Tips to Avoid a Proxy Fight

Learning from Past Mistakes to Avoid a Proxy Fight

All publicly-traded companies face the risk of a proxy fight with one or more of its current shareholders. In a nutshell, a proxy fight is a situation where two corporate factions (typically the Board/Executive Team vs. an activist shareholder or a group of company shareholders) fight for votes from remaining shareholders in order to effect change in a particular area of governance in the company.

This issue often occurs when a new slate of board members is proposed to replace a group of existing board members by an activist shareholder or group. The new slate of board members are generally individuals who are receptive to the activist shareholder’s views on how to change the company while the existing board members are often resistant to the activist shareholder’s views. Common areas of disagreement that can lead to a proxy fight include: future company strategy, executive compensation, company performance or whether a sale of the company or continuing as a stand-alone company is in the best interest of shareholders.

There are many examples of high-profile proxy fights in North America in recent years including: Proctor & Gamble, Yahoo, Dupont, CP Rail and Crescent Point Energy. However, recent research by Vinson & Elkins LLP has shown that in 2016, 83% of all proxy contests in the United States were at companies with market caps of less than $1 billion, which means that proxy fights are a risk for all size of companies in the marketplace. Even though many of these proxy fights result in unsuccessful vote outcomes for the activist shareholders, they often lead to significant change at companies. For example, Proctor & Gamble ended up appointing activist shareholder Nelson Peltz to its board even though Peltz lost the proxy fight. At Crescent Point Energy, while Cation Capital was unsuccessful in electing new board members, former CEO Scott Saxberg was forced to step down and the company indicated a renewed focus on capital allocation, cost reduction and return on capital employed. All had been promoted by Cation as part of its proxy fight. In a successful proxy fight, Bill Ackman was able to get his slate of new board members elected to the board at CP Rail in 2012, which resulted in an overhaul of management with the hiring of Hunter Harrison as CEO and a renewed focus on driving cost efficiency at the company. The resulting change was extremely beneficial to CP shareholders as its market capitalization has grown almost 300%, while significantly reducing its Operating Ratio under the new strategy and leadership.

The lesson here is not to say whether proxy fights are good or bad for shareholders, but to raise awareness that if you are a board member at a publicly-traded company you need to be aware of the risk and how to avoid getting into this difficult situation. Here are five strategies that can aid your board in avoiding a proxy fight.

Five Strategies to Help Your Board Avoid a Proxy Fight

1. Know your shareholders:

Have a deep understanding of your Top 10, 25 and 50 shareholders. Who are the most active among them? How much of your company’s shares do they own? Do they often vote their shares at your Annual General Meeting (AGM)? Do they follow the voting guidelines or research of a proxy advisory firm (e.g. ISS, Glass Lewis)? Do the shareholders have published voting guidelines on board make-up, corporate governance or executive compensation designs that they prefer? Having the answers to these questions will allow you to understand the potential concerns that shareholders might have with your company and help you address those concerns through your public disclosure or engagement activities.

2. Proactively engage with shareholders rather than react to their views

Seek a dialogue with your Top shareholders and try to engage with as many shareholders as possible either face-to-face or through active communication through e-mail or phone calls. This dialogue will allow you to communicate your Board and management’s story and share why you believe that your strategy and approach are in the best interest of the company. It also provides a vehicle for your shareholders to share their concerns, which allows you to better understand their views and potentially implement certain changes to the Board and management’s plan to address their concerns. If possible, you should try to include your CEO and/or Board Chair in these conversations, so that both the Board and management are hearing shareholder concerns. You must ensure that a consistent message is being presented by the Board and management in any of these conversations to ensure the same story is being told to all shareholders.

3. Monitor your company’s pay-for-performance linkage

Executive compensation has become a lightning rod in recent years for proxy fights when activist shareholders can point to relatively high compensation and relatively low performance over a 3 or 5-year period. It is imperative that the board monitor the relationship between pay and performance and ensure that there is general alignment between the two. While the Compensation Committee and board should be monitoring this alignment on an annual basis during committee/board meetings, another way to demonstrate alignment to shareholders is through the annual proxy circular where a company reports on the compensation for its top five executives. Compensation is required to be disclosed following a rigid format in the Summary Compensation Table, but that does not preclude a company from demonstrating executive pay in other ways using “Realized” or “Realizable” pay calculations. Inserting “Realized” or “Realizable” pay graphics into the annual proxy circular helps to illustrate that what has been paid, or is potentially owed to executives, aligns with the company’s performance even more so than what is disclosed in the Summary Compensation Table. The Compensation Committee and Board should also be monitoring the CEO’s annual performance scorecard to ensure Short-Term Incentive (bonus) payouts align with performance and do not surprise shareholders. The scorecard should also be updated on an annual basis to deal with the evolving strategy and the nature of the company’s operations.

