It was a bitterly cold February morning in Toronto just over a year ago when Gary Hawton witnessed a miracle. As CEO of Meritas Mutual Funds, a socially responsible investing company in Kitchener, Ont., he had been watching executive pay levels surge from generous to ridiculous over the last 15 years, and he’d had enough. As of 2007, the collective compensation of Canada’s 100 best-paid CEOs had crashed through the billion-dollar mark, and average individual pay packages were topping $10 million apiece. As a professional investor, Hawton knew that most CEOs were simply not worth that kind of money.
He sent letters to all the big Canadian banks asking them to allow shareholders to vote on CEO pay packages. He spoke out at shareholder meetings and talked up the issue to the press. At first, he was completely ignored. But Hawton, a former investment banker raised with strong Christian values, is a bit of a crusader. So last year, he decided to try a different strategy. He would introduce a shareholder’s motion that, if passed, would pave the way for a vote on executive pay whether the banks liked it or not. He knew it was a long shot. He knew it would take at least two years, quite a lot of money and infinite reserves of patience. He also knew that his mission would quite likely make him the financial world’s Don Quixote.
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Lone investors generally don’t stand a chance when taking on entrenched corporate directors. But lately it has begun to seem that maybe, just maybe, the executive compensation windmill was ready for a fall. As the recession drags on and real suffering sets in among working Canadians, mind-boggling pay packages for CEOs have triggered a palpable rage in the public and considerable uneasiness among the lucky few in the top tier. The Canadian Centre for Policy Alternatives recently calculated that after a bit more than a day of work, the average top-100 CEO has already earned more than the average Canadian worker will earn in a full year.
It’s not just the absolute amounts that are head-spinning, it’s the rate of increase. Between 1998 and 2007, after accounting for inflation, the average weekly wages and salaries of regular Canadian workers actually declined by a few percentage points. But real pay for the best-paid CEOs in the country exploded by about 145 per cent. By 2007, CEOs were making an incredible 259 times the pay of the average worker. “At what point does it stop making sense?” asks Hawton. “Is it really possible that someone is truly worth that amount? Is the average CEO really contributing 259 times more to the company than the average worker?”
That question was very much on his mind as Hawton sat in a ballroom at the plush Fairmont Royal York hotel in Toronto for CIBC’s 2008 annual shareholders meeting. He had a motion on the ballot asking the bank to give shareholders a non-binding say on executive pay, and if he managed to get six per cent of the shareholders to go for it, he could come back with a second motion in 2009. But when he tabled his proposal, there wasn’t exactly a groundswell of support. No other investors called to say they were onside, and CIBC’s directors made it clear they were dead set against it. “I remember sitting there and having no idea what the level of support for it would be,” Hawton says. As he waited for the results, he turned to the person next to him and nervously asked, “So, do you think we’ll get six per cent?” And then he heard a number that floored him: 45 per cent of the shareholders had supported his motion.
A year later, he flew to Vancouver for the follow-up vote at CIBC’s 2009 annual general meeting. Again, he enjoyed stunning success. A full 53 per cent of voters supported the second motion, finally allowing shareholders to have what’s called a non-binding “say on pay.” As he says, to win a motion that the board opposes is unheard of. “I can’t think of a time when I’ve seen it happen in Canada,” he says. “Ever.”
CIBC was just the first to fall in line. Within a month, every one of Canada’s big five banks had announced that they would allow say-on-pay votes—lest they be forced into it by shareholders. Since then, corporations such as TMX Group Inc. and Potash Corp. have adopted similar motions. SunLife Financial has announced it will adopt the policy soon, as has Bell Canada parent BCE. Manulife, which at first took an “over my dead body” approach to the issue, suddenly changed its mind a couple of weeks ago and will allow a vote on executive pay next year.
It’s gotten to the point where even the CEOs themselves are admitting that they make too much. For years, boards have defended their sky-high salaries by arguing that they’re based on complex formulas tied to the performance of the company. But earlier this year, the bank bosses looked around at the faces of angry shareholders and threw all that out the window, rejecting the board’s carefully engineered figures and setting their own pay at much lower levels. Dominic D’Alessandro, Manulife’s CEO, did a similar about-face just weeks ago. When critics first asked him to consider returning some of the $15-million payout he was to get for his last five months of work this year before he retires, he said, “I’m not given to self-serving gestures.” Then, just weeks ago, he suddenly changed his tune, announcing that he’ll defer 80 per cent of that pay in a scheme that could see him lose it altogether unless Manulife’s stock, which has been cut in half since last year, rebounds considerably.
Diane Urquhart, an independent financial analyst and shareholder advocate based in Mississauga, Ont., says that CEOs such as D’Alessandro are genuinely surprised at the outrage they provoke, because they truly believe they deserve their windfalls. “An intense greed has seeped into the upper echelons for corporate society, and these CEOs have lost touch with reality,” she says. “They do think they’re entitled, and all the people that they surround themselves with are of a similar mindset. So there’s no one there to put the brakes on that psychology.” Still, she adds, “There are now some slivers of hope that people are beginning to push back.”
