2020 Executive Compensation Amid Market Uncertainty

Effects of COVID-19 on Executive Compensation

With a global pandemic upon us, the world is a very different place, at least right now. However, just like there is no need to hoard cans of tuna and cases of toilet paper, we at GGA believe that it is not advisable at this juncture, to call off your organization’s executive compensation program plans for 2020. In fact, it is times like these that corporate governance, risk management, technology and innovation and board oversight are imperative to preserving shareholder value, while also and most importantly ensuring the health and safety of our employees. 

What we know from other market crises, is that corporate governance and executive retention are high on the list when navigating black-swan events.  If there ever was a black-swan event, COVID-19 may have now assumed the definition. 

We suggest that as long as the Board and/or the CEO maintains the ability to use their judgment on implementation timing, eligibility, etc., for example, then plans should proceed. There are obvious exceptions to this where an organization may not have the available cash flow due to this ‘black swan’ event (e.g. airlines, tourism companies, etc.).

In the interest of brevity, this piece is meant to cover only high level corporate governance and retaining key talent, but we understand that there are broader considerations when factoring in an organization’s complete workforce as many companies may have to layoff some of their staff due to decreased demand for their products/services and the corresponding decrease in cash flow for the business (as we write this a number of immediate family members and friends have already been impacted directly). While we cannot predict the future, we at GGA can share our observations within the marketplace and areas for consideration as boards make decisions over the next few months relating to corporate governance and executive compensation. So far, within the mining and broader commodity businesses, we have seen some proposed delays in work or a cautious movement forward, as planned. 

Areas for consideration during these difficult times include:

Board Oversight

Businesses are continuing to try to make the best of a bad situation and effective corporate governance needs to continue, within reason, in the same spirit, to ensure effective oversight of the organization. How easily is your board able to meet remotely as opposed to in-person? What decisions can be made via consent resolutions versus requiring a full meeting? Have you stress tested the impact of black swan events on your company’s operations? What plan do you have in place to deal with black swan events in a crisis and who is responsible for what?

Retention of Key Talent

Strategies for attraction and retention of executive talent are critical as even in immediately affected companies, the demands on executive teams are typically extremely high, more so than in normal market conditions, to chart out a path forward. If your board has observed a gap to market from a pay perspective, how are you going to let your executive team know that you recognize this gap, but also are taking into account the current market conditions? Some organizations will choose to “stay the course” and implement any compensation adjustments that were determined at the past meeting. Others may choose a more conservative route and announce salary freezes or even rollbacks, depending on the cash flow concerns of the business. A good middle ground might be to approve compensation adjustments in principle but hold off on formally enacting the adjustments for a few months until market conditions have stabilized and better financial projections can be made. In terms of Long-Term Incentive (LTIP) grants, previous grants may have been made at significantly higher share prices so you must also consider what value, if any, executives still have within their LTIP and what the prospects are for this value to rise over the next few months or even years. If you are only granting Stock Options, is there a chance for underwater options to get back in-the-money or is the probability low? If the probability is low, then executives are a flight risk as competitors will be able to offer them new LTIP grants at significantly lower exercise prices than if they stay with your organization. This may necessitate discussion on the need for new retention grants which can be made at a lower share price and increase the likelihood of long-term value to executives, thus acting as a retention device during this period.

Retention Strategy

While retention LTIP awards seem like a good idea in the current environment, these awards must be balanced with the equity dilution level of the organization under its existing equity compensation plans. At lower share prices, the level of equity dilution can increase dramatically and use up much needed room for LTIP grants in the future. In a time like this, stress testing of the impact on equity dilution levels of proposed grants is an important step that boards must conduct before approving regular or retention-based LTIP grants. If proposed grants are too dilutive then consideration of a fixed number of options or units to be granted, that will allow an organization to retain room for future grants, is something that should be considered in the interim until market conditions stabilize. For many organizations, dilution will also not support additional retention awards, so a board may need to consider a performance cash based award, that is granted outside of the shareholder approved equity plan. At all costs, while option surrender programs continue to be allowed by the regulator, categorically shareholder advisory firms consider this an option re-pricing problematic pay practice.

Performance Evaluation

If performance expectations under the Annual Balanced Scorecard have already been approved, the Board should evaluate the performance expectations set and determine whether those expectations are still reasonable in the ever-evolving environment. If expectations are now deemed to be unreasonable in the Board’s view, consideration of revised performance targets based on the new reality should be discussed to ensure executives are still motivated to achieve important objectives over the remainder of the year.

Remember that while retaining key talent is imperative and in shareholders long-term interests, the board must also give consideration to the shareholders who have potentially lost material amounts of their portfolio.  These executives are tasked with not only mitigating the financial blow in the downward market, but also to generate value when markets return.  Ensure your board is not making compensation decisions in a vacuum during these challenging times.  Seek the independent support necessary to give appropriate back testing and scenario analysis prior to making any potential retention decisions.

Contributing Authors:

Paul Gryglewicz, Senior Partner
Arden Dalik, Senior Partner
Peter Landers, Partner

ISS 2020 Policy Guidelines for the U.S.

Summary of 2020 Guidelines

On November 12, 2019 Institutional Shareholder Services (“ISS”) published their Americas Proxy Voting Guidelines Updates for 2020 for the Americas region, which includes the United States and Canada. While GGA has summarized updates directly affecting Canadian-listed companies in a separate blog post, we are summarizing the key updates affecting U.S.-listed companies as it relates to compensation and governance below. These updates will impact any shareholder meetings held on or after February 1, 2020. 

The updates are generally split into six separate categories:

  1. Voting on Director Nominees in Uncontested Elections (several updates)
  2. Independent Board Chair Proposals
  3. Share Repurchase Programs
  4. Equity-Based Compensation Plans – Evergreen Provision
  5. Diversity – Gender Pay Gap
  6. Pay-for-Performance Analysis

GGA’s summary of each change is provided below.