4. Be transparent

Ensure that your company is open with shareholders and is seen as acting in a transparent manner. Often, companies can find themselves in proxy fights and situations where shareholders are unclear on the company’s strategy or why compensation has been structured in a certain way. If shareholders are unclear on the future strategy or do not understand the compensation design, they are more likely to side with the activist shareholder who has a strong vision and strategy for the company with a clear compensation design that makes sense to them.

5. Monitor your Board renewal process

A common theme in many proxy fights is that the Board has become too entrenched in their role and has not done a good enough job at challenging management’s thinking. This issue tends to stem from the tenure of current board members. The activist shareholder may perceive that certain board members lack independence because they have sat on the Board for too long. This perception may not be the case, but it does not stop the activist shareholder from using this appearance to his or her advantage. Your Board should be actively monitoring its renewal process by evaluating the diversity of skill, background, gender and experience of board members – giving rise to the following questions:

    1. Are there areas where we can strengthen our skills or promote greater diversity in views and experiences?
    2. Are there board members who are not carrying their weight?
    3. Is the company moving in a new direction that requires a different set of skills at the Board level?

Being able to communicate this renewal process with shareholders is critical and can be communicated annually through the proxy circular or through providing this information on a company’s website. It will enlighten shareholders to the rigorous process your board follows to ensure it is operating as effectively as it can.

Closing Thoughts

Proxy fights are never fun. They disrupt the company and divert the Board’s and management’s attention away from executing on the company’s strategy and more towards fighting off an activist shareholder. In many cases though, proxy fights can be avoided through better understanding of your shareholders, hearing their concerns and proactively communicating the company’s story so that you can try to deal with any issues before they get out of hand. This strategy requires the company to act transparently; while monitoring the alignment between executive pay and company performance. Annually, the company can demonstrate this transparency through disclosure of the alignment between pay and performance, the company’s compensation design and its board renewal process in the proxy circular. Learning from past mistakes can ultimately help board members weather the storm at their company and hopefully avoid the costly and disruptive nature of a proxy fight.

The Secret to Successful CEO Succession

“Tim Hortons is hiring — Canada’s No. 1 coffee chain is looking for a new leader after the abrupt departure of its CEO. The company announced Wednesday that Don Schroeder, 65, no longer serves as president and CEO after three years at the helm and two decades as an employee.” 1 [i]said in a 2015 press release.

The board’s number one responsibility is CEO succession planning, yet so many boards ignore the criticality of proactively discussing the senior leadership succession plan.  While industrial psychologist researchers have identified that some of the most successful CEO successors are those that have been hired from within,  most organizations do not have the depth of talent necessary to identify the new captain of the team.

The Case For Internal Succession

When a board is confident in the direction of the company’s business strategy and it is staffed with a suite of executive team leadership, selecting a current team member who  demonstrates the competencies and leadership capabilities  generates the greatest chance of continued success of the organization.  When a board is put to the task of selecting its next CEO, many boards in this case will evaluate one or two internal executives through a series of interviews and competency profiling tests to determine who would be best fit for taking the next CEO role.  For year’s now, HR leaders have discussed the infamous “horse race” set up by Jack Welch at General Electric. The basic truth is that few organizations are the  “General Electric of a bygone era. All of my experience led me to the conclusion that unsuccessful searches revolve around a chasm between the financial expectations and performance criteria of the final candidate and the board.

The “Secret Sauce”

This blog focuses on how boards must get the uncomfortable conversations out of the way, before starting the negotiations with the desired candidate.  We call this the “board’s CEO negotiation playbook”.  It is the secret saucethat increases the probability of closing the candidate and getting the talent you want and mitigates the risk of the wrong candidate getting the offer.

