Where We Were, Where We Are, Where We Going Essay
In the aftermath of major scandals and bailouts in the United States, the world’s and the public’s confidence in public corporations, has been shaken. With the publicized scandals of Enron and other corporations in the United States, the faith in public corporations fell as fast as the stock market. Investors had no confidence in corporations or in their boards. Measures needed to be taken to form regulations to provide stronger accountability, to prevent these types of scandals from happening and to rebuild the confidence of investors.
Corporate governance of publicly traded companies was no longer an option, it became a must. The public and the media demanded laws to protect future investors and shareholders (Colley, Jr, Doyle, Logan, & Stettinius, 2005). With most of the world’s financial markets in crisis and recession, the public has become much more aware of corporate executive compensation plans. Executive compensation has been an on-going issue for many years. There has been a great amount of controversy over how executives’ pay structure is designed and who judges, oversees and determines executives’ pay.
As the scales get tipped on what executives are getting paid versus employee standard wages, the public is always on the watch for the next corporate scandal. Boards are always challenged by what executives’ pay should be based off of; this could be performance, industry standards or percentage of revenue. Boards need to determine the base salary, benefits or short term and long term options that will be offered (Colley, Jr, Doyle, Logan, & Stettinius, 2005).
This paper will look at the past trends of executive compensation that lacked disclosure and transparency, current trends that are being used today in pay in the United States and Canada and future trends that should be used when it comes to executive compensation and executive pay methods. This paper will also give some recommendations that Canada should adopt.
Past Trends in Executive Compensation
From the “original opening of the New York Stock exchange in 1792 executive compensation” (Bruvik & Whitney Gibson, 2011, p. 74) existed. In the early 1900’s stock options of stock awards, stock purchases, stock appreciation rights (cash bonuses) and freestanding dividend equivalents were formed (Bruvik & Whitney Gibson, 2011) and still exist today. During this time executive compensation was very private and did not have transparency or regulations. It was not until the market crashed in 1913 that the public was becoming more aware of executive inflated wages, and compensation for executives. In 1933 Securities Act legislation was passed that required disclosure of stock sales to the public.
Then came the introduction of laws that limited “fringes” (perks) this made executive compensation more transparent and created more awareness for the public. But in 1983 Ronald Regan’s administration dropped regulations and this changed the level of transparency once again and this would eventually lead to indiscretions in executive pay. This caused an artificial rise in stock market values and increased misuse of stock options thus the elevation of executive’s salaries. The United States Government’s lower marginal tax to 33%, which changed the quality of management, because as long an executives increased shareholders wealth the salaries of executives had very little regulations (Bruvik & Whitney Gibson, 2011).
In 2001 the Enron scandal, executives inflated their earnings and overvalued their stock prices when they knew the company was going under. Senior executives cashed their stock options profiting while investor and employees of Enron lost everything. The numerous corporate scandals such as Enron, Jack Welsh CEO of General Electric, TYCO, and WorldCom created distrust in public corporations and “cost investors billions” (Bruvik & Whitney Gibson, 2011, p. 78). In order to increase confidence in public firms, a change was needed in regulations and legislation.
This led to the Sarbanes Oxley Act (SOX) of 2002. SOX focused on corporate governance issues within a firm and led to rules of practice for boards of directors. Although SOX does not have mandates for executive compensation it does address how the compensation committee should be independent and how they should govern themselves. This has become very critical legislation to aid in ethical practices in public corporation executive compensation (Bruvik & Whitney Gibson, 2011).
Current Trends in Executive Compensation
The main foundation of executive compensation has not changed, it is designed to attract, inspire, motivate and in the end retain the superior talent in the management world. In 2008 a government fund TARP was “created to purchase troubled assets from financial institutions” (Bruvik & Whitney Gibson, 2011, p. 79). TARP funds put restrictions on executive compensation by; restricting paying out bonuses, limiting the “Golden Parachutes”, denial of benefits and used clawbacks if executive compensation was based on misleading statements (Bruvik & Whitney Gibson, 2011). In order to receive TARP funding, firms have to practice the US mandatory “Say on Pay” which was implemented in January 2011.
The United Kingdom has also implemented the “Say on Pay” concept. The “Say on Pay” is a concept that “shareholders should be given a nonbinding vote on board of director’s recommendations on executive pay” (Mangen & Magnan, 2012, p. 86). “Say on Pay” concept “increases shareholders activism within when it comes to the pay policies and practices” (Geddes, n.d, p. 22). Current trends for public corporations for executive pay is to use polices and committees that structure the compensation.