Voting on Director Nominees in Uncontested Elections

Exemptions for New Nominees

ISS clarified that they will now consider new director nominees on a case-by-case basis with a “new nominee” being a director who is being presented for election by shareholders for the first time. Vote recommendations for “new nominees” will generally depend on the timing of their appointment to the board and the problematic governance issue in question. This will include whether a director has been on the board long enough to be held responsible for a problematic governance issue at the company. On a related note, this “new nominee” exemption is being moved to the beginning of the Director Election section from Accountability, as it may be applied to other policies in the other ISS evaluation pillars of Independence, Responsiveness, and Composition.

Board Composition – Attendance

ISS also clarified its policy for director nominees who served only for part of the fiscal year. This includes nominees who may have been appointed to the board a few months prior to the first annual meeting that they are to be elected by shareholders at. In these cases, it is to be expected that a nominee would not have attended all meetings throughout the fiscal year and therefore ISS’ 75% attendance threshold should not apply.

Board Composition – Diversity (Russell 3000 or S&P 1500 Companies)

ISS has stated that they will generally vote “Against” or “Withhold” for the Nominating Committee Chair (or other directors on a case-by-case basis) at companies where there are no women on the company’s board. Mitigating factors that could lead to a For vote recommendation include:

  • Until Feb. 1, 2021, a firm commitment within the proxy statement to appoint at least one woman to the board within a year;
  • The presence of a woman on the board at the preceding annual meeting and a firm commitment to appoint at least one woman to the board within a year; or
  • Other relevant factors, as applicable.

The one-year transition period to appoint a female director provided by ISS has now passed, so even making a commitment to appoint at least one woman to the board within the next year will only act as a mitigating factor for 2020 for those companies who have had no women on their board previously.

In addition, for those companies that had at least one woman on their board in previous year, but not the current year, the company will clearly have to acknowledge the current lack of diversity on their board and provide a clear commitment to re-achieve a level of board gender diversity within the next year.

A “firm commitment” is defined by ISS as a plan, with measurable goals, outlining the way in which the board will achieve gender diversity.

Board Accountability – Problematic Governance Structure at Newly Public Companies

ISS has clarified its policy in two areas for newly public companies. One update states that ISS will generally vote “Against” or “Withhold” from directors individually, committee members or the entire board (except for new nominees who should be considered on a case-by-case basis), if prior to or in connection with a company’s public offering, the company or its board adopted the following by-law or charter provisions considered materially adverse to shareholder rights: 

  • Supermajority vote requirements to amend the by-laws or charter;
  • A classified board structure; or
  • Other egregious provisions.

ISS has noted that a reasonable sunset provision (7 or less years at the most) will be considered a mitigating factor when making their vote recommendation. In subsequent years, unless the adverse provision is reversed or removed, ISS will vote case-by-case on director nominees.

ISS’ second update states that for newly public companies, they will generally vote “Against” or “Withhold” for the entire board (except new nominees, who will be considered on a case-by-case basis) if, prior to or in connection with the company’s public offering, the company or its board:

  • Implemented a multi-class capital structure in which the classes have unequal voting rights without subjecting the multi-class capital structure to a reasonable time-based sunset.

They clarify that in assessing the reasonableness of a time-based sunset provision, consideration will be given to the company’s lifespan, its post-IPO ownership structure and the board’s disclosed rationale for the sunset period selected. A sunset period of more than seven years from the date of the IPO will not be considered reasonable.

In subsequent years, unless the problematic capital structure is reversed or removed, ISS will continue to recommend a vote “Against” or “Withhold” their vote from incumbent directors.

Board Accountability – Restrictions on Shareholders’ Rights 

ISS clarified its policy around restricting binding shareholder proposals to state that they will generally vote “Against” or “Withhold” its vote for Governance Committee members if the company’s governing documents impose undue restrictions on shareholders’ ability to amend by-laws. Undue restrictions include, but are not limited to:

  • Outright prohibition on the submission of binding shareholder proposals or share ownership requirements, subject matter restrictions or time holding requirements in excess of SEC Rule 14a-8.

If this restriction is not amended or removed, ISS will recommend an “Against” or “Withhold” vote on an ongoing basis.

ISS has also clarified that submission of management proposals to approve or ratify requirements in excess of SEC Rule 14a-8 for the submission of binding bylaw amendments will generally be viewed as an insufficient restoration of shareholders’ rights. Therefore, ISS will continue to recommend a vote of  “Against” or “Withhold” for Governance Committee members on an ongoing basis until shareholders are provided with an unfettered ability to amend the by-laws or a proposal providing for such unfettered right is submitted for shareholder approval.

Independent Board Chair 

ISS has stated that they will generally vote For on shareholder proposals requiring that the Board Chair position be filled by an independent director when the scope and appropriate rationale for the proposal is provided, in addition to other considerations. They have also clarified that the following factors will increase the likelihood of a For recommendation on the proposal:

  • A majority non-independent board and/or the presence of non-independent directors on key board committees;
  • A weak or poorly-defined lead independent director role that fails to serve as an appropriate counterbalance to a combined CEO/chair role;
  • The presence of an executive or non-independent chair in addition to the CEO;
  • A recent recombination of the role of CEO and chair; and/or departure from a structure with an independent chair;
  • Evidence that the board has failed to oversee and address material risks facing the company;
  • A material governance failure, particularly if the board has failed to adequately respond to shareholder concerns or if the board has materially diminished shareholder rights; or
  • Evidence that the board has failed to intervene when management’s interests are contrary to shareholders’ interests.

This view continues the evolution in North America thinking towards separating the Board Chair and CEO roles, which GGA has observed in recent years.