The absolute worst-case scenario for any board (and their recruiting strategy) is when your best and final job offer of compensation, benefits and perquisites isn’t “good enough” for the candidate receiving the offer.  This is not a discussion about an employee earning $100,000, rather a CEO’s executive compensation package that is in the realm of a multi-million-dollar contract with sign-on equity and bonus guarantees.  That’s right, the next leader to drive shareholder value!

  • Our observations of the many boardrooms when the CEO succession is underway is that the board, rightfully, structures an ad hoc CEO search committee and that committee works in isolation with an executive recruiter. What the executive recruiter seems to never get right is that because the paycheck for the recruiter is a function of the CEO’s compensation, the recruiter fails to get into the uncomfortable budgetary conversation  as the search begins. Boards often do not have a solid frame-of-reference on competitive pay structures for the CEO of their future.  They know only what they were paying the prior CEO, but they lack context of competitive pay levels and pay structures within the candidate pools of talent.

The Independent Compensation Advisor: Hired to Bridge the Gap

When conducting an external search, the board must hire a reputable retained executive recruiter to validate the CEO competency profile  and to help craft the CEO search strategy.  The search strategy will often identify a few industry sectors in which qualified candidates may be working.

That said, each industry sector may present a unique pay level that is materially different to the current executive pay being offered by the organization hiring the CEO.  When we work with our clients, we conduct a compensation review for each of the sectors of interest.  The compensation review would cover not only active CEO’s within the industry, but  other key executive roles  – to help understand the various pay levels by industry and by executive.  This review enables the board to understand how competitive their current compensation/incentive plan was for the former CEO.  In some cases, the compensation sector review may identify that, within the search strategy, some industries pay materially higher than the former CEO was compensated, or vice versa.  The compensation review also identifies compensation structure trends by industry and can help paint the picture of what is “market normal” in the broader sea of executive talent.

After the compensation review is completed, it is critical to sit down with the Board and articulate the “realistic” budget for the new CEO. The market data is very helpful in validating the reality of the compensation and incentive levels for CEO candidates. The peer compensation data provides an understanding of the market spectrum the viable candidate may consider.  Are they at the top end of the market range or the bottom?  After the broader compensation “bookended” budget is identified by the compensation review, the next layer is to understand the current governance trends around the “deal breakers”.  Here is where the independent advisor can really show their courage and brevity in advising the board.

The negotiation deal breakers are the one-time requests made by the candidate.  These include: buying out the executive’s forfeited equity he or she may lose when resigning at his/her company, guaranteed bonus period, crediting years of pension service in the company’s pension plan, paying for excessive perquisites etc.  The board’s advisor will have a strong understanding of the capital market appetite for recruiting. However, the board often ignores these critical conversations up front, which is one of the leading causes for failing to close the desired CEO candidate.  For the board members reading this blog, we challenge you to ask some of your board colleagues to discuss how much are they willing to offer in a sign-on situation. Our experience – two very different perspectives.

The Negotiation Rule Book

Once the compensation review is presented, the bookended CEO compensation budget is identified and the board is aware of the market appetite on one-time sign-on agreements; the board needs to come to a unanimous view of what the board will ultimately be willing to offer to close the right candidate.  This conversation is most helpful when done before the search is started and best when the recruiter is not present, to help avoid any unnecessary conflict of interest.  After the board comes to an agreement on the go/no-go recruitment offerings, then the negotiation rule book can be formulated and presented to the recruiter.

The recruiter will benefit from understanding the totality of the “rules of the search”.  The recruiter is your front-line representative that is doing the hard work to find the candidate.  According to Jay Rosenzweig, founder and CEO of Rosenzweig & Company, the world’s leading boutique executive recruitment firm, “a key component in structuring a successful search is establishing, in advance, realistic compensation parameters. This allows the recruiter to better target the most relevant candidates, which typically saves time and produces more satisfying results for all parties. As with so many things, strong up-front research and a common understanding of objectives can make or break an executive recruitment project.”  When the recruiter understands the entire truth of the budget, they will temper the candidates’ expectations early in the recruitment process.  When a recruiter does not fully understand the budget, or the one-time requests that might be offside, the recruiter may land in uncomfortable situations where they promise the world, but can only deliver an island.  The negotiation rule book also aids in how the recruiter uses their network throughout the search. The recruiter can pivot from potential candidates that will simply be “too expensive” for the role and can convert them into a connector for referrals.  This is gold for the company and the recruiter.