The question is whether the impulse for change will last. Investors have grumbled about fat executive paycheques for years, even as the payouts have accelerated. But these are not typical times, and thanks to outrageous bonuses given to executives at AIG, Fannie Mae, and other large American firms, executive pay is now a political issue on the international stage. In the U.S., President Barack Obama is talking of placing caps on executive pay, while some economists are even blaming executive greed for fuelling the worldwide economic meltdown. A few scattered Don Quixotes may have triggered a global reform movement, aimed at turning back the clock on executive pay by decades.
Executives have always been well-compensated, but the era of celebrity CEOs and obscene wealth is a relatively new phenomenon. Ironically, the explosive inflation in executive pay can be traced to two regulatory changes introduced almost 15 years ago, with the aim of protecting investors, says Christopher Chen, a compensation consultant with the Hay Group.
The first change was to begin publicly disclosing executive pay. It used to be that CEO pay rates were kept under wraps, so consultants like Chen would make educated guesses on what other CEOs were making, then advise their clients on an appropriate rate. “It was a black-box art,” he says. But in the mid ’90s, as stock prices started to balloon, so did CEO pay. In an effort to keep it under control, regulators in the U.S. and Canada began demanding that companies disclose how much top executives were pocketing. Soon after that, the U.S. also removed the tax-exempt status of executive pay over US$1 million. Both moves were intended to curb skyrocketing pay, but they achieved precisely the opposite effect.
Making CEO pay public led to the “Lake Wobegon effect,” says David Lynn, a U.S. partner at international law firm Morrison & Foerster. Named after the fictitious town of Lake Wobegon from the American radio series A Prairie Home Companion, where “all the women are strong, all the men are good-looking, and all the children are above average,” this effect describes the natural human tendency to rate ourselves above the pack. Since the boards of directors at most companies like to think that their CEO is “above average,” it only seemed fitting that their CEO’s pay should be above average too. Unfortunately, when every company pays its CEO an above-average salary, that average starts to move up in a hurry. In other words, says Chen, “the rising tide lifted all boats.” According to the International Institute for Labour Studies, in just the four years between 2003 and 2007, CEO pay in the U.S. shot up by 45 per cent.
A huge amount of that inflation was rooted in the rise of stock options. When the government removed the tax-exempt status of cash payouts over US$1 million, corporate boards shifted the majority of executive pay from cash to options. This was initially seen as a good thing. If a company did well, then its stock price would go up and the options would be worth more. But while it sounded good in theory, Lynn says that in practice it led to CEOs pumping the next quarter’s results at all costs, even if it meant fudging the numbers. “It had the unfortunate effect of causing scandals like WorldCom and Enron and all these major meltdowns that resulted from executives being focused on trying to boost their stock price,” he says.
As companies moved from cash compensation to increasingly elaborate pay structures, the true level of pay became ever more difficult to grasp. Today’s packages generally include base pay, stock options, restricted shares, annual bonuses, special bonuses, golden handshakes, golden parachutes and accelerated supplemental pensions. Lynn says that sometimes not even the boards of directors who set the pay levels know what they’re on the hook for. “Compensation decisions are typically made piecemeal,” he says. “At one meeting they might make the decisions as to equity grants, and then six months later they might make the decisions on performance goals for an incentive plan, and then at another meeting, they’ll discuss salary.” At every one of those meetings, the total pay package tends to get fatter.
The shareholders are supposed to act as the safety valve on all of this. If executive pay gets out of hand, then as the ultimate owners of the company, shareholders have the power to vote out the board of directors. However, Stephen Griggs, executive director of the Canadian Coalition for Good Governance (CCGG), which represents institutional investors controlling about $1.3 trillion, says the system for electing those boards doesn’t resemble anything most people would call democracy—unless you happen to be Kim Jong Il. “The main problem is that the vast majority of boards will have a nominating committee that sets a slate of directors,” he says. “And shareholders then either vote for that slate in its entirety, or their only other legal option is to withhold their vote. So you can have a scenario where a nominating committee puts whoever they want onto that slate, and as long as a single shareholder votes for that slate—even if you have 99.9 per cent of shareholders withholding their votes—then that slate is still elected.” It would be like introducing new rules for our next federal election that state you can either vote for Stephen Harper, or not at all. And as long as one person votes for him, he wins.