Share Repurchase Programs 

ISS has added new language relating to share repurchase programs stating that for U.S.-incorporated companies, and foreign-incorporated U.S. Domestic Issuers that are traded solely on U.S. exchanges, ISS will recommend shareholders vote “For” on management proposals to institute open-market share repurchase plans in which all shareholders may participate on equal terms, or to grant the board authority to conduct open-market repurchases, in the absence of company-specific concerns regarding: 

  • Greenmail;
  • The use of buybacks to inappropriately manipulate incentive compensation metrics;
  • Threats to the company’s long-term viability; or
  • Other company-specific factors as warranted.

ISS will also vote case-by-case on proposals to repurchase shares directly from specified shareholders, balancing the stated rationale of the company against the possibility for the repurchasing authority to be misused, such as to repurchase shares from insiders at a premium to market price.

Equity-Based Compensation Plans – Evergreen Provision

ISS has updated its list of overriding factors that will apply under the Equity Plan Scorecard analysis to include plans that contain an evergreen (automatic share replenishment) feature. This means that for those U.S.-listed companies that have historically had an automatic share replenishment feature in their formal plan documents, if that feature is not removed then ISS will recommend a vote “Against” the equity plan proposal.

GGA notes that this could lead to a lot more “Against” vote recommendations from ISS than in the past as we have noted many U.S. companies that include these automatic share replenishment features within their plans, so is something for U.S. companies to be mindful of when putting their equity compensation plans up for a shareholder vote at the annual meeting.

Diversity – Gender Pay Gap 

ISS has stated that it will generally vote on a case-by-case basis on requests for reports on a company’s pay data by gender, race or ethnicity, or a report on a company’s policies and goals to reduce any gender, race or ethnicity pay gap. While gender was included in this policy before, race and ethnicity have been added for 2020 within the policy.

ISS has also included whether the company has been the subject of recent controversy, litigation, or regulatory actions related to race or ethnicity pay gap issues; and whether the company’s reporting regarding race or ethnicity pay gap policies or initiatives is lagging its peers. This is in addition to ISS’ historical inclusion of gender pay gap issues in its considerations as well.

Pay-for-Performance Analysis 

Use of EVA as New Executive Compensation Metric to Replace GAAP-Based Metrics

Starting in 2020, ISS plans on incorporating a new performance metric (EVA) into the financial performance assessment, replacing the GAAP-based metrics used in 2019. Accordingly, EVA performance will now affect the quantitative pay-for-performance analysis and Say on Pay recommendations for the 2020 proxy season. GAAP-based metrics will continue to displayed within ISS reports for information purposes.

As a reminder, EVA will be calculated as follows by ISS:

EVA = Net Operating Profit after Taxes – (Cost of Capital * Capital)

ISS will look at EVA in four different ways as part of its analysis:

1) EVA Margin – EVA as a Percentage of Sales
2) EVA Spread – EVA as a Percentage of Capital
3) EVA Momentum (Sales) – Annual change in EVA Margin
4) EVA Momentum (Capital) – Annual change in EVA Spread

These four measures will then be weighted and compared to the same overall performance of the selected peer group for an issuer.

Further clarification of these calculations are expected from ISS in the months ahead leading up to the adoption of these changes for issuers with meetings falling on or after February 1, 2020.

Changes to Quantitative Pay-for-Performance Thresholds 

ISS has also updated its pay-for-performance thresholds relating to their Relative Degree of Alignment (RDA) and Pay-TSR Alignment test as follows:


2019 vs. 2020 Quantitative Pay-for-Performance Thresholds: All U.S. Companies

Measure Policy Year Eligible for
FPA Adjustment
Medium Concern High Concern
RDA 2019 -28 -40 -50
2020 -38 -50 -60
Pay-TSR Alignment 2019 -13% -20% -35%
2020 -22% -30% -45%

The Multiple of Median (MoM) thresholds will not change in 2020.

Addition of 3-Year Multiple of Median View of CEO Pay for Information Purposes

ISS has also indicated that their research reports will now feature a 3-year MoM view of CEO pay as a measure of long-term pay on a relative basis against an issuer’s ISS peer group. The 3-year MoM analysis will not be a part of the ISS quantitative screen methodology, but will be displayed in ISS reports for informational purposes only.

GGA continues to monitor the evolving proxy voting guidelines on a regular basis and will be reporting on any further developments as they are confirmed. Companies should be reviewing their compensation and governance practices against these updated guidelines to ensure that their current designs align to the updated guidelines as we move into the 2020 proxy season.

For more details on the ISS 2020 Proxy Voting Guideline Updates for the United States, please click on the following link:  https://www.issgovernance.com/file/policy/latest/updates/Americas-Policy-Updates.pdf

Further information on preliminary changes to ISS’ U.S. compensation policies for 2020 can also be found here: https://www.issgovernance.com/file/policy/latest/americas/US-Preliminary-Compensation-FAQ.pdf

Best Practices for Executive Compensation Disclosure

Helpful Tips as You Finalize Your CD&A

The heart of proxy season is upon us with the majority of Annual General Meetings (AGMs) scheduled to take place over the next couple of months. These meetings will highlight shareholder votes on important issues such as the election of directors for the upcoming year and approval of the company’s auditors. In many cases, shareholders will also be voting on whether they approve or disapprove of the compensation provided to a company’s top executives (otherwise known as a “Say on Pay” vote) or re-approving a company’s equity compensation plans for employees. It is on these last two issues (Say on Pay and equity compensation plan approval) where a company’s disclosure on executive compensation can play a critical role in influencing the outcome of votes at the AGM.