Board of Directors REMINDER! – When you find yourself in the position of needing to search for your next CEO – invite your independent advisor into the process early and use them as a partner to develop the negotiation rule book that is right for your organization.

Governance Effectiveness in Pensions

An Approach for Effective Governance Assessment

In the compensation and governance world, it is commonly known that shareholders are relatively quiet when companies are successful and driving returns. However, when things go south, shareholders question more and demand to know how corporate governance can be improved. These demands are accentuated for public pensions. When pension funds are performing well, there is little pressure, but after weathering through the past two recessions and, for some, experiencing co-payment holidays, under-funding status levels are understandably correlated to the increased level of pressure they are experiencing today.

In 2007, Ambachtsheer, Capelle, and Lum published The State of Global Pension Fund Governance Today. This study found that on an annual basis poor governance costs pensions 100 to 200 basis points (1%-2%). In our current market, where each basis point is precious, it is clear that governance is low hanging fruit on which all pensions should be focused.

An understood best practice in publicly traded companies is to conduct governance effectiveness assessments and disclose this activity on an annual basis. Due to the financial impact governance has on the success of publicly traded companies, the pension community should be proactively embracing this practice.

Pensions that undertake regular governance assessments can evaluate were they stand; maintain proactive improvement strategies; enable their Boards to become more effective in their oversight roles; and drive higher levels of financial success and sustainability for their funds.

When conducting assessments, pensions need to focus on:

  1. Their Board members’ knowledge and ability to oversee investment and financial operations.
  2. The composition of their Board members and the skills they possess.
  3. Their governance frameworks and strategic improvement aligned to their longer-term strategies.
  4. Ensuring that there is clarity on the roles of the Board and management, which enables both groups to function at their highest levels.
  5. The establishment and maintenance of high-performance cultures that include competitive compensation and proactive incentives (that only reward positive results).

It is our experience that pension Board members are committed to ensuring that their fund can deliver on the pension promise to its members. The bottom line is that Board members “do not know what they do not know.” Undertaking a simple governance assessment is a recognized best practice in the governance world; and a great way to improve areas that pension fund board members never knew could be improved. This best practice ensures funds are able to safeguard 100 to 200 basis points for the benefit of their members.

Board Meetings: Worst Practices

Factors that Result in an Ineffective Meeting

Ineffective Board and Committee meetings are one of the key factors that inhibit a board from operating most efficiently and helps drive better decision-making. As an advisor to boards, I have participated in hundreds of meetings over the years and have observed both efficient and inefficiently run meetings. Ultimately, the meetings that ran most inefficiently are distracted by trivial issues that delay decision-making.

Four Key Factors That Lead to Ineffective Board or Committee Meeting

1. Poor Time Management

2. Lack of Member Participation

3. Insufficient Time to Review Materials

4. Unprepared Board/Committee Members

Poor Time Management

This occurs in situations where the key issues to be discussed are side-tracked by trivial or unrelated issues that would be better discussed outside of the scheduled meeting time. It also can happen when an insufficient amount of time is allocated to discuss important issues. This means that decisions are either rushed or are deferred until future meetings, which can delay the organization’s overall agenda.

Lack of  Member Participation

This occurs in situations where one to two members of the Board/Committee dominate the conversation while other members are either unable to speak or are less prepared and therefore have little to add to the conversation. This means that the full breadth of views on an issue may not be discussed and considered, which can lead to less effective decision-making. It also can lead certain Board/Committee members, who are unable to participate, to question their relevance and value that they are bringing to the discussion.

Insufficient Time to Review Materials

This occurs in situations where meeting agendas and supporting materials are sent out only one to two days in advance of a meeting. Not only does this provide Board/Committee members with very little time to review materials before the meeting, but it also provides less time to adjust the meeting agenda and associated timelines if it is felt that too little time has been allocated to discuss certain topics.

Unprepared Board/Committee Members

This factor can be influenced by some of the aforementioned issues, but ultimately leads to less effective meetings as Board/Committee members are not able to effectively discuss the important issues or may take things sideways by discussing issues that were already addressed in the meeting materials. If members are not prepared, ineffective decision-making is the result, which ultimately is not in the best interest of the organization.

