Capital Markets 

John Tuzyk, Beth Romano (Student-at-Law) and Shavone Hayes (Summer Law Student)
Last year, the U.S. Securities and Exchange Commission (SEC) approved a proposal that would require U.S. public companies to disclose the ratio of CEO annual compensation to median employee annual compensation. Similarly, the European Commission is proposing the adoption of rules requiring certain publicly traded companies to report CEO pay ratios.
Proposals to use and disclose vertical benchmarking metrics in the form of executive compensation ratios are, at least in part, a response to a public debate concerning growing income disparity. The United States’ disparity gap ranks above the Organization for Economic Co-operation and Development (OECD) average with the average pay of American CEOs of S&P 500 companies 354 times that of the average U.S. worker in 2012. The OECD has reported that Canada’s disparity gap, though less than that of the U.S., is also higher than the OECD average and growing.
The SEC initiative raises the question of whether similar disclosure requirements may be adopted by Canadian securities regulators.
In 2010, the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank Act) mandated the SEC to adopt a rule requiring issuer pay ratio disclosure. This mandate was subject to significant debate in the U.S. Proponents of such disclosure argue that it will provide transparency on pay disparity, while opponents contend that it is onerous, prohibitively expensive to comply with and that the value of the information to investors is unclear. For example, David Hirschmann, president of the U.S. Chamber of Commerce’s Center for Capital Markets Competitiveness, expressed concerns over how the ratio will be used:
“The ratio is not going to be a meaningful way to help investors but will be used as a political tool to attack companies.”
Others believe that such disclosure will benefit shareholders. Robert Brown, Jr. made this case in the Harvard Business Law Review:
“With respect to the materiality of the information, ratios have particular importance in the era of ‘Say on Pay.’ An advisory vote on compensation gives shareholders an opportunity to comment on the reasonableness of CEO pay. Reasonableness, however, requires context. Metrics that allow for a comparison of pay practices among public companies can assist in providing the requisite context. Moreover, the ratios provide a mechanism for the first time for assessing the reasonableness of the compensation within each particular company.”
The SEC received over 20,000 comment letters prior to making its proposal in September 2013 pursuant to the pay ratio provision in the Dodd-Frank Act. Divided on party lines, the SEC proposed a requirement that U.S. public companies disclose:
  • The median of the annual total compensation of all employees of the issuer, except the issuer’s CEO (or equivalent)
  • The annual total compensation of the issuer’s CEO (or equivalent)
  • The ratio of those two amounts
The SEC’s proposed rule addresses some of the concerns raised about the pay ratio provision in the Dodd-Frank Act by offering flexibility in calculating pay ratios. The proposed rule allows companies to select a methodology to calculate pay ratios that is appropriate based on the size and structure of their business and the way the company compensates employees, rather than stipulating a required calculation methodology. The rule is proposed to become effective with respect to the first fiscal year of an issuer commencing on or after the effective date of the final rule.
The proposed rule would apply to companies listed on the U.S. exchanges. However, it will not apply to:
  • Emerging growth companies under the U.S. Jumpstart Our Business Startups (JOBS) Act (typically public companies whose initial public offering occurred after December 8, 2011, and have annual gross revenues of less than C$1 billion during their most recently completed fiscal year)
  • Smaller reporting companies (companies with a public float of less than C$75 million as of the last business day of its most recently completed second fiscal quarter)
  • Foreign private issuers that file annual reports and registration statements on Form 20-F
  • Canada-U.S. Multijurisdictional Disclosure System companies that file annual reports and registration statements on Form 40-F
The proposal was subject to a public comment period which ended in December 2013. A final rule has not yet been adopted by the SEC.
This U.S. disclosure change does not appear to have been motivated by pressure from institutional investors. According to a bulletin published by Towers Watson in June 2011, the number of shareholder proposals regarding internal pay ratio disclosure in the U.S. dropped from nine in 2010 to three in 2011. The proposals that have been made have also generally received limited support. For example, the International Brotherhood of DuPont Workers made a proposal in 2011 calling for the board of directors of E. I. du Pont de Nemours to compare the compensation packages for senior executives with that provided to the lowest paid employees. The proposal received only 5.8 per cent shareholder support.
It appears that the SEC disclosure change was politically motivated, rather than in response to investor pressure. The provision in the Dodd-Frank Act was introduced by Robert Menendez, a Democratic senator, who stated:
“We have middle-class Americans who have gone years without seeing a pay raise, while CEO pay is soaring. . . . What’s too costly here are the big paydays for CEOs. And the burden is falling on workers with stagnant wages.”
The European Commission’s proposal goes further than the SEC proposal by requiring a binding vote on a wide range of sensitive remuneration benchmarks, including CEO pay ratios. European lawmakers have taken a number of recent steps to control executive awards, including banning banker bonuses if the bonus is more than twice the level of fixed pay.
The European proposal will require over 10,000 listed companies to disclose clear, comparable and comprehensive information on their remuneration policies and how they were put into practice. Company pay policies will need to indicate the maximum executive compensation, and explanations will be required as to how each company’s executive team contributed to its long-term interests and sustainability. In addition, companies will need to explain how the pay and employment conditions of employees were taken into account when setting the executive pay policies, including disclosure of the ratio of CEO pay to the average employee.
The proposal is still in draft stage and is facing significant opposition. For example, Hendrik du Toit, chief executive officer of Investec Asset Management Limited, which manages US$110 billion in assets, said it would “put Europe at a disadvantage.” Further, the proposal may not receive support from the United Kingdom, Germany and other member states that declined to implement the disclosure of such ratios after domestic debates over corporate governance reform. In January 2012, following responses to consultations on the reporting, regulation and structure of executive pay, the U.K. government announced a package of measures to address key issues around executive pay. This package did not include disclosure of CEO to employee pay ratios, despite several proposals to introduce such disclosure.