In an earlier blog post, I discussed the importance of understanding what your options are from a disclosure perspective, in this article I am covering some best practices you can use to answer the three key questions that should be resolved through your disclosure on Top 5 Named Executive Officer (“NEO”) compensation:

  1. What was paid to executives?
  2. How was compensation paid to executives? and
  3. Why was compensation paid to executives?

There are many examples of best practices from a disclosure perspective that can be identified on an annual basis. Quite often, these best practices are summarized into annual reports by various organizations. One such publication is provided through DFin Solutions (formerly known as RR Donnelley & Co.) which publishes an annual Guide to Effective Proxies in the United States and Canada. This document provides readers with detailed examples of specific disclosure companies can use to better tell not only their compensation story, but other corporate governance and shareholder engagement efforts they have embarked on in the past year. In Canada, the Canadian Coalition for Good Governance (“CCGG”) also publishes an annual Best Practices for Proxy Circular Disclosure. Similar to DFin Solutions, the CCGG highlights specific examples of Canadian companies that provide the best disclosure in areas such as executive & director compensation, corporate governance and shareholder engagement, to name a few. These types of publications should be thought of as great resources for you to see how different companies approach disclosure and determine if these identified best practices can be adopted at your company.

It would take too long to identify all potential best practices from an executive compensation disclosure perspective, but I want to highlight a few specific examples of best practices that can be beneficial to companies as they finalize their 2019 proxy circular disclosures. These include:

  • Outlining what your company does and does not do from a compensation perspective
  • Summarizing how shareholder engagement has influenced executive compensation
  • Summarizing performance metrics used and how they impact compensation
  • Reported Pay vs. Realizable Pay
  • Summarizing key elements of your equity compensation plan


Outlining What Your Company Does and Does Not Do From a Compensation Perspective

A great way to summarize the key aspects of your compensation program to shareholders is to highlight the positive practices that you have put in place. This can include items such as: placing caps on annual bonus payouts, tying bonus payouts to specific performance objectives, annual review of the compensation peer group, the adoption of share ownership guidelines, the adoption of clawbacks on incentive compensation in the case of material misstatement or misconduct and/or having the ability to engage an independent third party to advise the Board on executive compensation. On the flip side, you can also use this section of your proxy disclosure to highlight the things you do not do from a compensation perspective. This could include items such as: not approving guaranteed and multi-year bonuses, repricing of underwater stock options, the use of Single Trigger Change of Control provisions and/or allowing executives to hedge the value of their long-term incentives. While I have highlighted a few areas you can choose to disclose, any positive attribute you feel shareholders should be aware of should be summarized in this section.

Summarizing How Shareholder Engagement Has Influenced Executive Compensation

In today’s environment, it is imperative that companies engage with their shareholders and listen to their views. One of the biggest areas for concern among shareholders surrounds executive compensation. With U.S. companies mandated to hold Say on Pay votes and the significant increase in Canadian firms voluntarily adopting Say on Pay, companies want to ensure that they receive strong support from shareholders on these votes. The embarrassment of receiving low support or even failing a Say on Pay vote is avoidable and one way to avoid this is by actively disclosing what you heard from shareholders around compensation and how you considered this feedback and made any changes. This can demonstrate your company’s commitment to engaging with shareholders and taking their concerns into account.

Summarizing Performance Metrics Used and How They Impact Compensation

Shareholders are demanding more information to better understand why executives received the compensation they did in the past year. A good way to demonstrate this alignment is by summarizing the key performance metrics (both Corporate and Individual) that went into determining executive bonus payouts and Performance Share Units (PSUs) under the long-term incentive program. The disclosure of a balanced scorecard that outlines the performance metrics used, the weighting for each metric, the expected performance levels and expected payouts under “Threshold”, “Target” and “Superior” performance is the best way to do this. Companies can add to this by then disclosing the Actual level of performance achieved in the past year and the associated payout multiplier for each metric with a calculation of what the final bonus payout is for each executive. A similar approach can be used for PSUs outlining the expected performance levels over a 3-year performance period and Actual performance at the end of each 3-year period. This will show the impact of performance on the vested value of PSU payouts. This is all in the spirit of providing increased transparency to shareholders regarding your compensation program.

Reported vs. Realizable Pay

With the goal of demonstrating the alignment between executive pay and performance over longer time periods, companies are increasingly providing supplemental disclosure that compares the value of compensation reported in the Summary Compensation Table with the “realizable” pay the CEO is entitled to at the end of each fiscal year. Often times, the reported pay figure in the Summary Compensation Table is quite different than the “realizable” pay figure. This is often the case in cyclical industries such as Oil & Gas or Mining where a certain grant value of Stock Options, RSUs and/or PSUs is provided to the CEO that appears quite high, but with downward pressures on share prices the actual “realizable” value is much lower as stock options are often out-of-the-money, PSUs may not be on track to vest and RSUs are worth much less than they were granted at due to a lower share price. By calculating and reporting on the “realizable” pay figure at the end of each fiscal year, either through a table or graphic and comparing it to the trend in your company’s share price, you can demonstrate the alignment between your company’s performance and executive pay levels more clearly.

Summarizing Key Elements of Your Equity Compensation Plan

Receiving approval from shareholders on an updated equity compensation plan is becoming more difficult in today’s environment with ISS and Glass Lewis espousing specific voting guidelines that, if not met, could result in a recommending “NO” vote on your equity compensation plan. While disclosure of the full plan document text is recommended and viewed positively, these plan texts can be quite lengthy and complicated to review and understand. Increasingly, companies are summarizing the key elements of their equity compensation plan such as: Plan maximums, limits on non-employee director grant levels, vesting treatment under different termination scenarios and other key provisions in a short summary table or section within their circular with reference to the full plan text in an appendix. This highlight section found within the body of the circular provides shareholders with the most important elements of the plan they need to be aware of when making the decision of supporting the plan or not.