Effective Meetings Lead to Higher Performance

Ensuring effective meetings of the boards and its committees is key in making sure that your board is performing at a high level. If you find your Board/Committee meetings are less effective, look for signs of this through the factors listed above and read: Creating Board Meetings – Best Practices. By looking at what works best in creating effective meetings, you can improve your board’s overall effectiveness which should lead to better decision-making and positive results for your organization.

Best Practices for Board Meetings

Advice for Efficient and Effective Meetings

Effective Board and Committee meetings are one of the key factors that allow a board from operating most efficiently and helps drive better decision-making. As an advisor to boards, I have participated in hundreds of meetings over the years and have observed both efficient and inefficiently run meetings. Ultimately, the meetings that ran most efficiently allowed the Board/Committee to move forward with its agenda and not be distracted by trivial issues that delay decision-making.

Six Actions to Ensure an Efficient Meeting

1. Development of a clear meeting agenda.

2. Provide enough notice and appropriate materials for members to be prepared.

3. Keep the meeting on time and on topic.

4. Ensure each member is able to voice their views and opinions.

5. Ensure that results are accomplished and/or action items identified.

6.  Include some social interaction and networking time.

Development of a clear meeting agenda

This includes identifying the topic and issues to be discussed during the meeting, so there is no confusion on the purpose of the meeting. The agenda should also include any actions that are required to be taken by the Board/Committee as part of the meeting (i.e. is a topic “for information only” or “does it require a decision”). Identifying who will lead the discussion of each topic must be added to each agenda item. Lastly, each agenda item should have an associated timing, provided in the agenda, so that Board/Committee members have a sense of the timing and importance of the issues to be discussed.

Provide enough notice and appropriate materials for members to be prepared

As a best practice, meeting materials and the agenda should be sent out a minimum of one week before the associated meeting to provide members with sufficient time to review the materials. Some of the boards I have worked with will even send materials out two weeks beforehand and have a pre-meeting internally to discuss materials before the actual meeting date.

Keep the meeting on time and on topic

While this task is one that ultimately is the responsibility of the Board/Committee Chair, it is important that the timelines provided in the agenda are followed. Meetings should not stray too far outside of their purpose. As an extreme example, if your Audit Committee is discussing the organization’s budget, the discussion should not stray into discussing a specific personnel issue around the CEO’s performance or compensation which are unrelated to the topic at hand. If you find your meetings starting to stray off topic, acknowledge the member’s concern as being important but that it be taken off-line and discussed at a later time. This ensures that your meeting stays on schedule and respects all Board/Committee member’s time.

Ensure each member is able to voice their views and opinions

While this task largely falls on the Board/Committee Chair, it is important that all members feel their opinions matter and are provided sufficient time to discuss their views. If you find one to two members dominating the conversation, make sure that once they have finished their point that you then ask other members, who have not had the chance to speak, to weigh in on the topic and provide their perspective. This helps ensure that all members feel like they are providing value to the Board/Committee and that a comprehensive discussion of all potential views can be had amongst the group.

Ensure that results are accomplished and/or action items identified

It is important that any actions required of the Board/Committee relating to the agenda are generally accomplished, as part of the meeting. This means bringing items to a close after an appropriate discussion has been had to ensure things are kept on track. If it is felt that more time is needed to discuss a specific issue, a follow-up action item should be identified, at the very least, so the Board/Committee has specific direction on what the next steps are to come to a resolution on a specific issue.

Include some social interaction and networking time

It is important that you allow Board/Committee members to have some time outside of the scheduled agenda to interact and network amongst each other. This helps to create a positive atmosphere and culture amongst the Board/Committee which will help ensure that all members feel respected and trust can be built. Many boards will schedule Board dinners the night before/after a Board meeting for all members to interact. This can also be done through scheduling team-building experiences/exercises either between meetings or at strategic off-sites where the Board and management are discussing organizational strategy.

Effective Meetings = Positive Results

Ensuring effective meetings of the boards and its committees is key in making sure that your board is performing at a high level. Effective meetings also lead to an appropriate discussion of all relevant issues and opinions amongst its members before actions are taken. If you find your Board/Committee meetings are less effective, look for signs of this through the factors listed above and ask questions about how you and your board can improve. By looking at what works best in creating effective meetings, you can improve your board’s overall effectiveness which should lead to better decision-making and positive results for your organization.