This is vexing enough when a company is performing well, but in recent years there have been several examples in which top executives have walked away with massive payouts despite mediocre to poor results. When Michael Sabia stepped down as CEO of BCE, his plan to sell the company to private investors had fallen apart and the stock was pretty much right where it was when he took the job six years earlier. Yet he still walked away with a $21-million package. Robert Prichard is leaving Torstar next week with almost $10 million, even though the company’s stock has been cut by two-thirds under his watch. Hydro One CEO Tom Parkinson received more than $4.8 million on his way out the door, even though he left under a dark cloud following a scathing report on the company’s billing practices by Ontario’s auditor general. Just last week, the executives who sit on Ottawa’s Public Sector Pension Investment Board, which has lost billions of dollars of federal government workers’ pension money, declared that they would not rule out awarding themselves huge bonuses for their sad accomplishment.
Given that CEOs and directors make the rules, it shouldn’t come as a shock that they’ve stacked the deck in their favour. But while this used to be a problem just for shareholders, it’s increasingly becoming a problem for everyone. Many are now saying that the reckless pursuit of short-term corporate profits over the past few years—much of it fuelled by outlandish executive bonuses and stock option packages—is largely responsible for the crisis that’s crippling the global economy. At the recent G20 summit in London, the Financial Stability Forum, which includes central bankers and other major national financial authorities from around the world, delivered a stinging rebuke of the prevailing compensation culture among CEOs, and urged sweeping reforms to rein in runaway pay.
Luis Navas, who runs independent compensation advisory firm Global Governance in Toronto, says that if they’re not careful, CEOs could soon find the government getting involved. “Finally, it looks like they want to regulate the compensation process and create accountability,” he says. “They’ve actually come out with worldwide regulation regarding executive compensation, and Canada’s head of the Office of the Superintendent of Financial Institutions was part of it.” In its own formal and diplomatic way, the Financial Stability Forum expresses the very same exasperation that millions of angry workers have been expressing for years: it’s not right that CEOs can ratchet up their salary when times are good, and then keep their bonuses when times are bad. But it’s more than unjust, says the forum, it’s dangerous. After all, if you got huge bonuses when your stock went up, but lost nothing when your stock tanked, you’d bet the house every time. As the report puts it, “compensation must be symmetric with risk outcomes.” The “asymmetry of bonus practice,” it says, “encourages taking of excessive risk.”
Navas, Griggs and Hawton all agree that given the current state of economic affairs, the political and social will is finally here to make real, lasting changes to executive pay. The more difficult question is: how? The Financial Stability Forum plan is a good start, and Navas agrees with many of its recommendations. He’s particularly keen on regulating firms such as his own, which advise boards on setting executive pay. Right now, anyone can put out a shingle and start advising boards for $700 an hour, and the profession is known for its yes-men, who were famously mocked by Warren Buffett when he described the fictitious consulting firm of “Ratchet, Ratchet and Bingo” a few years ago. As Navas says, “Auditors, doctors and lawyers are monitored. So why not us?”
Ed Woolard, the former CEO of Dupont and past chair of the New York Stock Exchange’s compensation committee, also has a few ideas. In a speech to corporate directors a few years ago, he set out a blunt plan for addressing an issue that “has eroded the trust and confidence in American business leaders.” In his speech, he attacked the time-worn excuses given for lush pay packages one by one. CEO compensation is driven by competition? “Bull,” he said, arguing that directors needed to tie CEO pay to the pay rates of other executives within a company, rather than competing for higher pay with the CEOs of other firms. Compensation committees are independent? “Double bull,” he retorted, suggesting that the committees should deal only with outside consultants who are not allowed to talk to anyone at the firm, including the CEO. What got him the most riled up though, was the idea of paying CEOs huge severance packages for failing. “No one else gets paid excessively when they fail,” he said pointedly. “They get fired.”
Navas says it’s all got to come back to accountability. The simple truth is that many CEOs will set their pay as high as they can, unless someone stops them. That’s where the shareholders are supposed to come in, which is why Gary Hawton’s mission to give them a voice is so important. Hawton’s say-on-pay movement will help because, while the votes are non-binding, such votes won’t allow the boards to maintain the illusion that shareholders are okay with outlandish pay packages. In the U.K., where say-on-pay has been standard for years, Navas says the votes haven’t lowered CEO pay rates across the board, but they have helped to solve the most galling problem: bad CEOs who still reward themselves with huge bonuses.
So far, Meritas and other investment firms have managed to pressure more than a dozen big blue chip companies into allowing say-on-pay votes at shareholder meetings. Hawton’s next step, he says, is to convince the Canadian Securities Administrators to enact new regulations that would force every public company in Canada to adopt say-on-pay.
These days activist shareholders like Hawton are looking less and less like Don Quixotes, and more and more like trailblazers. Hawton says he was taught long ago that unbridled greed inevitably leads to disaster, and while that kind of thinking seemed almost heretical a few years ago, today it’s hard to argue with. Hawton still believes in capitalism, he says. He still believes in compensating executives well for a job well done, and he believes in the free market. “But there has to be balance, too. It’s not just how much money you make—it’s how you make it.”
ALSO AT MACLEANS.CA: Canada’s Top 50 CEOs and their astronomical take-home pay increases