Comparators in spotlight with Executive Compensation Framework

Ontario’s new rules have public sector working hard to justify C-suite numbers
By Sarah Dobson
|Canadian HR Reporter|Last Updated: 03/06/2017
Electricity CEO
Jean-Bernard Levy, CEO of France’s state-owned electricity company EDF, in Paris on Feb. 14. Levy makes considerably less than the suggested CEO salary for Ontario Power Generation, despite his company having much larger revenues and much more employees, according to Bertrand Malsch, associate professor and distinguished faculty fellow in accounting at the Smith School of Business at Queen’s University in Kingston, Ont. Charles Platiau (Reuters)

When the Ontario government announced a new Executive Compensation Framework last fall, broader public sector employers knew they’d be in the hot seat when it came to justifying their numbers.

And it didn’t take too long — after employers such as Ontario Power Generation started posting proposals earlier this year, the government asked them to try again after concerns were raised about the salary comparators they were using.

Executive compensation in the public sector has been restrained under the Broader Public Sector Accountability Act, 2010, since 2012. All elements of compensation were frozen, including base salaries, and the freeze is in effect until employers post final executive compensation programs on their public websites.

The newer framework is meant to enhance the transparency of executive compensation decisions. It includes caps on salary and performance-related payments for hospitals, universities, colleges, school boards and government agencies.

“This balanced approach will ensure that broader public sector organizations are accountable for compensation decisions and are able to attract and retain the necessary talent to deliver high-quality public services while managing public dollars responsibly,” said Liz Sandals, president of the Treasury Board.

While publicly traded private employers are accustomed to this kind of transparency and attention — in part because of the growing say-on-pay movement from shareholders — the broader public sector is still new to the concept of explaining remuneration.

Focus on comparators

The Executive Compensation Framework caps salary and performance-related payments for designated executives at no more than the 50th percentile of appropriate comparators. It also prohibits signing bonuses, retention bonuses, cash housing allowances and pay in lieu of perquisites.

All designated employers must have a written executive compensation program posted by Sept. 5, 2017, that includes the compensation philosophy, salary and performance-related pay caps and comparative analysis details.

When it comes to the latter, comparable positions must be selected for analysis from at least eight different organizations. These must be similar to the employer with respect to several factors, including: the scope of responsibilities of the executives; the type of operation; industries within which the organization competes; and the size and location of the organization.

And it’s not surprising the government is asking some employers for re-evaluations if they sense there could have been better comparators out there, said Christopher Sinal, a lawyer in the labour and employment group at Siskinds in London, Ont.

Ideally, the government is trying to balance the public interest of making sure salaries are reasonable with these organizations’ ability to recruit competitively both from within the system and outside the system. But the factors for comparison, such as “scope of responsibility,” are all pretty broad, he said.

“Even though it looks like the regulations are very specific for how we’re going to determine these comparators, there is still a wide degree of latitude that’s in there.”

And with the “Sunshine List” — listing the salaries of public sector employees who make $100,000 or more — people already know where a lot of the designated executives are sitting anyway, said Sinal.

“(But) when you start engaging in the private analysis, and if you’re given permission, by the government to do that, then there may be some difficulties in finding that out, if the organization isn’t required to disclose salaries.”

If an employer feels there is a need to use comparator organizations from outside the Canadian public sector or broader public sector, it must seek approval from the Treasury Board using a business case.

This should identify the positions or classes of positions that require comparison to private or international comparators, and demonstrate the lack of comparable positions in Canada’s public sector, along with the inability to attract talent from, or the loss of talent to, markets outside of the Canadian public sector.

The important question to ask, from a comparative perspective, is where are you losing talent to, and where are you attracting it from? said Christopher Chen, senior client partner and Canada practice leader, executive pay and governance, at the Korn Ferry Hay Group in Toronto.

“I’m not saying it’s a black and white issue, there’s some nuances to it, but that’s the basic fundamental question. And I think the organizations that can persuasively support the argument that they have a draw or a loss to another sector, whether it’s the Canadian private sector or the United States, I think they have a legitimate argument,” he said.

“And if there’s a track record that you’ve been recruiting out of the private sector or losing to the private sector, there’s a compelling argument there that that’s part of your comparator group at an initial starting point, which should then inform who you’re trying to benchmark compensation against.”