Determining Executive Compensation

Guidelines to Establishing Executive Compensation

This year’s FIFA World Cup highlights the importance of using defense to create a top-notch offense. The same can be said for Boards of Directors. The board’s best offense is a good defense, and good defense starts with a great fundamental base.  That base, in the world of compensation, is the Compensation Philosophy, and that philosophy needs to mirror the business strategy of the company.

Two critical roles of the board of directors are establishing CEO succession plans and establishing executive compensation plans that both attract and retain executive talent and deliver the outcomes that align with the goals set by the board. While the board may act in good faith, there are times when there is shareholder push back.  How can the leading boards of directors develop executive compensation plans that are shareholder friendly?  Let’s take a deeper look at how executive compensation should be established in order to better align executive pay with shareholder returns.

The data from CEO compensation research continues to illustrate that the top paid CEOs have many layers of executive compensation.  When a board’s Compensation Committee finally agrees on how executive compensation is determined, it must ensure that it is market defensible and will pass the seemingly infinite views on “appropriate compensation”.

Four Steps a Board Should Follow

There are four steps a board should follow when determining executive compensation:

  1. Establish the compensation philosophy and peer group;
  2. Review current executive compensation against market practice;
  3. Assess the business impact before making final approvals;
  4. Report the process and compensation results to the executives and shareholders via the annual Proxy.

Establish Compensation Philosophy and Peer Group

The compensation philosophy for the company is the foundation the board needs to ensure so that the outcome, at the end of the process, is highly defensible, if ever scrutinized.  The compensation philosophy must account for the business strategy, risk appetite and the principles and objectives of the total compensation program.  This philosophy can and will be unique to every business – even those competing within the same sector.  Take two of the Top 4 tech companies: Amazon and Facebook.  Amazon has stated that its business culture and strategy is built on experimentation, and as a result they do not believe in rewarding top executives with an annual bonus.  They have claimed, in the 2018 Proxy Circular (DEF 14A), that some of the examples of successful experimentation include the creation of Alexa.” Alexa…how do you define executive compensation?” …you might ask.  In contrast, Facebook says that it acknowledges the business still being in the early stages of its journey, and that it must hire and retain people who can continue to develop the strategy, quickly innovate and build new products, bolster the growth of the user base and user engagement and constantly enhance the business model.  To achieve this, Facebook believes in more equity compensation, so it has further stated that it intentionally positions the cash compensation (base salary and annual bonus) below market but provides more of a heavy focus on equity-based compensation.  Overall, Facebook has stated it wants its executives to be bold, move fast and communicate openly.  In contrast to Facebook let’s examine Amazon and its approach to motivating executives.

Amazon, in line with its compensation philosophy, expressed that an annual bonus paid to the top executive officers is counterproductive to supporting an experimental business, and that short-term objectives will only focus on the “known.”  Amazon says that without a bonus program, the executive team will be more willing to truncate projects when early failure is detected.  Amazon states, in the proxy, that by not having a bonus program, it allows the executive team to abandon “failed” experiments, to focus on the “winning” ones.  One example that Amazon states, in the proxy, is that the management team was able to exit its auction type business early and focus on other winners such as Amazon Web Services (AWS), which has become a dominant force in Amazon’s revenue growth.  In lieu of the use of an annual bonus, Amazon has focused on a reasonable base salary but a dominant equity-based compensation arrangement, that ultimately will link future realized income for executives tied to the future Amazon share price (positive or negative).

What each board has demonstrated is that while Amazon and Facebook both compete for exceptional executive talent, the compensation philosophy has been customized to reflect the unique business strategy each company is employing.

Your board, with the aid of  the Chief Human Resource Officer, CEO and a knowledgeable independent executive compensation advisor will work through the process of coming to an agreement on the compensation philosophy that best fits your organization.

My advice is to be bold, dive deeper, and ask the hard questions about the business strategy to eventually arrive at the strong foundation level that the executive compensation program will be based upon.

