Executive compensation: what is top of mind for boards in 2022?
This time last year, boards and compensation committees were primarily focused on how best to incentivize their management teams during the COVID-19 pandemic in the face of fluctuating share prices and uncertainty in financial performance. During 2021, we have seen evidence of recovery in many markets and companies are generally more optimistic now than they were last year. Companies have had an opportunity to analyze and adapt to the impact of COVID-19 on their compensation programs.
While still dealing with some continued market uncertainty, boards and compensation committees are now increasingly focused on retention and talent management, as well as other priorities. This article will highlight a few of the compensation trends we are seeing in the marketplace and provide some guidance with respect to what boards and compensation committees should be thinking about when implementing some of the more prevalent strategies.
This year, we collaborated with Hugessen Consulting to provide perspective and commentary on their annual Director Pulse Survey (the Survey). The Survey analyzes the responses of 75 Canadian director participants collected in the final two weeks of November 2021. The directors sit on a wide range of company boards, including with respect to ownership, industry, geography, and company size. The graphics and trends presented and discussed below are derived from the Survey.
Top board priorities
The Survey asked directors about top board priorities going into 2022 and talent management, retention and succession planning were at the forefront. Large-cap issuers drove this result, with 72% of their directors responding that talent management, retention and succession planning are very high priorities (see Figure 1 for a complete breakdown).
Figure 1: Top board priorities in 2022
Having the right management team is crucial, so it is not surprising that talent management, retention and succession planning topped the list of board priorities for 2022. To retain top-level talent, we are seeing companies increasing base compensation and providing senior management with enhanced incentive opportunities. Going into 2022, 74% of directors who participated in the Survey anticipated an increase to executive salary budgets, the vast majority of which (86%) being equal to or above pre-COVID expectations (see Figure 2). Of those that expected a specific percentage increase, 54% indicated an increase of 3%, while 16% indicated an increase of 4% or above.
Figure 2: What increases do you expect for 2022 executive salary budgets?
These compensation increases may present an opportunity for companies to amend their current contractual arrangements or enter into new contractual arrangements with their management teams that provide greater protections for the company. Companies may consider implementing new or revised restrictive covenants, such as non-competition1 or non-solicitation obligations, or revising current contractual provisions to increase the likelihood of enforcement. For example, updating provisions governing the termination of the employment relationship in employment agreements or incentive plans, including in light of recent jurisprudence such as the Waksdale decision2 and the Ocean Nutrition decision3, may be desirable. However, companies should be cautious when proposing to amend existing contractual arrangements as it may present an opportunity for the employees to negotiate other enhanced entitlements.
Public companies will also want to consider their public disclosure obligations and anticipated stakeholder reaction before providing any increases in compensation or amending any executive employment agreements.
Use of Discretion in Modifying Targets and Determining Payouts
According to the Survey, 74% of respondent directors expected slightly or substantially better financial performance compared to expectations at the beginning of 2021 (see Figure 3).
Figure 3: What are your expectations for financial performance for 2022, compared to the beginning of 2021?
We expect these improved results to have a direct impact on compensation, as 90% of the respondent directors anticipated at or above target incentive payouts this year (see Figure 4).
Figure 4: Do you expect incentive payouts to be on target in 2022?
It appears that boards and compensation committees continue to consider exercising discretion in determining short-term incentive plan (STIP) payouts in respect of 2021. In fact, 28% of respondent directors expected to apply discretion and of the 28%, 58% anticipated applying upwards discretion and 16% anticipated applying discretion negatively or in a manner that is adverse to participants.
We expect the application of discretion to long-term incentive plans (LTIP) to be more muted as we find that boards and compensation committees are generally more reluctant to modify multi-year performance targets and payouts, and are mindful of the potential for increased shareholder and proxy advisor scrutiny as further discussed below.
Prior to exercising discretion to modify STIP or LTIP targets or determine payouts, boards and compensation committees will want to ensure they have the authority to use such discretion, particularly if discretion is being used to adversely impact participant entitlements. Boards and compensation committees will also want to avoid the use of discretion in one year, which may be viewed as obligating the company to use similar discretion in subsequent years. These objectives can be achieved, in part, through clear and concise plan documentation and employee communications. Companies should review their STIP and LTIP plan documents (including any award agreements) and contractual arrangements with their employees to ensure there is express and unambiguous language that permits the use of discretion for the desired application.
Public companies will want to consider the views and interests of their stakeholders before exercising discretion to modify targets or determine payouts, including the views of institutional investors and proxy advisory firms. Institutional Shareholder Services is generally not supportive of changes to outstanding LTIP awards and will evaluate any changes on a case-by-case basis to determine if appropriate discretion was used and if adequate explanation was provided to shareholders of the rationale for the change. Glass Lewis is also focused on sufficient disclosure and rationales being provided to shareholders in connection with compensation-related changes and will assess the reasonableness of proposed changes by considering if they are consistent and in proportion to the impact on shareholder interests and employees.
