Commentary: The importance of tying executive compensation to performance

Over the past decade there has been increased effort, often advocated by shareholder advisory groups, to link executive compensation with executive and corporate performance (so-called “pay-for-performance”).

This link has become particularly significant for mining companies in the face of recent falling commodity prices leading to concomitant deteriorating share prices. While some companies have reduced executive compensation in an attempt to preserve capital, there have also been many examples of shareholders challenging mining companies for what is perceived to be excessive compensation, or compensation that is disconnected from the performance of the company.

This is a difficult issue for mining companies that may see their struggling performance as being related to market conditions that are out of their control and not directly related to their executives’ performance.

While most of the high-profile examples of shareholder challenges have involved major mining companies, junior mining and exploration companies face the same issues, albeit in a less public forum. 

When unhappy shareholders wish to voice displeasure with a company’s performance (or the performance of their investment in it), executive compensation practices that are perceived as disconnected from such performance can be an effective argument for making board or management changes. With many mining companies currently struggling, avoiding costly and time-consuming shareholder disputes is an important aspect of survival. Maintaining shareholder support can help a company resist and survive an unsupported attempted takeover or proxy fight — shareholders who have faith in the leadership and direction of the company are undoubtedly less likely to support a dissident slate of directors, or lock-up or tender to a hostile bid.

One of the many ways in which a company can ensure that shareholders continue to support the company’s management and executives is by structuring compensation practices such that a significant portion of the overall compensation of its directors and officers is tied to performance.

The important link between performance and executive compensation is often highlighted in the recommendations of shareholder advisory groups such as Glass Lewis & Co., Institutional Shareholder Services (ISS), and the Canadian Coalition of Good Governance which review the compensation policies of public companies to determine whether the policies properly reflect such principles. All three shareholder advisory groups value performance-based compensation, and frequently make reference to pay-for-performance practices throughout their recommendations.

Shareholder dissidence can often arise when a company’s executive compensation levels rise while the company is experiencing economic difficulties. A high profile Australian example arose in October of 2014 when shareholders of Newcrest Mining, an ASX-listed Australian mining company, delivered a strong protest vote against the compensation of its executives. Newcrest had a difficult prior year, in which it had been handed a regulatory fine, faced large losses, and had been unable to pay a dividend throughout the year. Newcrest also hired a new CEO in 2014 and from the outset there were questions about whether the new CEO’s compensation was excessive, as it was about 62% higher than that of his predecessor. 

Given the financial difficulties the company had experienced, many shareholders were displeased with the levels of executive compensation that they viewed as being overly generous. Of particular concern, which was reflected in the recommendations of certain shareholder advisory groups, was the fact that the new CEO’s compensation was materially higher than not only that of his predecessor, but also of the chief executive officers of several major mining companies. Prior to the company’s annual general meeting (AGM), ISS recommended that shareholders formally reject Newcrest’s remuneration report, and Glass Lewis heavily criticized the remuneration report, though ultimately did not recommend its rejection.

On the other hand, shareholders are generally less likely to object to executive compensation practices, even when a company experiences losses, where such practices, and the method behind calculating such practices, are both clearly disclosed and tied to performance. A company can help ensure the support of shareholders during periods of challenging market conditions by ensuring that compensation practices focus on pay-for-performance; requiring that executives maintain an equity stake in the company; and ensuring that compensation disclosure is clear.

Like many other miners, Barrick Gold’s share price has been adversely affected in recent times by falling commodity prices. Shareholders demonstrated their disapproval with Barrick’s pay practices at the company’s 2013 AGM by delivering a 15% approval rating on its advisory say-on-pay vote.

In response to this rejection, Barrick implemented changes to its executive compensation structure, announcing that the company intended to increase its use of pay-for-performance measures. The new compensation strategy included a requirement that executives hold their Barrick shares until they leave the company. To solidify the impact of the requirement, Barrick also imposed a minimum shareholding requirement on upper management.

Arguably in part as a result of such changes, Barrick received 80% support on its say-on-pay vote at the company’s 2014 AGM.

Changing an executive compensation plan in the face of challenging economic conditions is not a strategy that is unique to major miners. A junior or mid-tier mining company, especially one which has experienced shareholder dissent, may also wish to implement structural changes to its compensation programs.

This was the approach adopted by Golden Star Resources, a TSX-listed mid-tier gold producer, after it received only 38% approval of its compensation plan from its shareholders on its 2013 advisory say-on-pay vote.

In response to that vote, Golden Star made substantial changes to its executive compensation in 2014, including share ownership requirements; the addition of performance share units as a component of compensation; a prohibition on directors and officers hedging their shareholdings; and a compensation clawback policy.

Perhaps unsurprisingly, Golden Star received a 97% shareholder approval of its compensation plan on its 2014 say-on-pay advisory vote.

During difficult market conditions, shareholders are willing to challenge companies on compensation that is perceived to be excessive, or compensation that is not adequately tied to performance.

Companies that fail to adequately focus on pay-for-performance linkage, or fail to explain how their compensation practices are linked to performance, risk shareholder dissent and, in certain cases, open revolt.

With a more transparent approach there is less opportunity for shareholders to object to a company’s compensation scheme. In Golden Star’s case, a few important changes to its compensation scheme led to overwhelming support for its compensation practices in 2014.

Junior and mid-tier miners would be well advised to review the Barrick and Golden Star situations, as well as the recommendations of shareholder advisory groups, to determine if they are protecting themselves from shareholder dissent over executive compensation matters.

— Stuart Breen is a partner at law firm Lawson Lundell LLP, practising corporate and commercial law. He has extensive experience acting for
clients involved in mining industry, including advising clients on and completing commercial transactions such as joint ventures, option/earn-ins, royalties, strategic investments and asset acquisitions. He can be reached at sbreen@lawsonlundell.com and tel. (604) 631-9149.

Andrew Robertson is an associate at Lawson Lundell who practices corporate and securities law and has experience in a variety of transactions, including share and asset acquisitions, corporate reorganizations, public offerings, and various other corporate proceedings. He works with both public and private companies, and can be reached at arobertson@lawsonlundell.com and (604) 631-9131.

With offices in Vancouver, Calgary and Yellowknife, Lawson Lundell LLP is a leading western Canadian business law firm known for its practical, strategic approach to legal and business problems. Visit www.lawsonlundell.com for more information.