Canada: Executive Compensation Disclosure Issues In Tumultuous Times

Canadian public companies are facing unprecedented financial and market conditions and business challenges, and this fact has been reflected in outcomes under 2008's compensation plans. In many cases, previous equity grants are underwater, performance metrics for 2008 cash incentive plans have not been met, and participants in executive compensation plans are looking more fondly at their base salaries than in prior years.

Compensation committees and boards have reviewed the results of 2008's compensation plans and made executive compensation plans for 2009 under radically different circumstances than in prior years. We have set out below the issues our clients have found to be most challenging in preparing their executive compensation disclosures this year.

Disclosure of Changes to Compensation Plans in Light of Current Conditions

Disclosure of executive compensation by a public company is, generally, disclosure of what was paid in the previous year ― and why ― to certain executives, known as the Named Executive Officers (NEOs), rather than what the company proposes to pay them this year. In light of significant changes in business conditions, many companies have looked very critically at how they are compensating their employees, including their NEOs, and as a result have made changes to their compensation plans for 2009.

The new Compensation Discussion and Analysis (CD&A) in respect of the previous fiscal year is required for the first time this year. The CD&A requires an explanation of why each element of compensation was paid to NEOs in 2008. Disclosure of a change made to compensation plans for 2009 and later is not required unless the change could affect a reasonable person's understanding of compensation paid in 2008. Public companies may use their CD&A as an opportunity to communicate with shareholders just how the company is responding to business challenges and shareholder losses. Even if disclosure is not required, issuers may consider it beneficial to demonstrate the response being taken to the current economic challenges under the company's compensation plans, or to advise shareholders of future changes.

Salary Freezes/Increases/Decreases

Many companies have frozen or at least moderated increases in base salaries for employees, including NEOs, with the following disclosure implications:

  • the total salary paid for 2008 must be disclosed;
  • a change to an NEO's salary for 2009 must be disclosed if it is necessary to understand the compensation paid to the NEO for 2008; and
  • although not required, an issuer may wish to disclose salary changes for 2009 to demonstrate the actions it is taking in response to the economic downturn.

Issuers must also discuss whether benchmarks were used to determine compensation for 2008, including base salaries. If changes have been made for 2009 in light of specific business challenges, disclosure of 2008 benchmarking may not reflect the basis upon which compensation for 2009 was set. If this is the case, issuers will need to consider adding an outline of changes made for 2009 to their disclosure of their 2008 benchmark use.

Cash Incentive Plans

We have noticed a number of changes to cash incentive plans in the current downturn, including:

  • scaling back bonuses even if 2008 performance metrics were met, to save cash or, more rarely, awarding bonuses if performance metrics were not met to recognize exceptional performance in unanticipated circumstances;
  • changes to performance metrics going forward; and
  • executives foregoing bonuses.

Many compensation committees have taken into account current economic conditions when making bonus decisions for 2008. The CD&A should disclose whether the compensation committee had any discretion to set the bonus, and, if discretion was used, the decision-making process, the factors considered, and any differences in treatment between individual NEOs.

Underwater Equity-Based Incentives

In the past few years, equity-based incentives have become a much larger component of total compensation for many NEOs. Just as many shareholders have seen their shares decline in value, many NEOs have seen the value of their equity-based compensation decline ― in many instances to a level where the current market price is below the exercise price for the securities in question.

Unless necessary to understand total compensation provided to NEOs in 2008,changes implemented for 2009 (such as repricing, converting options into other types of incentives, changes to the grant basis or changes to vesting criteria) will not require disclosure for 2008. However, the TSX may require shareholder approval (for further information, see our article " Considerations for Repricing Options and Other Equity-Based Compensation") to amend a plan or outstanding options; and institutional investors' voting policies may need to be considered.

Issuers may also wish to outline the difference between the value of the options on the grant date and the value of the options in the current economic situation. As shareholders have seen a significant decline in the value of their investments, this is a way for issuers to show that the incentives given to NEOs similarly reflect this loss.

'Say on Pay'

'Say-on-pay' proposals have been gaining traction in recent months in Canada. At the annual meetings of the National Bank, Royal Bank, CIBC, Bank of Montréal, and Scotiabank, among others, shareholder proposals calling for a non-binding advisory vote on executive compensation achieved a majority of votes in favour, and thisis an issue boards of directors proactively needto consider for their 2010 annual meetings. Executive compensation disclosure this year should be prepared in the expectation that shareholders may well have a 'say-on-pay'vote in future years. This issue is discussed in greater detail in another article.

Other Issues

Other actions being considered include:

  • clawbacks of bonus payments or equity based compensation;
  • incentive payout delays;
  • implementation of performance conditions on payouts;
  • pension plan changes; and
  • decreased perquisites.

Finally, many of the actions discussed in this article have employment law consequences that must be considered before making changes to a compensation plan.

For more information on developments in executive compensation in light of current economic conditions, please see our Legal Update.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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