This pay should be transparent and increase the long-term shareholder value. Stock option incentives should be restrictive, meaning they cannot be sold for a set amount of years or until after resignation. Corporations have still not restricted the pay of top executives and the total compensation is still quite elevated compared to that of the regular employee. A great number of firms feel that to retain good quality CEO’s some pay incentives have to be competitive.
Corporations feel that “superior incentives for executives (and traders whose actions can substantially impact an organization) to manage firms in investors longer-term interest” (Romano & Bhagat, 2009, p. 1). Corporations continue to struggle with the balance of reward based compensation that ensures future results and increases shareholders wealth in the short and long term (Colley, Jr, Doyle, Logan, & Stettinius, 2005). Executive compensation packages will continue to need to be governed by compensation committees to hold the confidence of the public, shareholders and the market.
How Canada Measures Up
As discussed earlier the United States along with United Kingdom has adopted the mandatory practice of “Say on Pay” which has increased shareholder involvement in the pay structure of their executives. Canada has not implemented this practice to be mandatory, even though it is, recommended as the best practices for firms. The five big banks in Canada have adopted the “Say on Pay” methodology (Mangen & Magnan, 2012). In January 2012 the Huffington Post stated that Canadian CEO’s are reluctant to discuss that executive compensation has got out of hand in Canada. The article discusses that executives’ incomes have continued to increase even though the wages of average Canadians have remained stationary.
The article interviewed Fraser Institute’s Niels Veldhuis and he stated “When you call for a policy that limits CEO pay what you are doing is you’re signaling that we’re going to have even more regulations on how businesses operate here in Canada, and unfortunately, that will cause businesses to relocate or locate elsewhere” (Mendleson, 2012). One could make the assumption that because Canada does not have the volume or the stability that the United States does in the their corporations, that Canada is not implementing stronger regulations because of fear of losing what they have already and want to attract more corporations to Canada.
At this time Canada uses a principles-based approach to governance in which standards are set and corporations are encouraged to meet them. Compared to the United States that uses a rules-based approach that requires corporations to meet the practices and legislation (Milne, 2006). In Canada the Canadian Coalition for Good Governance (CCGG) was formed to promote to good governance practices and recently the CCGG released the 2013 executive compensation principles. Corporations need to hold to the following principles: 1. A significant component of executive compensation should be “at risk” and based on performance.
2. Performance should be based on key business metrics that are aligned with corporate strategy and the period during which risks are being assumed. 3. Executives should build equity in the company to align their interests with those of shareholders. 4. A company may choose to offer pensions, benefits and severance and change-of-control entitlements. When such perquisites are offered, the company should ensure that the benefit entitlements are not excessive. 5. Compensation structure should be simple and easily understood by management, the board and shareholders.
6. Boards and shareholders should actively engage with each other and consider each other’s perspective on executive compensation matters (Moncrieff, 2012). The principles above are the best practices for boards and corporations and are recognized to be the superior standards, but as of yet Canada does not rules or regulations to enforce these practices. The Canadian government at this point has no plan to put caps on executive compensation. At this point the Canada’s tax laws are not in line with the compensation governance and reform is needed (Geddes, n.d).
Future Trends for Executive Compensation
Corporations, shareholders and boards are faced with meeting higher standards when it comes to executive compensation. This will mean adopting the “Say on Pay” and this trend is what is needed. Compensation committees must remain independent, transparent and must continue to ensure their programs attract, retain and motivate executive talent. Committees must ensure they are paying for performance that ensures long term profitability and value for both executives and shareholders (Stikeman Elliott, 2009).
Recommendations for Canada
Canada needs to focus on moving towards rules and regulations and not principles and guidelines. Canada will need to reform their standards to be more unified with the rest of the world’s expectations. If Canada wants to attract more corporations to develop in Canada then they need to be the benchmark of standards and practices and set even higher rules and regulations to maintain level, of integrity.
Executive compensation could become out of hand and it cannot just be the banks that maintain the higher standards. Canada needs to adopt the “Say on Pay” and make it mandatory and also move to regulations that are superior to SOX and align the tax laws to levels that keep up with executive compensation packages. Canada needs to embrace being the ethical governance leaders. Conclusion
There will always be unethical practices in executive compensation packages and it is not likely to decrease as long as there is competition and the need to retain talented CEO’s, but Canadian businesses can set higher benchmark when it comes to corporate governance, executive compensation and our regulations and practices for boards of directors. We have to remain ethical, transparent and continue to disclose. This is the only way we are going maintain the public and shareholders confidence and continue to attract investors to invest.
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