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Complex management and director compensation plans have become more prevalent in recent years. We believe that each compensation plan must be reviewed in its entirety to determine if the individual parts serve the purpose of providing the right incentives to managers and directors and if the plan is reasonable on the whole.
Compensation and incentives to management and directors should be consistent with the long-term interests of the shareholders of the company. Salaries should reflect the requirements of the marketplace with employees paid the amount necessary to attract and retain the skills and abilities required. All perquisites should reflect a justifiable corporate need and should be able to stand on their own merits under a cost-benefit analysis. Incentive compensation plans must have the overriding purpose of motivating and retaining individuals and must not be unduly generous. Such plans should be closely related to individual and corporate performance.
One of the most complex and contentious components of many incentive compensation plans is the use of equity incentives to motivate senior and middle managers. We are not opposed to the use of equity incentives to motivate managers; however, we are concerned that equity plans are sometimes poorly designed and administered or abused.
Equity compensation plans require a high level of scrutiny and disclosure:
- Expense equity compensation in financial statements. Generally Accepted Accounting Principles, or GAAP, in Canada and the United States, require public companies to expense the value of the equity incentives granted during the year.
- Tie equity incentives to performance. Many equity plans in existence today base rewards on general market or sector performance rather than on individual company out-performance of the market or sector. We would prefer to see that the exercise price or the vesting schedule of the equity incentive be linked to the achievement of appropriate, company specific, performance or profit thresholds.
Alternatives to stock options include stock appreciation acquisition rights, or SARs, phantom stock, restricted stock plans, and deferred share units. SARs are similar to stock options, except that when the rights are exercised, the grantee receives a cash payment rather than shares.
Phantom stock plans often take the same form; instead of payment being made in shares, payment is made in cash having a value equal to the value the underlying shares would have had. Restricted stock plans are awards of shares that have holding period restrictions, often vesting over a period of five years or more. Deferred share units are not actual shares, but units which derive their value from the value of underlying shares. Their value is received in shares or cash upon the manager’s or director’s retirement from the board or the company, as the case may be. Whereas stock options have value only when the market price is above the exercise price at the time of exercise, restricted stock and deferred share awards have a value that varies directly with the price of the underlying stock and is virtually always greater than zero.
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