Since the Supreme Court of Canada’s decision in BCE Inc. v. 1976 Debentureholders, boards and compensation committees of Canadian companies have become accustomed to considering the interests of multiple stakeholders, including shareholders, employees, creditors, and governments, among others, when exercising their business judgment. Under Canadian law, directors are required to act in the best interests of the company and the company’s interests are determined by reference to the interests of the various stakeholder groups that together comprise the corporate enterprise, and those interests may not always be aligned. While a decision to modify STIP or LTIP targets or payouts could create conflict with the short-term interests of investors, boards and compensation committees need to think holistically and carefully balance the views of investors with the long-term best interests of the company and the need to incentivize and retain their executive team members.
2022 STIP & LTIP Modifications
Nearly one-quarter of directors who participated in the Survey anticipated making design modifications to their incentive programs in the upcoming year and the most common change was adding or removing STIP and LTIP performance metrics. By way of example, we are seeing increased incorporation of ESG (Environment, Social, and Governance) metrics into incentive programs. In fact, 83% of director respondents confirmed that their companies have adopted ESG incentive metrics or foresee adoption in the next year (up from 74% last year) and we are seeing year-over-year increase in focus on ESG-related priorities, such as environmental / sustainability (see Figure 1 above). ESG matters have become an important strategic priority, and boards and compensation committees are being held accountable for their ESG commitments.
Read our article, “Key Priorities for Boards in 2022” for additional commentary regarding ESG and stakeholder engagement.
Any modifications to STIP and LTIP designs, including applicable performance targets, must be clearly drafted and communicated in a timely manner to eligible participants in order to avoid any future conflicts or disputes. Additionally, any such modifications will generally trigger shareholder disclosure obligations in a public company’s annual proxy circular, regardless of whether the amendments require shareholder approval. If the modifications do require shareholder approval, public companies will need to consider the applicable stock exchange requirements.
Companies will need to be mindful of public perception, potential reputational damage and overall scrutiny that could arise from compensation decisions that are perceived as protecting executives’ interests relative to employees and other stakeholders. It will be important for public companies to provide a clear and compelling rationale for any changes being made to their STIP and LTIP designs.
Conclusion
This year will continue to present boards and compensation committees with the challenging task of evaluating their STIP and LTIP programs under the continuing impact of the COVID-19 pandemic. Many companies established their 2021 performance metrics when there was significantly more uncertainty regarding COVID-19. Boards and compensation committees are now re-evaluating whether these metrics are still appropriate, and many are shifting their focus and attention to other priorities, including talent management and retention. While strategies can be implemented to compensate management teams and retain top talent, boards and compensation committees will want to be sure they have taken appropriate measures before implementing decisions related to compensation.
- In Ontario, non-competition obligations in employment agreements (non-compete agreements) are now prohibited (and, if applicable, voided) in employment contracts entered into with a non-“executive” employee after October 25, 2021. For additional details, please see “Ontario passes Working for Workers Act, 2021”.
- The Ontario Court of Appeal’s decision in Waksdale v Swegon North America Inc., 2020 ONCA 391 (“Waksdale”), remains the law in Ontario, and includes the determination that an unenforceable “for cause” termination provision rendered all termination provisions in an employment agreement void, regardless of whether or not the termination provisions are separated within the agreement. For additional details, please see “Court of Appeal rules that unenforceable ‘for cause’ termination clause voids separate ‘with notice’ termination clause”.
- The Supreme Court of Canada’s decision in Matthews v. Ocean Nutrition Canada, 2020 SCC 26 (“Ocean Nutrition”) includes the determination that incentive compensation will normally be payable during the reasonable notice period, absent clear contractual language to the contrary. Exclusionary clauses that seek to limit an employee’s right to incentive compensation will be strictly construed and must be absolutely clear and unambiguous, covering the exact circumstances that have arisen. For additional details, please see “Supreme Court of Canada: Incentive compensation is payable during the reasonable notice period absent clear contractual language to the contrary”.
Le mois dernier, le Canada a publié sa première Stratégie industrielle de défense (la Stratégie), qui souligne l’engagement du Canada à développer une base industrielle de défense solide et à stimuler la croissance économique. Ces efforts pourraient aussi comprendre le renforcement de l’état de préparation à la biodéfense et aux contre-mesures médicales, ce qui pourrait constituer des débouchés pour le secteur canadien des sciences de la vie en raison de l’importance accordée aux capacités nationales en ce sens et de la nécessité d’atténuer les risques d’urgences sanitaires.
Développement de contre-mesures médicales au Canada
Comme indiqué dans les bulletins précédents, le quatrième pilier de la Stratégie est axé sur la « sécurisation des chaînes d’approvisionnement pour les intrants et les biens clés » par le renforcement de la production nationale et le stockage de ressources. L’accent est mis tout particulièrement sur les contre-mesures médicales, en précisant que nos « alliés ont établi un lien explicite entre l’état de préparation à la biodéfense et aux contre-mesures médicales et leur sécurité économique et nationale, en élaborant de nouvelles stratégies et de nouveaux mécanismes pour faire progresser ces travaux ». Les contre-mesures médicales désignent divers produits réglementés pouvant être utilisés pour protéger la population lors d’une situation d’urgence de grande ampleur, comme l’éclosion d’une maladie ou une attaque impliquant des armes chimiques, biologiques ou nucléaires. Il peut s’agir de vaccins, de médicaments thérapeutiques et produits biologiques, de dispositifs de tests diagnostiques, des équipements de protection individuelle ou industrielle, et d’autres dispositifs médicaux. Les contre-mesures médicales sont essentielles à la réduction et à l’atténuation des dommages lors d’une urgence de santé publique.