After the compensation philosophy is established the peer group will start to gain clarity on finding the best organizations a company needs to benchmark against.  It’s important to understand that the peer group itself can be used in a few ways.  First is the obvious, the peer group helps to identify market pay levels of similar executive roles within the industry.  Second is perhaps less obvious, and that is that the peer group helps to establish market precedence and pay structure trends.  This is one of the most valuable pieces of information for the board to understand when determining how its executives should be paid.  The peer group can help give clarity on the use of various bonus and incentive awards, such as the general structure of the annual cash bonus plan, the use of stock options, restricted or performance shares, the use of pension and benefits etc.

A deeper dive in the peer group data helps to appreciate where the market is today and where it is heading tomorrow.  The latter of course, is best interpreted from an independent advisor that has a pulse on market trends before they are made public.

Review Executive Compensation

Now that the foundation is laid, and the board and management are in agreement with the overarching compensation philosophy, it’s time to compare current pay levels and structure with the market.

As mentioned earlier, the peer group data is highly valuable in multiple ways.  The independent advisor plays a key role to guide the board through identifying gaps between the current executive compensation program with the compensation philosophy and business strategy.

Depending on the gaps identified, the advisor will need to prepare some stress tested recommendations that will bridge the gap between the current and future executive compensation program.  Here is where a board can get nervous, as it may be reluctant to wake the sleeping giant.  The giant being the mass of shareholders, of course.  However, in order to drive management behaviour and shareholder returns, the compensation program needs to reinforce those behaviours that drive success.  In Amazon’s case, it’s experimentation that leads to life changing technology ~ “Alexa, is the blog almost over?” “Yes, you’re almost done.” ~ and therefore counter to the market norm – rewarding executives using an annual cash bonus. Amazon boldly linked more of the compensation to long-term shareholder value creation by awarding more of the total executive compensation program in equity.

Assess the Business Impact Before Making Final Approvals

Now that the process has clarified the business strategy and its impact on the compensation philosophy and the peer group is examined, the board will face decisions to potentially modify pay levels, pay structure or both.  When the board considers modifications, it is important that the board weighs the impact of those recommendations.  As I reflect upon pay adjustments, I place these adjustments into two broad categories – “opportunity” and “actual”.  The recommendations we make today are nothing more than an opportunity for the executive to receive the compensation.  As we know, it is common that more than 80% of an executive’s pay is at risk, so “opportunity” is nothing more than that.  The “actual” is the real impact on the business financials, share price and dilution levels,  and to the executive.

The board must see a scenario analysis and stress test of the various impacts any compensation adjustments will have today and in the future under various scenarios of success or failure; and the potential financial impacts on the business and shares.

Lastly, the stress test should examine shareholder advisory firm guidelines to focus on potential areas of risk that the compensation arrangements may trigger.

Report the Process and Compensation Results to The Executives and Shareholders via The Annual Proxy

Now to the fun part – reporting.  The board has the duty to shareholders to disclose in “plain language” the executive compensation program.  The fundamentals of great shareholder communication fall into three key categories.  To ascertain if the company’s proxy has done an effective job at communicating and rationalizing the executive compensation to shareholders, the board (at the end of reading their Compensation Discussion & Analysis section of the Proxy) must have a comprehensive understanding of the answer to these three key questions:

  1. How did the executive get compensated?
  2. What is the rationale behind that executive compensation?
  3. How much did the executive receive?

A quick read of Facebook and Amazon’s proxy help to illustrate the rationalization of rewarding pay packages in the echelons of $20+ and $30+ Million (Facebook’s Sheryl Sandberg 2017 reported compensation of $25,196,221 and Amazon’s Andrew Jassy 2017 reported compensation of $35,609,644).  For reference, Facebook passed its last say on pay vote in 2016 with a 91% YES and Amazon passed the say on pay vote in 2018 with a 98% YES.

Remember to examine the performance metrics within the bonus plan, the types of equity used, and if performance conditions are attached to the vesting criteria. The board must understand that even when the future share price is higher or lower than the grant date, the board must be comfortable with the level of pay the executive may receive.

Final Words of Thought

At the end of the day, it is highly unusual for a board to be successfully sued for how much compensation they elected to award to executives. However, that does not mean they will not find themselves under shareholder pressure from time to time.  After all, the board’s best offense is a good defense, and good defense starts with a great fundamental base …  the four steps every Board of Directors should follow when determining executive compensation.