Closing Thoughts

As you can tell, there are many ways in which to identify compensation disclosure best practices across North America with organizations providing specific examples of best practices you can reference and make your own. While there are many best practices to choose from, a few of the key practices to consider for 2019 include:

  • Outlining what your company does and does not do from a compensation perspective
  • Summarizing how shareholder engagement has influenced executive compensation
  • Summarizing performance metrics used and how they impact compensation
  • Disclosing Reported Pay vs. Realizable Pay
  • Summarizing key elements of your equity compensation plan

Executive compensation is becoming more complicated as the demand for more rigor and structure in determining compensation levels grows. This makes the need to simplify disclosure by summarizing the key features of your compensation program, the performance metrics used and how your pay aligns with company performance over time even more important. The use of summary tables and graphics to better tell your compensation story is also something to consider, as opposed to inundating shareholders with pages and pages of text. The scrutiny on executive compensation is higher than ever, so following disclosure best practices can only aid in ensuring the continued support of your shareholders and the avoidance of an unwanted result in approving your equity compensation plan or Say on Pay vote at your upcoming AGM.

Establishing Compensation Programs for Growth in the Cannabis Industry

Don’t let this opportunity go up in smoke!

It has been two eventful years since the Canadian federal government announced its plans to pass legislation to legalize the recreational use of marijuana. In the U.S., over 80% of the states including California, Colorado, Oregon and Washington have legalized recreational and/or medicinal use of marijuana at the state level.  The California industry alone is projected to hit over $7 billion in a few years. This has led to a growing list of emerging companies in the cannabis space seeking financing through the public markets as they see the opportunity in building up their operations to cater to a significant spike in marijuana use now that it is legalized in Canada and more and more U.S. states are legalizing it in some form or fashion. While listing on exchanges in the United States can still be problematic due to the current U.S. federal ban, Canadian stock exchanges have provided a reputable market for cannabis shares with companies listing on the TSX Venture Exchange and Canadian Securities Exchange (CSE). Certain Canadian listed companies have also been able to dual-list their shares on the NYSE such as Canopy Growth, Aurora Cannabis and Aphria with others such as CannTrust currently in the process of listing in New York. This is providing greater exposure of these stocks to institutional investors and index funds.

This shifting dynamic creates a great opportunity for companies throughout the value chain of the cannabis industry such as research and developers, producers, processors, distributors, wholesalers and retailers to realize significant growth through first mover advantages. However, it also requires that the Boards of Directors of these companies put in place the proper executive compensation structures to attract, retain and motivate its executives to execute on the overall business strategy. Companies must also be aware of the various rules and regulations that come with being a publicly-traded company. For those companies graduating up to major exchanges such as the TSX, greater scrutiny from institutional investors and proxy advisory firms such as Institutional Shareholder Services (ISS) and Glass Lewis on compensation levels and designs can also be expected. With this in mind, here are the top areas boards of publicly-listed and privately-held companies across the spectrum of the cannabis industry must consider when dealing with executive compensation matters as they continue to navigate this exciting time of expansion in 2019.

Top Area of Focus for Executive Compensation

  1. Compensation Philosophy & Peer Group
  2. Executive Compensation Levels
  3. Short-Term Incentive Design
  4. Equity Compensation & Related Documentation
  5. Employment Agreements
  6. Shareholder Engagement 

Compensation Philosophy & Peer Group

A company’s executive compensation philosophy establishes the foundation for its compensation program as it outlines the objectives of the program and the types of compensation to be offered. It also outlines the peer group that will be used to benchmark compensation levels and practices as well as a company’s desired positioning when compared to that peer group. For companies in a rapid growth phase, peers that might have been comparable a year ago from a size and strategic perspective may have become obsolete due to their size or through acquisitions. The peer group for a $100 million market cap company will look a lot different than a $1 billion company! A good rule of thumb is to look for a peer group of companies within 0.5x to 2x the current size of your organization. Then consider other characteristics such as business model, location of operations, product offerings as well as who you would look to recruit from, or who you might lose talent to, within the marketplace. This could include not only cannabis industry peers, but also other pharmaceutical or fast-moving consumer goods companies in regulated industries such as alcohol and tobacco. Companies in high growth mode will also be looking to attract key talent to drive this growth, which may require a philosophy that targets compensation levels closer to the 75th percentile as opposed to the typical peer group median.

Executive Compensation Levels

In the early stages of a business, there tends to be less concern over compensation levels as the majority of compensation is tied to equity compensation that is intended to provide a windfall if and when future share price growth is achieved. As a company matures, the need to attract and retain key talent becomes paramount and requires a better understanding of the compensation provided to similar professionals in a competitive market. In stages of rapid growth and the resulting change of peers (as described above), a competitive Base Salary provided to the CEO in one year might be well below market when compared to a different peer group of larger companies. As a company grows, the need to compete with smaller peers becomes less relevant and the need to compete for talent against larger peers becomes more pronounced. This may require adjustments to executive compensation levels. With this in mind, it is important for companies to take into account the level of growth of their company. In a rapidly changing business environment, the need to review compensation levels on an annual basis is more important to ensure the continued competitiveness of Base Salary and Incentive opportunities against an ever-evolving peer group of companies.

