Overall profits at financial services firms have generally doubled in the past five years, yet aggregate executive pay has hardly changed. Does that mean shareholders are getting a better deal on management labour? Hardly. Executives are just getting paid more up front, and leaving less to chance in the markets.

Investment Executive has long tracked the size and composition of pay packages that CEOs and other top brass in the financial services industry receive for their toils. The numbers never fail to impress. In total, the top executives of the publicly traded financial firms take home hundreds of millions in annual compensation. But then, they also help generate billions in profits for shareholders.

In fact, they’ve been far better at ramping up profits in the past five years than in expanding their own pay packets.

IE estimates the total value of executive pay by adding up all forms of compensation granted in the firm’s latest fiscal year, as disclosed in companies’ proxy circulars. For options or stock appreciation rights that have no cash value at the time they are granted, we estimate a value on the basis that the grants do have an intrinsic value at the time of the award and should count as part of the executive’s reward for performance in the year they are granted. To arrive at an estimated value, we project the ultimate value at expiry based on very conservative growth assumptions, and then discount that estimate to current value to give it a value in the year of the grant. Because we value options and SARs in the year they are awarded, we don’t count executives’ gains from exercising their options as part of their annual compensation.

On that basis, we estimate that aggregate executive compensation for the financial services industry’s public firms reached more than $438.7 million in fiscal 2004. CEOs alone accounted for about $140.3 million of the total.

While the numbers are impressive, it should be remembered that the firms also generated more than $23 billion in corporate profit for shareholders in the same time frame. Total executive compensation ate up less than 2% of total net income — which seems like a pretty good deal for shareholders.

The bargain sounds even more attractive when you consider that shareholders appear to be getting far more bang for their buck than they did several years ago. For example, our 2000 survey of industry executive compensation (which looked at fiscal 1999) found that aggregate estimated executive pay was slightly higher than it was in the past year. It reached an estimated $454 million, vs $438.7 million this year. The aggregate profits of the firms we studied that year amounted to less than $12.5 billion (vs $23 billion).

To be sure, the roster of firms included in our research has changed a lot in the past five years. A number of firms featured in the 2000 survey, such as Trimark Financial Corp., Mackenzie Financial Corp. and Canada Life Assurance Co., have been swallowed up by others and are no longer publicly traded. A number of new players, including ING Canada Inc., TSX Group Inc. and GMP Capital Corp. , have come to market, but the overall numbers still show that industry profits have almost doubled as total executive pay has modestly declined.

Unfortunately for shareholders, the story isn’t quite as favourable as the headline numbers would suggest.

While executive pay may not have changed much from the 2000 survey, the composition of compensation packages certainly has evolved. Nowadays, bosses are taking much more of their money up front. In 2000, total estimated executive pay was $454 million, but slightly more than $178 million of it was liquid (salary, bonuses and other forms of tangible compensation), and the bulk came in large options grants. Today, the liquid component is up to more than $364.5 million. So, as profits doubled, cash and near-cash executive pay has effectively doubled as well.

Getting more up front

It’s the same story for CEOs. While total estimated CEO compensation is down to $140.3 million for the past year , the liquid portion is more than $110 million. In 2000, the liquid side of CEO pay was only about $48 million.

The big difference between then and now is clearly the prevalence of options. Stock options were once a mainstay of executive compensation in the financial services industry. Options also won favour when they didn’t have to be expensed and they seemed like free money.

@page_break@Since then, options have become less attractive to companies and executives alike. Stock markets have suddenly become much less certain places, and many executives aren’t quite as eager to have two-thirds of their pay package riding on them. The free ride is over for companies, too, as they’ve been pushed to start expensing their options grants.

Options are so out of favour that CEOs are taking home more in straight salary than they are from options. That’s not including bonuses, profit-sharing, restricted shares and other annual compensation. That’s a stark turnaround from a few years ago, when CEOs made their real fortunes in the markets.

The big-bank CEOs were probably the biggest beneficiaries of the fashion for options. By implication, they are also the ones that have seen the largest falling off in their overall estimated pay in the past few years. In 2000, we estimated that the banks’ executives were awarded an aggregate $271.8 million in compensation. In 2005, that’s down to $174 million. However, their liquid compensation has more than doubled, to $142 million from $63.4 million; going to 81.6% of overall estimated pay this year from 23% in 2000.

Despite the diminished rewards, executives have still managed to do an impressive job expanding profits. The best performer among the Big Five banks in 2004 (as measured by net income and return on equity) — Bank of Nova Scotia — was run by the lowest-paid executive team among the five, and it had the lowest-paid CEO in the group.

Similar results are evident on the insurance side: the firms whose top managers seem to make the least (in terms of aggregate executive compensation relative to net income) are also generating the highest ROE, namely Great-West Lifeco Inc. and ING Canada Inc. The insurers didn’t offer the big options rewards that the banks did in 2000, so they haven’t seen such a dramatic reweighting of their compensation toward more tangible forms. Still, their total liquid pay has doubled for executives as a group, and insurance company CEOs have seen their liquid pay triple since 2000. Of course, total profit at the firms has more than doubled, too.

If there’s one group whose compensation has kept pace with their profit growth it’s the asset managers. Total estimated executive compensation for asset managers has barely budged in the past five years, to $56.6 million from $50.4 million in 2000. And profits have declined to less than $1 billion from $1.2 billion. Firms such as CI Fund Management Inc. have seen a huge increase in profits in that time, yet compensation is up only modestly.

As for bargains among the asset managers, things get a little sketchier as you move down from the large-cap companies to the smaller players, for which profits are often more volatile. However, there are still firms — such as IGM Financial Inc. and CI — whose executive teams are producing far greater profits than their rivals in the category.

The TSX Group’s executive team also stands out as a bargain, with compensation at about 3.4% of net income, yet generating an impressive ROE of 39.5%.

The independent brokerage houses also post strong ROEs, although their “eat what you kill” approach to compensation can mean that top-level executives carry off a large chunk of the firm’s revenue. Yet that’s only fair as, compared with huge companies such as the big banks, individuals tend to have much greater direct impact on revenue and profit at independent brokerages.

All said, there are relative bargains to be had among the biggest firms’ executive teams. However, don’t think that a period of strong profit growth and a modest gains in overall pay means that all financial industry executives are now working cheap. Their overall take may be down, but it is also much less dependent on the markets. IE