Slowly but surely, financial services firms have been dragged toward better disclosure of executive compensation, but there’s still plenty of room for improvement in detailing exactly what they pay their executives — and why.

Corporate executives have always been reluctant to say much about how they are remunerated. But while most people wouldn’t want to broadcast their finances to the world, it’s essential that the numbers are released for public companies. The stakes are high, and management may have a large say in setting its own compensation, so the temptation to plunder shareholders can be great. Disclosure is the only way investors can ensure they aren’t being ripped off.

Investment Executive has tracked executive compensation disclosure in publicly traded financial firms for at least a decade, since disclosure requirements were first introduced.
Early attempts at disclosure were often modest, revealing the dollar amounts of executive pay packages, but often just larding the discussion of compensation with rhetoric about pay for performance and keeping rates competitive with rival firms. Company reports were conspicuously short on substance.

Things have been getting better. In the past few years. The management proxy circulars IE reviews as part of its survey show that some companies have become more forthcoming, and the disclosure is getting more user-friendly. We’re seeing less obfuscation about the details of variable pay components such as options grants. More important, companies are revealing more about the metrics they use to measure their executives’ performance, the targets they set and the mix of factors that go into setting executive pay rates.

Take Sun Life Financial Inc. as an example. Its latest proxy circular devotes 14 pages to executive compensation disclosure, including eight pages of discussion of its pay philosophy and an analysis of the factors that go into setting it. When executive compensation disclosure was first made mandatory, many companies would simply have devoted a paragraph to the subject.

CIBC is another firm that appears to be leading the way in providing more useful information. Its 15-page report includes a table summarizing total compensation paid to each named executive for the past three years.

Some companies are voluntarily improving disclosure, but securities regulators have had a hand in it, too. In 2002, they targeted executive compensation disclosure as part of their ongoing continuous disclosure reviews. At the time, they found that most firms’ disclosure was far too general and boilerplate to be useful. They suggested that companies step it up.

In 2004, the Ontario Securities Commission followed up with a further review of 37 of the issuers that were reviewed in the 2002 initiative. It found that firms had followed through on most of the changes that they had agreed to make, but also noted that the management discussion of the underlying rationale for compensation was often lacking.

John Hughes, the OSC’s manager of continuous disclosure in Toronto, says the quality of executive compensation disclosure is improving overall: “To the extent that there continue to be problems, it could be argued that they’re partly attributable to the limitations of the form requirements.”

Nevertheless, regulators continue to tackle the issue in a variety of ways. In March, the OSC brought allegations against Hollinger Inc. and several of its top executives and directors — alleging, among other things, that the firm failed to disclose executive compensation information from 1998 to 2001.

The allegation has not been proven. It was followed by the filing of fraud charges in the
U.S. The Department of Justice there alleges that two former Hollinger International Inc.
executives disguised compensation as non-compete fees in an effort to enrich themselves “at the expense of Hollinger’s public shareholders and corporate assets” and to avoid Canadian taxes. Those charges haven’t been proven, either.

The regulator is also using its compliance power. In May, the OSC required a firm to refile its executive compensation disclosure to fix a problem the OSC found with the firm’s 2004 proxy circular: compensation that was originally disclosed as a “management contract” had to be added to the compensation disclosure table.

Regulators have also been pushing firms to reveal more about the pensions they provide executives. The issue first came to light in the annual round of shareholder proposals that afflict the big banks. In 2004, shareholder activists pushed the idea of better pension disclosure. The cause was taken up by more mainstream governance advocates and, in mid-January, the Canadian Securities Administrators issued a notice detailing how firms should provide enhanced benefits disclosure. Such disclosure remains voluntary, although, the CSA noted, it may become mandatory.

@page_break@Still, executive compensation remains a common theme in some of the shareholder proposals that were filed this year. Among other things, they call for a limit to executive salaries and for firms to replace stock option plans with restricted-share plans. While the proposals are routinely voted down, they often lead the way in terms of corporate governance reforms. For example, shareholder activists pushed the idea of separating the chairman and CEO positions long before any of the banks were prepared to do it. While the shareholder resolutions on this point were always defeated, the banks did ultimately adopt the change of their own volition.

While shareholders are pushing companies to reform compensation practices and disclosure habits, it may come down to regulators requiring it from companies that don’t do so voluntarily. Hughes says the U.S. Securities and Exchange Commission “has been saying for some time that it is considering a new initiative in this area. If it does that, it will clearly trigger a reassessment of Canadian rules [which are largely based on the U.S. rules], as well .”

Indeed, former SEC chairman William Donaldson beat the drum for improved executive compensation disclosure earlier this year. “I would also like to see greater disclosure of pay packages — with not only the total amount of compensation provided, but for each element of this compensation to be clearly explained, including benefits that may not be easily assessed but which carry a clear value and which the CEO clearly cares about,” he said. Donaldson added that the SEC’s division of corporation finance is looking at ways to modernize the compensation disclosure rules.

Alan Beller, head of the division, has outlined several concerns the SEC has about the quality of compensation disclosure. Among them: companies concern themselves only with filling out disclosure forms and not making complete disclosure of all modes of compensation; certain perks, such as the use of corporate jets, are not properly revealed; and too much of the discussion of compensation is simply boilerplate, as Canadian regulators also complain.

Beller says the regulator is looking at revising its disclosure rules in a number of ways, including whether it should require enhanced disclosure of total compensation and how that might be achieved; possibly expanding the roster of named executive officers to include specific officers apart from the CEO, such as the CFO and/or general counsel; introducing rules dealing with disclosure of director compensation (proposed in 1995, but not adopted); improving compensation discussion; amending related-party disclosure; improving how companies categorize and value perks; and beefing up retirement benefits and deferred compensation disclosure. So far, the SEC has not said whether it will be proposing changes in any of those areas or not.

The push in the U.S. comes on the heels of corporate scandals, such as those involving Tyco International Ltd. and Adelphia Communications Corp., in which it was alleged that executives essentially treated their firms as their private piggy banks. Last year, the SEC brought an enforcement action against General Electric Co., alleging that it didn’t properly disclose post-retirement benefits granted to outgoing CEO Jack Welch. The U.S. also witnessed outrage at the sheer size of executive pay in the case of the New York Stock Exchange and its former CEO, Dick Grasso. But it remains to be seen whether new SEC chairman Christopher Cox shares the concerns.

“I think it’s just a matter of time until this area comes up for reconsideration in Canada,” Hughes adds, noting this is not necessarily the position of the OSC. “We’re seeing various incremental shareholder proposals and voluntary disclosure enhancements, and it seems to me that the ground is slowly shifting.”

Part of the shift reflects recognition by companies that they must do more to shore up investor confidence, and increased compensation transparency is a relatively painless way to do it. In a June briefing, the Conference Board of Canada counselled firms to “overdisclose” key elements of compensation.

Investors are also demanding more from companies. The Canadian Coalition for Good Governance has issued a working paper that, among other things, calls for improved compensation disclosure, including a three-year comparative table that summarizes every component of the compensation package at the time it was granted (as CIBC now does) and a table that reports the total consideration paid to the CEO since being appointed. IE