Glass Lewis Releases 2020 Proxy Guidelines for the United States

by Peter Landers | Nov 18, 2019 | Glass Lewis, Proxy Guidelines, United States

Summary of Guideline Updates

On November 1, Glass Lewis released its 2020 Policy Guideline updates for the U.S. market. These changes are expected to be effective for shareholder meetings taking place on or after January 1, 2020. They have identified several updates in the areas of compensation and governance with several covering Say on Pay votes.

Updates in Compensation and Governance

Post fiscal year-end changes

Glass Lewis clarified that in their review of Say on Pay proposals, they would include post fiscal year-end changes to executive compensation and one-time awards, “particularly where the changes touch upon issues that are material to Glass Lewis recommendations.”

Company responsiveness to Low shareholder support

Glass Lewis added “insufficient response to low shareholder support” to their non-exhaustive list of issues that may cause them to recommend voting against a company’s Say on Pay proposal. In addition, Glass Lewis clarified what they consider to be an appropriate response to low shareholder support of a Say on Pay proposal (i.e. those proposals not receiving at least 80% support). Glass Lewis noted that the level of responsiveness should corresponding with the level of shareholder opposition both in a single year and over time. Lower levels if support should lead to a higher level of responsiveness by a company. Glass Lewis also indicated that engaging with a company’s large shareholders to identify concerns and implement changes (where reasonable) to address those concerns would be considered an appropriate response. From a disclosure perspective, GGA would recommend outlining in a table a summary of what a company learned from its shareholder engagement in the prior year, what the board and management discussed and reviewed to address shareholder concerns, and finally what the board has ultimately decided that may address or not address the shareholder concern and a rationale for why they have done so as a best practice to address this concern.

Short-term incentives

Glass Lewis noted that in cases where a company lowered goals mid-year or increased calculated short-term incentive payouts from the original formula result, they expect a robust discussion of why the Board made that decision within the Form DEF 14A. GGA advises any of its clients who have applied discretion to adjust formulaic results to provide an adequate level of explanation of why this discretion was applied and why it is in the best interests of the company.

Change in control

Glass Lewis reiterated its belief that “double trigger” change in control arrangements that require a change in control and subsequent termination of employment of an executive in order to be triggered as a best practice. They also addressed broad definitions of change in control scenarios as being problematic as they could lead to situations where executives are paid additional compensation, but have not witnessed a material change in their position or duties.

Contractual arrangements and amended employment agreements

Glass Lewis provided an updated list of problematic practices that could lead to a negative Say on Pay vote recommendation. This includes:

Excessively broad change in control triggers;
Inappropriate severance entitlements;
Inadequately explained or excessive sign-on arrangements;
Guaranteed bonuses (especially as a multiyear occurrence); and
Failure to address any concerning practices in amended employment agreements.
Glass Lewis made it clear that they view failures to address problematic pay practices within an amended employment agreement as a missed opportunity and that companies should seek to align to current best practices when amending employment contracts.

Additional key updates for the 2020 proxy season

Shareholder Proposals

Glass Lewis stated that they believe “companies should only omit shareholder proposals in instances where the SEC has explicitly concurred with a company’s argument that a proposal should be excluded.” Therefore, Glass Lewis will now consider recommending a vote against all members of the Governance Committee where SEC Division staff:

Decline to state a view on a shareholder proposal and the company does not include the shareholder proposal in its proxy statement; and
Orally concurs with a company’s no-action request but the Division staff does not provide any written record and/or the company does not provide any disclosure relating to the result of its no-action request.

Standards for Assessing the Audit Committee

Glass Lewis will now consider recommending a vote against the Audit Committee Chair when fees paid to the company’s external auditor are not disclosed. If the company has a staggered board and the Audit Committee Chair is not up for re-election, then Glass Lewis will not recommend a vote against other Audit Committee members, but will note its concern regarding the Audit Committee Chair.

Compensation Committee Performance

Glass Lewis will now consider recommending a vote against all members of the Compensation Committee if the board adopts a frequency for Say on Pay votes that differs from the frequency that received the most votes from shareholders.

Nominating and Governance Committee Performance

Glass Lewis will now consider recommending a vote against the Governance Committee Chair when board and committee attendance is not disclosed in the Form DEF 14A or similar document. Glass Lewis will also consider recommending a vote against the Governance Committee Chair when a director’s attendance is less than 75% of the board and applicable committee meetings, but the disclosure is too vague to determine which director’s attendance was lacking.

Forum Selection Clauses

Glass Lewis will continue to consider recommending a vote against the Governance Committee Chair if the board adopted a forum selection clause without shareholder approval during the past year. They did clarify that they would “evaluate the circumstances surrounding the adoption,” and if the forum selection clause “is narrowly crafted to suit the particular circumstances facing the company and/or a reasonable sunset provision is included,” then it may make an exception to its voting policy.

