance, says John Tuzyk, a partner at Blakes in Toronto. "So compensation, which is perfectly fine if things are going relatively smoothly, (is) not fine when commodity prices drop." In Canada, there's no question say on pay votes improved be- tween 2012 and 2013 when TSX performance also improved, says Michael ompson, a partner in Mercer's talent practice in Toronto. "e number of companies that have say on pay votes is increasing and companies who have say on pay votes don't want a failed vote, so if it's voluntary and you're going to bring it to market, presumably you're going to bring something pretty positive to market — so it may be kind of a self-fulfilling outcome." In looking at the United States, the higher the level of total share- holder return in the company, the higher the say on pay vote. "ere's no question it is a re- port card on both the design of the compensation programs and shareholders' satisfaction with performance," he says. "If you have say on pay vote in a year when you have bad financial results, your chances of being suc- cessful are probably slim unless you have a pay design that really demonstrates a material impact on the executive, to the negative." e first year Cameco ever held a say on pay vote, it had over- whelming support of more than 90 per cent, says Paul Grygle- wicz, managing partner at Global Governance Advisors in Toronto. e following year, there was the Fukushima earthquake and while the compensation elements didn't change, the vote changed. "ere's definitely a direct link between company performance and shareholder voting behav- iour," he says. "e end result is either the corporation that gets a 'no' vote, they either, at a mini- mum, they pick up the phone and they talk to those institutional shareholders more than they have, and that is a desired outcome of both parties." Compensation design, levels Considering the scrutiny, compa- nies are being more transparent and deliberate in executive com- pensation design. But could they be too restricted by the votes? Companies are trying to deci- pher the voting intention of the proxy advisory firms' recommen- dations and, therefore, intending to adopt cookie-cutter compensation plans to earn a positive vote from groups such as Institutional Share- holder Services (ISS), says Tuzyk. "Tailoring plans to a company's circumstances runs the risk of a negative ISS recommendation, which can lead to a significant although not majority withheld vote," he says. "To some degree, (companies are) reaching out to shareholders but I'd say the more predominant influence is what the proxy advisory firms recom- mend… to those shareholders." When companies change com- pensation programs specifically to meet say on pay tests, that's a bit problematic as they need to design programs that make sense for them, says ompson. For ex- ample, ISIS may look to the U.S. for comparator groups because there are too few in Canada. "By definition, it means you're always behind the eight ball… even though you've followed good governance process, even though you've been rigorous and bal- anced in the way you've identified your compactor group — it may not meet the test that ISS is fol- lowing to assess you." And while say on pay may not be meant to dictate pay levels, that still can happen, says Gryglewicz. In looking at the methodologies and math behind the recommen- dations of advisory groups, evalu- ations of peers can be problematic. "They are influencing how much you do end up paying be- cause they don't want you to pay too many percentage points out- side of what they would classify as your peer group, whether it's your peer group or not," he says. "ey look at it under one lens and they say, 'If you're paying too high, then we're going to mark you negative in that category.' So they are, in a way, trying to control pay levels." But say on pay votes don't seem to be having much of an effect on executive pay levels, says Tuzyk. "ey've got to be really, re- ally, really out of market and then, even then, tied to bad corporate performance. But for 95 per cent of companies, I don't think it's having any effect on levels." Pay levels have actually risen because of the exposure with say on pay, says ompson. A "perfect market of information" has been created, making it difficult for a board to negotiate with a CEO who knows about the compensa- tion of others in the industry. "If we really wanted to be more tough-minded and to create a sort of an outcome that resulted in decline of executive compen- sation…. you'd change disclosure because the absolute disclosure of individual compensation ele- ments has had no other effect oth- er than to increase compensation." Overall, say on pay is a very in- teresting approach to governance, he says. While shareholders have always had the ability to vote out directors or sell their shares if they don't like a company's program, process or performance, now they have this additional pro- cess around compensation, says ompson. "You kind of wonder where it fits relative to other things that they might also have a point of view about — they're not asking for a say on business strategy vote or financing strategy vote, they're asking for a say on compensation and I think that's a reflection of how significant the public optics are of inappropriate compensa- tion. And, for most companies, that's just not the case. For the vast majority of companies, boards have good governance around these processes, the design of pro- grams is completely transparent." Impact on directors e votes are having a significant effect on boards, according to ompson. "e say on pay vote