Short-Term Incentive Design

With cash typically at a premium in the early days of a firm, bonuses are traditionally made on a discretionary basis, if paid at all. They might also be provided in one-off situations to secure key talent from a larger competitor or different industry. In either case, there is generally a lack of structure surrounding how bonuses are to be paid on an annual basis. As a company matures, the mix between Salary, Cash Bonus and Long-Term Incentives tends to change with more weight placed on Cash Bonuses, thereby making it more important to place more structure around how bonus payouts are determined. Companies might feel that a Profit Sharing Plan is a good way to structure bonus payouts as many companies use Earnings as one of the key performance metrics to determine cash bonuses. In the cannabis industry, however, accounting rules under International Financial Reporting Standards (IFRS) require companies to value certain inventory on a mark-to-market basis which can greatly impact earnings results, either positively or negatively. This may make earnings less suitable for determining executive performance in a given year. As a result, following the incentive design of a majority of General Industry companies may not be the best way to measure performance. Given many cannabis companies are in a high growth stage, better types of performance metrics might include Revenue Growth, Cash Flow from Operations or specific milestones tied to acquisitions, production levels or Research & Development (R&D). Measuring performance across a variety of metrics (ideally 4 to 5) using a “Balanced Scorecard” design can bring more structure to determining cash bonuses while focusing executives on multiple drivers of future growth for the company. If a company is private and looking to enter the public markets, tying part of their scorecard to achieving their public listing on schedule and at a targeted valuation level can also be considered as well.

Equity Compensation & Related Documentation

The traditional thought process is that any small cap company should conserve as much cash as possible by granting stock options to its executives in order to incent these executives to significantly grow the share price of the company, which will produce wealth for both shareholders and the executives. While this approach makes sense in the early stages of a company, as a company experiences significant growth and investor interest, greater scrutiny is placed on a company’s equity compensation plans. Institutional investors and groups such as ISS and Glass Lewis pay close attention to the level of share dilution allowed under your equity compensation plans. The TSX, for example, limits companies to up to a 10% dilution, while exchanges such as the Nasdaq and TSX Venture Exchange allow up to 20% dilution in certain cases. Those companies graduating to new exchanges should be aware of any changes in the rules governing equity compensation plans as they will greatly impact the allowable room to make future equity grants. No longer can a company run itself with the notion that stock options are “free” as there is a cost associated to them and therefore more structure around how they are granted and who is eligible must be put in place. With the run up in cannabis-related stocks there is also talk of whether a “bubble” is building that is inflating the price of current shares. If the “bubble” were to burst, those executives holding stock options could see the value of their equity fall. Given this possibility, consideration of full value awards such as Restricted Share Units (RSUs) or Performance Share Units (PSUs), that can retain value even in times where share prices may drop, can provide greater retention value for executives in place of stock options. RSUs and PSUs can be less dilutive to equity compensation pools, providing more flexibility to the Board when granting equity to key talent.

Employment Agreements

With the movement from a private to publicly-traded company, or in cases of significant growth and investor interest, greater scrutiny is placed on the employment agreements of your top executives. Shareholders, along with ISS and Glass Lewis, have specific views on severance payments to be made upon a Change of Control of the company (i.e. acquisition of the company) or other termination scenarios. Severance payouts of 3x or 4x eligible compensation (typically Salary Only or Salary + Bonus) were commonly accepted in the past as the cost of doing business. The new acceptable norm is a maximum of 2x for the CEO with multiples of 1x to 1.5x for executives below the CEO, thereby lowering the cost of exiting executives upon a termination scenario. “Single Trigger” Change of Control payments based solely on control of the company changing hands, but not the termination of an executive, have been widely criticized and are being replaced by “Double Trigger” Change of Control provisions – payout is only made to the executive if control of the company changes and they are subsequently terminated from their position within a 12 to 24 month period. Boards of cannabis companies should review the severance provisions being provided to executives under existing employment agreements to ensure they are in-line with new market norms and avoid potential pushback from shareholders.

Shareholder Engagement

Annual General Meetings (AGMs) were considered a “rubber stamp” process for approval of general corporate matters such as the re-election of directors, or executive compensation. In the era of shareholder activism and the rise of proxy advisory firms such as ISS and Glass Lewis, AGMs have become forums to voice disdain, directly challenge executive decision-making, and assert the power of all shareholders to hold a board accountable for its actions. If shareholders’ concerns are not met, they will be heard through the AGM vote. With Majority Voting guidelines becoming more the norm in North America, requiring directors to step off the Board if they fail to receive more than 50% of shareholder votes at the AGM, it is becoming increasingly important for Boards to engage with their top institutional and retail shareholders to gauge their views on issues they deem important. Failure to be proactive increases the embarrassing risk of having one of their directors voted off the board. Boards that fail to embrace the latest in technology solutions dedicated to corporate governance, such as SaaS-based shareholder engagement platforms, deny themselves solutions that can greatly assist the board, executive and Investor Relations team with engagement efforts in an increasingly complex environment. These solutions should be examined as they make the process of engaging with an entire shareholder base much more effective and efficient than the traditional way of doing things.

Proper Due Diligence Maximizes Growth

The past couple of years have provided quite an opportunity for companies across the entire value chain in the cannabis industry due to the relaxation of marijuana laws across North America. While this has led to significant growth for many companies in terms of market cap, the higher amount of investor interest puts more pressure on boards to come up with market competitive compensation packages for its executives that are deemed reasonable by shareholders. By focusing on the key executive compensation issues discussed above, companies across the spectrum of the cannabis industry will be able to confidently defend the process they have followed and the decisions they have made to both shareholders and their executives through their engagement efforts. Opportunity knocks, but without the proper board due diligence the opportunity for growth presented in the current environment can quickly go up in smoke.


Options for Executive Compensation Disclosure

Understand Your Options

The clock struck midnight on December 31st, ringing in the start of a new year. While most companies work to finalize their audited financial statements in the next month or two, they also need to be aware of other important tasks required in the months ahead. This includes the calculation, review and approval of Annual Incentive payouts for 2018 as well as the review and approval of any adjustments to Base Salary, Target Annual Incentive and Long-Term Incentive opportunities for 2019. Once these approvals are made, companies must figure out how they are going to communicate the executive compensation decisions made for 2018 and potentially what shareholders can expect for compensation in 2019, to shareholders. This information is provided through a company’s Form DEF 14A in the United States or its Canadian equivalent, the Management Information Circular, also referred to as the proxy circular. Specifically, the Compensation Discussion & Analysis (“CD&A”) section is where the majority of information can be found.