Shareholder Proposals – Supermajority Vote Requirements

While Glass Lewis generally supports shareholder proposals seeking to eliminate supermajority voting provisions, they clarified that they may recommend that shareholders vote against proposals that seek to eliminate supermajority voting provisions at controlled companies, because these provisions may protect minority shareholders.

Shareholder Proposals – Gender Pay Equity

Glass Lewis will review on a case-by-case basis shareholder proposals requesting disclosure of a company’s median gender pay ratio. However, if a company has disclosed “sufficient information” about its diversity initiatives, including how it is “ensuring that women and men are paid equally for equal work,” then Glass Lewis will generally recommend a vote against these proposals.

GGA continues to monitor the evolving proxy voting guidelines on a regular basis and will be reporting on any finalized changes coming out of ISS in the coming weeks 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 access to the full Glass Lewis’ 2020 Proxy Voting Guidelines for the United States, please click on the following link: https://www.glasslewis.com/wp-content/uploads/2016/11/Guidelines_US.pdf

Glass Lewis Releases 2020 Policy Guidelines for Canada

by Peter Landers | Nov 18, 2019 | Canada, Glass Lewis, Governance, Proxy Guidelines

A Summary of Guideline Updates

On November 1, Glass Lewis released its 2020 Policy Guideline updates for the Canadian market. These changes are expected to be effective for shareholder meetings taking place on or after January 1, 2020. They have identified several updates in the areas of compensation and governance.

Updates in Compensation and Governance

Meeting Attendance

For TSX companies, Glass Lewis will recommend that shareholders withhold votes from the Governance Committee Chair when board and committee meeting attendance is not disclosed in the annual proxy circular or similar document. Beginning in 2021, Glass Lewis will also hold the Governance Committee Chair responsible if the number of Audit Committee meetings has not been disclosed. The Audit Committee Chair will also be held responsible if the Audit Committee did not meet a minimum of four times during the year and will receive a withhold vote recommendation as well.We at GGA have noted increasingly more companies doing a better job of disclosing the attendance of board members at both board and committee meetings within their proxy circular and have successfully worked with our clients to incorporate this level of disclosure on an annual basis. We expect this to be a relatively easy improvement for companies to make for 2020.

Board Skills

Since the 2019 proxy season, Glass Lewis has included board skills information as part of its report on S&P/TSX 60 Index companies. In this regard, Glass Lewis expects proxy circulars for TSX 60 companies to include meaningful disclosure regarding the skills possessed by the board as a whole and also on an individual board member level. It is indicated that if a board has failed to address material gaps regarding its mix of board skills and experience, Glass Lewis will view this negatively.

We at GGA have noted that many of Canada’s largest companies, by Market Cap, have started disclosing a formal board skills matrix within their annual proxy circulars. It is a governance best practice to identify areas for individual and broader board skills development and can be extremely useful in identifying the skill sets required of any new board members to be added as part of the regular board renewal process. If a company has not already done so, disclosing a board skills matrix should be an identified area for improvement in the 2020 proxy circular. For a board member sitting on multiple boards that disclose board skills, the director should maintain a repository of skills they posses, so there is consistency at each company they are a director at.

Board Responsiveness

Glass Lewis has codified its approach to board responsiveness to significant shareholder opposition (deemed as 20% or greater) relating to Say on Pay votes. They have identified appropriate responses to opposition which include:

Engaging with large shareholders to identify concerns; and
Enacting changes in the compensation program to address any concerns raised.

Issuers who faced significant shareholder opposition must be able to provide evidence in the proxy circular that the board is actively responding to shareholder concerns. This is usually in the form of expanded shareholder engagement disclosure within the circular, which we at GGA have noted much more companies are adopting in recent years. Failing to clearly disclose shareholder engagement activities after facing significant opposition in a Say on Pay vote may result in Glass Lewis recommending withhold votes for the Compensation Committee Members responsible at the next AGM.

GGA notes the importance of ongoing engagement with shareholders whether there has been significant opposition to a company’s pay programs or other governance concerns identified. It aids shareholders in better understanding the company’s strategy and rationale for why it has structured its pay plans and governance framework the way that it has. Proactive engagement should be preferred instead of reactive engagement to avoid situations such as those identified by Glass Lewis as companies should be striving for a 90%+ approval rate for Say on Pay and other governance matters.

Companies that face Say on Pay scrutiny should also consider disclosing a table that summarizes what they learned from shareholder engagement in the prior year, what the board and management discussed and reviewed to address shareholder concerns, and finally what the board has ultimately decided that may address or not address the shareholder concern and a rationale for why they have done so.

Contractual Agreements

Glass Lewis has codified several provisions that it deems as problematic within executive employment agreements. These include:

Excessively broad definitions of change of control;
inappropriate severance entitlements;
excessive sign-on arrangements without accompanying rationale; and
guaranteed bonuses.