In Canada, executive compensation disclosure rules have historically been driven by investor demand, particularly institutional investor demand. Canadian institutional investors and asset managers have not to date voiced significant interest in the use or disclosure of executive compensation ratios. So, while disclosure of executive compensation ratios has been implemented or widely debated in various countries, there has been very little debate in Canada regarding requiring this type of disclosure. 
Institutional Shareholder Services Inc. and Glass Lewis & Co., two shareholder proxy voting firms that provide advice and governance to larger institutional investors, have not expressed a position on such an initiative in their Canadian voting guidelines. Furthermore, the voting proxy guidelines of the major Canadian institutional investors, such as OMERS, Canada Pension Plan Investment Board and Caisse de dépôt et placement du Québec, do not refer to CEO pay ratios.
Stephen Erlichman of the Canadian Coalition for Good Governance (CCGG), which represents many of Canada’s largest institutional investors and asset managers, expressed concern that such ratios distract from other issues around compensation. In CCGG’s view, such ratios are just one measure of executive compensation and can be difficult to compare across industries and even companies, and could be a distraction from other important compensation measures. Concern has also been voiced that companies will outsource their lowest-paid jobs to push their average worker pay higher and improve their CEO pay ratios.
However, the Shareholder Association for Research & Education (SHARE), which calls itself a Canadian leader for responsible investment services for institutional investors, indicates it will support proposals that ask companies to provide shareholders with a comparison of the compensation of their executive and non-executive employees, provided the reports can be produced without undue expense or revealing confidential information, and will vote on specific proposals for companies to establish specific ratios on a case-by-case basis.
NEI Investments submitted shareholder proposals last year to the six major Canadian banks requesting disclosure of a CEO to employee pay ratio. The proposal was withdrawn given the banks’ agreement to study the use of benchmarking in executive compensation. The Meridian Compensation Partners report that was commissioned by the banks concluded that when horizontal benchmarking is used properly, it provides relevant context and is an important input for committees when setting executive pay and a key input in setting pay parameters. The report also concluded that while vertical benchmarking is unlikely to be sufficient on its own to guide committees establishing executive compensation, it can provide additional context to assist decision-making.
The Royal Bank of Canada in its most recent proxy circular indicated that its compensation committee was provided with vertical pay ratios for additional context in making compensation recommendations for the CEO. However, the disclosure did not indicate what level of employees were involved in the vertical pay ratio analysis or what role, if any, such ratios played in determining executive compensation beyond providing “additional context.”
There have been previous Canadian shareholder proposals regarding CEO pay ratio disclosure. In 2010 and 2011, Mouvement d’éducation et de défense des actionnaires (MÉDAC), a Quebec-based organization representing non-institutional shareholders, made several shareholder proposals that companies should adopt executive compensation practices that took into account vertical compensation metrics. Specifically, MÉDAC proposed that boards of directors establish a senior executive aggregate compensation ceiling in the form of a multiple of the median compensation of an employee. The form of the MÉDAC proposal was typically as follows:
“The compensation of the most senior officer should be justifiable relative to the employees who contribute to his or her success and that of the company. It is proposed that the board of directors adopt a policy stipulating an internal pay ratio that it deems ‘ethically acceptable’ and that this be justified in the management circular.”
The voting results published following the respective annual meetings of shareholders showed an overwhelming vote against the proposal, with the highest percentage of support at 18.6 per cent. The results suggest that while the measure may be supported by some retail investors and SHARE, very few institutional shareholders or asset managers endorsed these proposals. Instead, the focus in Canada of institutional shareholders and asset managers appears to be on the adoption of say-on-pay votes and pay-for-performance proposals.
The disclosure of such ratios has been raised previously in the Canadian context in relation to executive compensation disclosure. In 2011, in the course of amending Form 51-102F6 Statement of Executive Compensation, the Canadian Securities Administrators (CSA) received four comments recommending that companies be required to provide pay ratio disclosure. The CSA responded that the costs imposed on companies to provide this disclosure outweighed any benefits of disclosing the pay ratio and did not amend the form to include this disclosure in response to these comments.
Major institutional investors, their organizations such as CCGG, and their proxy advisory services have historically driven Canadian practices and requirements relating to executive compensation disclosure. Few, if any, of these are requesting that companies provide such disclosure or that the Canadian securities regulators enact a rule similar to the proposed SEC rule to require such disclosure. As a result, only Canadian dual-listed companies that do not qualify for the foreign private issuer, or other exemptions, will be required to provide such disclosure to comply with the proposed SEC rule. Given the lack of interest by Canadian institutional investors and asset managers in such disclosure, it currently appears that Canadian securities regulators will not be adopting such a requirement. Such a requirement would likely only come about as a result of a political mandate from provincial governments to do so, such as the recent Ontario government initiative with respect to the OSC proposal to require disclosure of companies’ approach to the participation of women in boards and in senior management.
For further information, please contact:
John Tuzyk    416-863-2918
or any other member of our Capital Markets group.
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​John Tuzyk, Beth Romano (Student-at-Law) and Shavone Hayes (Summer Law Student)

Tags: Capital Markets, Corporate Governance, Pensions, Benefits & Executive Compensation

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