One of the biggest challenges for boards dealing with executive compensation issues are questions of fairness.

Is the executive getting the rewards to which she or he is entitled, given the company’s performance? Or, are the amounts too rich, draining money out of the company at shareholders’ expense?

The recent past, of course, is fuelling current concerns. With memories of Enron Corp. and Arthur Andersen still fresh in the minds of many, boards are increasingly turning their attention to ensuring that the decisions they make about their executives’ million-dollar pay packets are based on informed and independent advice. They are turning to compensation consultants who report to the boards of directors and the compensation committees — not management — to provide expert advice on the remuneration of its top people.

Executive compensation can be enormously complex, especially for very large corporations, and Canada’s largest public companies lure talented executives with the promise of complex reward programs for short-, medium- and long-term performance — including perquisites, salary, bonuses and deferred bonuses, among other enticements. The larger the firm, the more complex the measurements of achievement for each category.

At a certain point, board members typically become aware that the elements of a pay package have moved beyond their areas of expertise. At that stage, help is called in. But they are not off the hook: it is up to board members to assess the advice they are receiving — often without a full appreciation of the pros and cons.

“Board members are not necessarily experts in the field,” says John Hughes, associate partner at Deloitte & Touche LLP in Toronto.

As well, the firm recommending the size of an executive’s paycheque may well have been receiving its own paycheque from management. Only by seeking outside advice, uncoloured by conflicting interests, can the board and the committee adequately serve the shareholders.

But what is “fair” and what is “independent”?

“There is not a universal definition,” says Lisa Slipp, a worldwide partner of executive remuneration at Mercer Human Resources Inc. in Toronto. Companies define their own standards for independent advice. Says Slipp: “Regardless of who retains us, we want to provide the most objective, relevant advice.”

Canada is in the unique situation of having a marketplace in which expertise in assessing executive compensation is “pretty thin,” says Slipp. Given the small number of such firms active in Canada and the relatively high number of committees, boards and management groups seeking advice, the field can be a little incestuous.

At the same time, there is not a lot of incentive for more players to enter the market. Advising boards and committees on executive compensation is “small potatoes” for major consulting firms.

In the fiscal year ended Oct. 21, 2006, Bank of Nova Scotia’s human resources committee paid $30,000 to Hewitt Associates, while Hewitt received more than 20 times that — $678,600 — from the bank itself for unrelated consulting services for benefits and pension administration.

In fiscal 2006, Bank of Montreal retained Mercer for routine advisory work not related to compensation, paying $4.3 million.

Still, executive compensation remains a focal point for shareholders. Canada’s major banks, which are subject to a high degree of scrutiny, have a narrow definition of “independence,” says Slipp, and lead the way in terms of demanding independent advice, even if it means maintaining ongoing relationships with several consulting firms.

In the hunt for independence, some companies have looked to the U.S. for advice. But differing cultures have proved problematic. For one, executives in U.S. firms are more highly compensated, making it difficult for U.S. consultants to give informed assessments of Canadian pay packages. Boards that retain consultants on both sides of the border have found themselves treating the advice they receive from Canadian firms as the “definitive factor” in making their decisions, even if it does not fit all the criteria of independence. Faced with the problem of weighing relevant expertise against independence, some public companies have created a framework that uses Canadian consultants in conjunction with U.S. consultants.

It is also becoming common for boards to require that a consulting firm disclose any other services it may be performing for the issuer. Approval from the chairman of the compensation committee may be required in order for the company to retain the consulting firm for further services for management. In addition, it may be a condition of the retainer that a consultant can work for either management or the compensation committee ‚ not both — during a certain time period.

@page_break@Despite the incestuous relations of the past, Canadian firms are ahead of their U.S. counterparts, says Bill Mackenzie, director of special projects for the Canadian Coalition for Good Governance in Toronto. Indeed, executive compensation is not a sideline but is the main business of Hugessen Consulting Inc. in Toronto, Canada’s only firm that works exclusively on executive compensation. Ken Hugessen, formerly of Mercer, launched the firm along with two partners over a year ago in order to provide completely independent advice on executive compensation. The company, he says, has been “swamped” ever since.

“Enron was an accounting story, but also an executive compensation scandal,” says Hugessen. Enron’s numbers were initially fudged so that company executives would meet performance hurdles. Enron, along with the collapse of Arthur Andersen, put pressure on other boards to “get control of executive compensation” and forced firms that give advice in this area to “pick sides,” he says. According to Hugessen, shareholders are best served when the work of the committee’s and management’s consultants is complementary rather than “duelling.”

Bob Levasseur, senior consultant on executive compensation with Watson Wyatt Worldwide in Toronto, echoes Hugessen’s assessment. The emerging system — in which every party has its own consultant — is still “teething,” he says. “Our greatest fear is that it will be reduced to two sides, [each consulting firm] arguing about its data.”

Ideally, the consulting firm succeeds if it provides an independent perspective by using comparator groups — comparing companies in the same industry and geographical region with the company retaining them. In addition, the consulting firm should also provide the appropriate metrics for determining what an executive’s rewards should be, as well as a reasonable and fair method for tying that executive’s compensation to the performance of the company. IE