Glass Lewis also expects double-triggered change of control provisions in all employment agreements, where the cash severance multiple is three times or less. The inclusion of long-term incentives in the severance multiple has also been identified as being problematic by ISS.

GGA notes that the three times multiple sighted by Glass Lewis is higher than the limit used by Institutional Shareholder Services (“ISS”) which has historically been set at a two times multiple. In our consulting experience, we observe that most companies have trended towards the use of no higher than a two times multiple when setting new employment contracts, so we do not believe there will be a huge push towards moving the standard back to three, since the low watermark standard by most institutional shareholder vote guidelines remains capped at 2 times.

When amending existing employment agreements or adopting new ones, we at GGA encourage companies to be aware of the problematic practices identified by both Glass Lewis and ISS and avoid including terms that could lead to negative sentiment from these groups, unless there is a business case to do so.

Problematic Pay Practices

Glass Lewis has also codified several new provisions that it deems as problematic and could lead to a negative Say on Pay vote recommendation or recommended withhold votes for Compensation Committee members where there is no Say on Pay vote. These include:

Targeting overall compensation above median without adequate justification;
Paying discretionary bonuses when short & long-term incentive targets are not met; and
Applying upward discretion either by lowering short-term performance goals at mid-year or increasing calculated payouts from the original formula.

In GGA’s experience, most companies targeted the median of the market for compensation, but in some cases, there may be a business case to justify why a company need to target above median. If a company is in this situation, while the threat of a withhold vote is heightened, they will need to do a great job in their proxy circular of explaining their company’s rationale which will help in justifying to shareholders why the approach makes sense, even if it still results in an Against recommendation from Glass Lewis or ISS. This explanation needs to go beyond just indicating that a specific executive or group of executives is performing above target. They will need to demonstrate this with clear evidence in the circular.

Having participated in thousands of board meetings that included discussion on finalizing annual bonuses, we are not convinced that Glass Lewis got this one right. Discretion is something that we at GGA believe boards should have as there may be specific accomplishments made by an executive or group of executives that fall outside of the original scorecard formula and deserve to be recognized. On the flip side, the scorecard results may lead to higher results, but not necessarily take into account recent events at a company that are affecting its operations or underlying share price such as new trade wars, environmental incidents, safety incidents, labour disputes, etc. The board should retain the discretion to adjust calculated payouts downwards as well, so discretion has to work both ways. What is most important, given the new guidance from Glass Lewis, is that if a company chooses to use discretion to adjust payouts upwards, it must do an excellent job of explaining its rationale for doing so and why it is in the best interests of the company.

Excessive Non-Audit Fees

Glass Lewis has clarified that in the second consecutive year where Non-Audit Fees have exceeded Audit or Audit Related Fees, they will hold the full Audit Committee responsible (not just the Audit Committee Chair), which may lead to recommended withhold votes.

Company Board Size

Glass Lewis has identified that a TSX-listed company should be made up of no less than 5 board members and that TSX Venture-listed company should be made up of no less than 4 board members. They have also established a maximum board size of 20. For larger financial institutions such as Canada’s Big banks, they have indicated that they may make an exception on a case-by-case basis, but will require appropriate rationale for why a larger board makes sense. One exception to the minimum size rule is controlled companies, where Glass Lewis has indicated that it will waive the size threshold, but maintain the maximum limit of 20 board members.In GGA’s experience, most boards are made-up of no less than 5 members with the median ending up around 9, so we do not believe this new requirement will affect too many companies.

Quantitative Pay for Performance Analysis

While Glass Lewis’ 2020 guidelines did not discuss any material changes to their quantitative pay for performance model, it will be interesting to see how Glass Lewis responds to the recent move by ISS to include more Economic Value Added (“EVA”) metrics within their quantitative pay-for-performance model. While nothing has been formally announced, the new partnership between Glass Lewis and CGLytics should lead to some additional pay-for-performance analysis offerings to demonstrate the strength of this new formal arrangement. We at GGA will continue to monitor these trends and keep our clients informed on any new developments.

GGA continues to monitor the evolving proxy voting guidelines on a regular basis and will be reporting on any changes coming out of ISS in the coming weeks 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 access to the full Glass Lewis’ 2020 Proxy Voting Guidelines for Canada, please click on the following link: https://www.glasslewis.com/wp-content/uploads/2016/11/Guidelines_Canada.pdf

Best Practices for Executive Compensation Disclosure

by Peter Landers | May 6, 2019 | Executive Compensation, Governance, Leadership

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:

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

by Peter Landers | Feb 25, 2019 | Cannabis, Executive Compensation, Governance, Market Trends

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

Compensation Philosophy & Peer Group
Executive Compensation Levels
Short-Term Incentive Design
Equity Compensation & Related Documentation
Employment Agreements
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 75^th 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

by Peter Landers | Jan 14, 2019 | Executive Compensation, Governance, Leadership

Understand Your Options

The clock struck midnight on December 31^st, 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.

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