Effective for the 2009 proxy season, the Canadian Securities Administrators (CSA) have adopted new requirements for executive compensation disclosure in the form of the revised Form 51-102F6 (the New Disclosure Requirements). The following excerpt from "Executive Compensation After the Boom: A Guide for Canadian Public Companies in 2009" will review the new disclosure requirements as they affect the principle of pay-for-performance.
The New Disclosure Requirements call for a new narrative form of discussion and analysis of executive compensation (called Compensation Discussion & Analysis, or CD&A). CD&A is required to contain a discussion of, among other things, the objectives of the compensation program, what the compensation is designed to reward, the elements that comprise the compensation package and why the company chooses to pay what it pays, as well as a discussion of how each element of compensation and the company’s decision about such element fits into its overall compensation objectives.1
Preparing for this disclosure provides an opportunity to determine whether the compensation package is adequately tied to the type of performance that is meant to be or should be rewarded. Pay-for-performance essentially refers to the correlation of the different elements of executive remuneration with the achievement of desirable corporate goals. As described in RiskMetrics’ 2009 Canadian Policy Updates, the principle of pay-for-performance, aligned with an emphasis on long term shareholder value, takes into consideration the linkage between pay and performance, the mix between fixed and variable pay, performance goals and equity-based plan costs.2
To assess whether pay is properly tied to performance, a company first needs to determine what performance it wants to reward. This involves a focus on the key success factors of the business and a determination of the metrics that best measure those factors, taking into consideration all appropriate factors, both quantitative and qualitative. Quantitative factors include, among others, revenue and profit growth, net income, cash flow and cash flow management, return on equity, margins, cost containment and market share. Assessment of qualitative achievements requires a more tailored approach as these may vary significantly from one enterprise to another and include measures such as leadership, customer satisfaction, product or service quality, fostering of compliance, ethics green initiatives or similar desirable outcomes.3 The questions raised by this analysis are “what drives the business” and “how do we measure it?”
The New Disclosure Requirements also specifically target pay-for-performance by requiring companies to disclose any performance goals or similar conditions that are used for determining compensation payments. The only exemption from this disclosure is where disclosure of specific quantitative or qualitative factors would be seriously prejudicial to the company’s interests (and even then, if the company wishes to rely on this exemption, it must state what percentage of the executive’s total compensation relates to this undisclosed information and how difficult it could be for the executive, or how likely it will be for the company, to achieve the undisclosed performance goal or similar condition). If a company discloses performance goals or similar conditions that are non-GAAP financial measures, it must explain how the company calculates these goals from its financial statements. CD&A also contains new requirements to discuss, under the five-year shareholder return graph, how the trend shown by the graph compares to the trend in the company’s compensation to executive officers over the same period.4 This type of greater transparency is similar to executive compensation disclosure requirements adopted by the U.S. Securities and Exchange Commission (the SEC) in 2006.5 Subsequent to the implementation of these rules, the SEC has on numerous occasions highlighted that boilerplate or legalese will not suffice.6 The CSA will no doubt be of a similar view.
One of the challenges represented by the new level of disclosure required for performance targets is that it has the potential to encourage companies to lean towards more short term and concrete targets that are easier to identify and that it is more comfortable disclosing, as opposed to more long term measures that may be considered competitively sensitive.7 Boards and compensation committees facing these challenges should keep in mind the underlying goals that are the basis for their compensation policies, notwithstanding these may represent sensitive disclosure matters.