Three Key Questions

When providing disclosure to shareholders, companies need to keep in mind three key questions that should be answered through its disclosure on Top 5 Named Executive Officer (“NEO”) compensation:

  • What was paid to executives?
  • How was compensation paid to executives? and
  • Why was compensation paid to executives?

This includes describing each form of compensation that is provided to executives (i.e. Base Salary, Annual Incentive, Long-Term Incentive, Benefits, Pension and Perquisites). It should also provide shareholders with information on the exact level of compensation given to each NEO for each compensation element. Lastly, disclosure should also explain why each of the compensation elements was provided to executives. This can include the purpose of each compensation element and how they link to a company’s strategy and shareholder value. Information on the performance achieved during the year that justifies the level of Bonus or Long-Term Incentive granted to the executive should be included as part of this and also, where possible, disclosure of the specific performance metrics used to determine performance and the level of performance achieved against these metrics.

How Information is Presented in the Proxy Circular

While certain forms of disclosure, such as the Summary Compensation Table outlining the value of compensation granted to a company’s Top 5 NEOs or the Outstanding Share-Based and Option-Based Awards table for NEOs, are mandated by regulators to be disclosed, companies have a variety of alternatives to choose from in terms of how much they want to present within the proxy circular. Companies typically will fall into one of three buckets in how they choose to present information:

  • Minimum Compliance
  • Minimum Compliance Plus
  • Award Seekers

Minimum Compliance

This bucket is where many Small and Micro Cap companies fall into as they have limited resources available to them in order to complete the annual proxy circular. The task is typically performed by the company’s Chief Financial Officer, Corporate Secretary (if they have one) or outsourced to outside legal counsel with the mandate to provide only what is required by the regulators in order to stay in compliance. This keeps preparation costs and the time required to complete the exercise at a low level. Minimum Compliance disclosures often do not provide information on a company’s practices in a clear and easy-to-read manner, ending up with a lot of text and little to no graphs and tables to help present information in a more readable format for shareholders. A company’s compensation practices are often not as robust as larger companies, with executives typically receiving only a Base Salary and Stock Option grants with Annual Incentives paid on more of a one-off and discretionary basis with little structure in how they are determined. This means that the company often has little to no formal process to disclose to shareholders and therefore keeps the level of disclosure at a minimum. These companies also tend to have more of a Retail shareholder base and in many cases, although not always, will face less scrutiny on their compensation practices from shareholder advisory groups, such as ISS and Glass Lewis, to improve upon their compensation disclosure practices. They can get away with providing limited information until they grow and more of an Institutional shareholder base begins to enter the stock and requires clearer information from the company.

Minimum Compliance Plus

This bucket is where the majority of companies find themselves in the market (often at Mid Cap and growing Small Cap companies) as they seek to meet the minimum required standards, but also want to improve upon that disclosure by adding in more graphs and tables to tell a better compensation story to shareholders. These companies tend to have slightly more internal resources available to them in order to complete this task and will often have a Human Resources representative work with the Corporate Secretary as well as a company’s independent compensation advisor to draft and review the annual disclosure and improve upon past practices. While they don’t necessarily want to be on the leading-edge of compensation disclosure, they better understand the value that improved compensation disclosure can bring when communicating with shareholders. Often at this stage, in a company’s life cycle, they begin to implement a more structured strategy to determine how they make annual Base Salary adjustments, determine Annual Incentive payouts and grant Long-Term Incentives to executives. Because of this added structure, a company now has a more formalized process to share with shareholders and is in a better position to disclose how it goes about determining compensation on an annual basis. Given the company’s size, they tend to have more Institutional shareholders in the stock and therefore the opinions of ISS, Glass Lewis and their Top Institutional shareholders start to have a larger impact on voting results at their Annual General Meeting. These groups demand better disclosure from companies and will ensure that their voices are heard if they do not receive the expected disclosure.

Award Seekers

This bucket is where many Large Cap companies find themselves as they seek to go well beyond the required disclosure to provide a clear, but comprehensive story to shareholders on the process followed to determine executive compensation on an annual basis. These companies have a much higher level of internal resources available to them and will put together a team made up of their Human Resources, Legal and Finance divisions to work on the annual disclosure. They will also work with their independent compensation advisor and other outside parties to produce a document that not only provides great information, but also is much more visually appealing to the reader than the typical proxy circular. These companies fully understand the value that plain language and easy-to-read material can bring when communicating with shareholders. They have had a formal compensation design in place for many years, when determining executive compensation, so the objective of disclosure is not just to provide readers with information on the structure of pay, but to provide shareholders with a better sense of a company’s annual process and any compensation improvements they have made in the past year, based on the feedback they have heard from shareholders. Given the company’s size, they have a majority of Institutional shareholders in the stock and therefore the opinions of ISS, Glass Lewis and their Top Institutional shareholders have a direct impact on the voting results at their Annual General Meeting. As an example, a negative vote recommendation from ISS, Glass Lewis or group of top shareholders has the potential to lead to a failed Say on Pay vote, which is embarrassing for the company and its Compensation Committee. Once a solid disclosure format is put in place, “award seekers” are always looking to improve upon the proxy circular, making annual disclosure an ever-evolving process as they are never satisfied.