It’s not necessarily true that public sector organizations have more difficulty finding comparables than the private sector, said Bertrand Malsch, associate professor and distinguished faculty fellow in accounting at the Smith School of Business at Queen’s University in Kingston, Ont.

“It should be possible and, in the end, it’s really a question of reasonability. And it’s really a question of what do you start with? Do you start with what the market tells you or do you start with what you need? And once you get the mind(set) of what you need, and what you’re willing to pay in the first place, without thinking too much of the market, then you try to see if this person exists.”

But if an organization knows it’s at the top of the list and, depending on how it chooses its comparators, the median is going to result in it being significantly above that, then it only has three years before it is going to have to reduce the salary, said Sinal, citing section 9.2 of the Broader Public Sector Executive Compensation Act.

“The legislation provides that where you have existing employees in there and they’re above the mandate required by the compensation framework, they can continue receiving (that)... But then there’s a hard limit of three years after the compensation plan gets in where you can’t be over,” he said. “So, to me, the plain interpretation of that is you have three years to sort it out.”

Competitive numbers

What’s been published so far by employers under the new Ontario framework is the maximum possible amount that could be paid to executives, which is what’s requested, said Chen.

“They’re asking the organization to figure out what the maximum amount is, the range, so to speak, the top of the range,” he said. “That’s easy to misconstrue. If organizations were to actually come out and say, ‘This is what we’re actually paying, this is our actual increase,’ that’s a different story.”

A lot of the organizations know the Sunshine List is going to expose the numbers next year anyway, said Chen.

“It didn’t go away — you still have to disclose all the compensation you make in a year,” he said. “It’s a bit of a tempest in a teapot potentially because eventually everyone’s going to have to disclose. Everyone.”

And there’s actually a freeze built into the framework, said Chen.

“The way we understand the framework to be written, once you make your adjustments to compensation based on the new comparator group and the market, you are only allowed to move your executives at the same pace as the rest of the management team, so if it’s one per cent, two per cent, three per cent, that’s as fast as you’re moving… so this is not ‘The bank vault is open’ — not even close.”

That may also be why employers are starting with such high amounts.

“Theoretically, I can see that, because this is it. The legislation is actually written where you will not move at a faster percentage than the rest of the management team outside the executive team, so there’s limiter in there already,” he said.

But Malsch still has questions about those high numbers. Looking at the situation with Ontario’s OPG and Hydro One, he compared their numbers to those of Hydro-Québec and Électricité de France (EDF) in 2015. Looking at revenues, EDF was at about $105 billion, Hydro-Québec at $40 billion, Hydro One at $6.5 billion and OPG was at $5.5 billion. For employee counts, EDF had 160,000, Hydro-Québec 20,000, OPG 10,000 and Hydro One 5,600.

But when it comes to executive renumeration, the numbers tell a different story. At EDF, it was $630,000 and at Hydro-Québec it’s $493,000. But at Hydro One the number was $4 million and at OPG, it’s targeted at $3.8 million.

“The raw fact is that EDF, which is the number one energy sector organization in the world, almost 20 times bigger than OPG… pays $630,000,” he said.

“There is tension here between the extreme complexity of finding appropriate comparables, and the bottom line of looking at two or three numbers and you see if it makes sense or not.”

The role of boards, consultants

However, when employers try thinking outside of the market, it can be very disruptive, said Malsch.

“I can imagine the board meeting: ‘Let’s stop having this market reasoning, just let’s decide what we think would be a decent amount of money and then let’s look for the people.’ But I have the impression that usually this is the other way around — people start with the market and then look for people, so it’s a market-driven process.”

But consultants can help, he said. “One of their main value-added is they come with comparables because they have access to information… they run the data.”

Advisors are definitely a help in making sense of the numbers and finding appropriate benchmarks, but they don’t have final say, said Chen.

“The way the framework is written, the buck stops with the board — they’re the ones making the final call on everything, they’re the ones who have to sign off, they’re the ones who have to sign off on the final posting, the public posting that’s going to be up for 30 days. They’re the ones who have to sign off on the business case, if they have to make it; they’re the ones who have to go to the minister — all the responsibility is back on the board, so anyone who’s consulting or advising in the broader public sector is now in the same role they would be in the private sector, where you give advice. But, at the end of all this, it’s the board who has to make the final call.”

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