is highly public — a failed say on pay vote is rare so the exposure's significant but, more than anything else, they just see it as an expected part of a good governance process," he says. "Corporate directors now are thinking about the proxy circular not just as a compliance docu- ment but as a communications document and so they're invest- ing in drafting these documents in a way which makes the mes- sages very clear and specifically addresses issues and concerns that shareholders may have about compensation programs so that the plans are as transparent as they can be and as understood as they possibly can be." Say on pay is also having a significant effect on directors with the introduction of individual di- rector voting. "e director who assumes the role of chair of the compensation committee tends to get the low- est support of shareholders as a director, so it's a bit of a cursed role right now… it really shouldn't be, it just needs a good strong person with the right knowledge to oversee the committee — it's a necessary evil," says Gryglewicz. As a result, companies will probably be adjusting pay levels for chairs of compensation com- mittees to reflect their growing responsibility. "ere's a pattern emerging for those directors that happen to sit on a committee that must be staffed properly with the right lev- els of skill, and that skill is going to be HR, legal, finance, industry, in that compensation committee... given this extra layer of individual voting risk," he says. With majority voting policies, it's more dangerous to be a direc- tor on a compensation committee than an audit committee, accord- ing to Tuzyk. "at's going to start to effect, and has begun to effect, how com- pensation committee members do their executive compensation process and make their executive compensation decision because they don't want to get a large with- held vote, frankly." But independent directors on compensation committees are far better-educated and more capable in dealing with executive compen- sation these days, says ompson. "ere's been a steep learning curve and they're all well-qualified to deal with issues now." SAP may not have prioritized it enough in the past, but the company is now in an acceler- ated mode, fast-tracking employ- ees and rounding them out, said Walsh. "We're looking at rotation pro- grams, putting them on challeng- ing assignments, social sabbati- cals… education programs," she said. "We're really looking at the multiplier effect, how do we make sure that we have that leadership culture... and we measure that through employee survey results." It's not apparent whether orga- nizations really understand what they want in leadership, said Potts. "Sometimes, we find it's dif- ficult to do the hard messages: 'Frankly, you're not going to make it.' We tend to shy away from de- livering those messages and it is a pyramid, in the end — there are only certain people whose roles and characteristics demand lead- ership and we should be ruthless- ly selecting the best. And I don't think we do." Skills gap When it comes to employee con- cerns, layoffs (18 per cent) are the least of their worries after obso- lescence (40 per cent), not enough opportunities for advancement (35 per cent), inadequate staffing levels (31 per cent), wage stagna- tion (27 per cent) and technologi- cal change and economic uncer- tainty (both 19 per cent), found the survey. "Employees are freaking out about their jobs going away," said Cone. "People are really con- cerned about getting left behind by a changing workplace, by tech- nology and by culture changes, globalization… and they don't feel that their companies can support them. "ere's a real anxiety out there among workers and a real hunger for leadership and development and training, and yet companies are having a hard time developing a learning culture." Newer ways of learning can be much more effective, user-friend- ly and less expensive than tradi- tional top-down training where you go off-site or pull everybody off work for a while, said Cone. "Instead, it's real-time, as-need- ed and peer-generated — I think that can be very powerful." e pace of change is just so fast now, it's about keeping up with what's going on, keeping up your skill set, said Potts. "I find it amazing when I go around businesses now to see how few of them have genuine knowl- edge-sharing, instant products in the way young people and all of us are used to using things like You- Tube," he said. "Businesses don't do it and they shy away from it... we've got to change very quickly how we think about learning and how we learn from each other." It's about the balance between being able to deliver your work and learning at the same time, which can mean giving people challenging assignments, with like-minded people, where they're evolving their skills, said Walsh. "We have to use multiple me- diums to be able to address the whole topic of learning." This is a huge challenge for companies, said Cone. "If you get this right, if you build that learning culture, it's not going to solve all your other problems but it's going to address each of those problems," he said. "It's going to help you with lead- ership, it's going to help you accli- matize and acculturate millen- nials, it's going to help you bring contingent workers in and edu- cate a generation of leaders, it's going to help people understand what's available to them and be a benefit to them." Developing a learning culture workForce < pg. 2 "corporate directors are thinking about the proxy circular not just as a compliance document but as a communications document."

• Cover