Closing Thoughts

As you can tell, a company has a variety of ways in which it can choose to provide annual disclosure on executive compensation, which is often predicated on the exact circumstances facing the company. Does the company have a high Retail or Institutional shareholder base? Has the company received negative feedback from ISS, Glass Lewis or a Top shareholder in the past? What stage of life cycle is the company in and what kind of structure is currently in place to determine executive compensation? What resources does the company have available to it to prepare disclosure? These questions should all be asked when determining the type of disclosure, the company can provide to shareholders. However, no matter which level of disclosure a company chooses to provide, it should always remember to answer the three main questions that all shareholders want to know as it relates to compensation:

  • What was paid to executives?
  • How was compensation paid to executives? and
  • Why was compensation paid to executives?

Without answers to these three questions, a company will face scrutiny on its executive compensation disclosure practices.

5 Trends for Executive Compensation in 2019

USMCA, Cannabis, Energy Sector, Government, Say on Pay All Have an Impact

Several developments over the last year will have an impact on trends in executive compensation for 2019, including the North American Free Trade Agreement (NAFTA) revamp — upgraded to the United StatesMexico-Canada Agreement (USMCA) — increased scrutiny of cannabis companies, “say-on-pay” adoption, and a downturn in the energy sector.

High-sector growth will also drive additional upward pressure on talent and compensation into 2019, which will have a retention impact on the pharmaceutical, fast-moving consumer goods and tech sectors.

Tariffs and USMCA

While the full effect of U.S.-imposed tariffs on aluminum and steel and the new USMCA remain unclear, they could have an impact on how executive compensation is structured for 2019. In late 2018 and early 2019, compensation committees will be working with their advisers and CEO to determine key performance objectives for 2019 for the C-suite. This will include discussions around performance expectations for 2019 to achieve “target,” “threshold” and “superior” performance as part of finalizing the annual performance scorecard used to determine 2019 short-term incentive payouts. With U.S. tariffs and the new trade deal threatening certain Canadian companies, committees are expected to take this threat into account and set performance expectations accordingly. An emphasis on measures such as earnings or revenue may be lowered, with more put on maintaining market share, developing new markets for products or cost-cutting measures to deal with trade concerns.

Cannabis Sector

2018 has seen the continued rise in share prices of cannabis companies, leading up to the legalization of recreational cannabis use as of Oct. 17. Many of these employers have witnessed such rapid growth that their compensation programs have been unable to keep up. They have been playing catch-up by trying to implement more formalized compensation structures for executives and staff. This has forced companies to review the dilution of current equity incentive plans (for many companies, stock options only) which have been highly diluted by equity grants made to attract key executives and staff at much lower share prices. This means current equity pools have little room left to make future grants for new hires heading into 2019. Companies are forced to review who has and has not received equity grants in the past year, and also the share price these grants were made at, to determine who is in most need of a grant to keep them engaged, as well as allow for the equity pool to eventually be replenished and provide the right pay-for-performance balance.

Aside from the cannabis sector, it’s expected companies across Canada (especially small- to mid-cap companies) will review the dilution level in current equity plans when developing 2019 recommendations. For companies looking for shareholder approval of equity plans at the annual general meeting in 2019, conducting this review against Institutional Shareholder Services (ISS) and Glass Lewis guidelines will be imperative to ensure they receive positive vote recommendations and have their plans approved. In addition to equity plans, more structure is expected through the development of balanced scorecards identifying five to seven key corporate and individual performance measures for 2019 to be put in place for cannabis companies to measure 2019 performance and determine 2019 short-term incentive payouts at the end of the year. This trend is expected to grow in prevalence across Canada for all industries as ISS, Glass Lewis and shareholders demand more rigor and structure be put in place to align executive pay with performance — both on an annual and long-term basis.

Downturn in energy sector

The Canadian energy sector has witnessed another downturn in share prices, especially in the energy equipment and services industry. In 2019, energy companies are expected to review executive compensation levels and determine whether downward adjustments (similar to earlier this decade) are required to send a message to shareholders that executives are feeling the pain, too. Companies are expected to review whether short-term incentives should be paid for 2018 at all, or whether deferral into a long-term incentive grant to preserve liquidity for the business and tie executives more to the company’s long-term performance makes more sense. Employers will also face dilution concerns due to lower share prices, so they need to be diligent in ensuring they do not overly dilute their equity pools and restrict their ability to make grants in future years. Focus on the retention of critical talent and high-potentials will be imperative in 2019.

Government intervention

Government scrutiny of executive compensation has received much attention in recent years. During 2018, the Doug Ford government in Ontario rallied against executive compensation at Hydro One which led to the removal of many executives and board members. In Alberta, the NDP government has also shown a willingness to intervene to control executive compensation at universities, colleges, agencies, boards and commissions. With less than one year before an election, will the NDP government implement more rules on executive compensation in Alberta? And will Ford look to intervene in other quasi-public sector organizations? Only time will tell.

Say-on-pay adoption

Say-on-pay failures continued in 2018 with Crescent Point Energy, IMAX and Maxar Technologies each receiving less than 50 per cent approval. While say-on-pay adoption has stagnated of late, the recent announcement by Alimentation Couche-Tard that a say-on-pay vote will be held at its 2019 annual meeting sparked hope that other companies will follow. In looking at Canada’s top 100 companies, close to 30 have yet to adopt such a vote, according to Global Governance Advisors, including corporate titans such as Power Corporation of Canada, Rogers Communications, Canadian Tire and Loblaw.

Will Alimentation Couche-Tard’s decision influence these companies or will these companies continue to lag behind other large companies in Canada? With all these developments, companies are rethinking the structure of their executive compensation programs in terms of the type of compensation offered and metrics used to measure performance. And with the changing economic outlook, they are also determining how to best attract and retain the key talent needed to successfully handle the new reality.

Paul Gryglewicz is a senior partner and Peter Landers is a partner at Global Governance Advisors in Toronto, a human capital management firm providing boards of directors and senior management teams with advisory and technology solutions. For more information, visit www.ggainc.com.