Exploiter les voies réglementaires mises en place lors de la pandémie de COVID-19
Pendant et après la pandémie de COVID-19, le Canada a mis en place plusieurs nouvelles voies réglementaires comme mécanismes d’accélération des approbations de produits médicaux, ce qui pourrait offrir au gouvernement des options pour déployer des contre-mesures médicales afin de faire face aux risques pour la santé publique. Au début de la pandémie, Santé Canada a émis diverses ordonnances provisoires pour permettre l’importation et la vente de médicaments et de dispositifs médicaux qui n’avaient pas eu l’approbation des voies réglementaires traditionnelles. Or, Santé Canada a plutôt fait confiance aux voies d’approbation réglementaire et de l’exemption de certaines exigences en homologation de produits des pays impliqués dans la transaction. Beaucoup de ces règles provisoires ont depuis été officiellement intégrées à la réglementation en vertu de la Loi sur les aliments et drogues et ont été appliquées bien après la COVID-19. Conformément au Règlement sur les aliments et drogues, Santé Canada tient à jour la Liste des maladies qui menacent la santé publique et utilisera une procédure d’autorisation modifiée pour les médicaments d’urgence de santé publique pouvant traiter les affections figurant sur la liste. De même, le Règlement sur les instruments médicaux a établi une liste d’instruments médicaux répondant à un besoin urgent de santé publique, ce qui permet à Santé Canada d’autoriser la commercialisation de ces instruments de manière accélérée. Ces outils réglementaires sont utilisés automatiquement quand une situation médicale présente un grand risque pour la santé publique au Canada et nécessite une action immédiate pour contrer ce risque.
Le rôle de la Stratégie dans le renforcement du régime réglementaire de la santé au Canada
La stratégie prévoit que le Canada adoptera une approche proactive en matière de planification en amont des crises sanitaires. Le gouvernement entend s’assurer que les produits médicaux sont déjà disponibles au Canada afin qu’ils puissent être distribués rapidement en cas d’urgence. D’autres modifications récentes au Règlement sur les aliments et drogues permettent de prépositionner au Canada tous les médicaments d’urgence en santé publique, ce qui signifie qu’ils peuvent être importés dans des installations d’entreposage canadiennes avant que leur mise sur le marché n’ait été autorisée. La Stratégie s’appuie sur ces fondements, en faisant référence à l’organisme existant Préparation aux crises sanitaires Canada (PCSC), un organisme opérationnel spécial au sein d’Innovation, Sciences et Développement économique Canada (ISDE), et à un nouveau Fonds des sciences de la vie, lesquels « collaborent avec des partenaires internationaux et de soutenir l’élaboration et la production de contre-mesures médicales ». PCSC supervise la Stratégie en matière de biofabrication et de sciences de la vie du Canada, qui vise à développer un secteur national des sciences de la vie fort et compétitif doté de capacités de biofabrication de pointe, en mettant l’accent sur la capacité à se préparer et à faire face aux futures priorités et crises sanitaires. Dans cette optique, il y aura des occasions pour les fabricants de nouer des collaborations de recherche et des accords commerciaux ou d’approvisionnement liés aux contre-mesures médicales financées par des programmes fédéraux.
Étroitement lié aux capacités nationales, le pilier III de la stratégie implique « Investissement ciblé pour renforcer un secteur canadien de la défense novateur », avec la promesse que le gouvernement fédéral « soutiendr[a] la recherche et le développement, protéger[a] la propriété intellectuelle, soutiendr[a] les petites et moyennes entreprises, investir[a] dans les compétences et la formation, et encourager[a] les exportations afin de créer un secteur de la défense agile et concurrentiel à l’échelle mondiale ». La nécessité de favoriser le développement de la propriété intellectuelle (PI) et la conservation des droits du Canada est mentionnée à plusieurs reprises dans la Stratégie. Par exemple, la Stratégie prévoit l’établissement de partenariats officiels avec l’industrie canadienne qui « [assureront] la propriété et le contrôle nationaux de la propriété intellectuelle (PI) et des capacités essentielles. » La Stratégie reconnaît l’immense talent des établissements canadiens et la précieuse recherche qui y est menée actuellement et qui est déjà financée par des subventions de recherche d’organismes tels que le Conseil de recherches en sciences naturelles et en génie et les Instituts de recherche en santé du Canada, et fait aussi référence à l’engagement de 1,6 milliard de dollars pour de nouveaux fonds de recherche dans le budget de 2025. Cette prise de conscience de la nécessité de promouvoir et de soutenir l’innovation au Canada laisse présager des possibilités de financement, notamment dans les domaines où le Canada accuse un retard en matière de production nationale et où des engagements d’investissement et de fabrication au Canada peuvent être pris.
Prochaines étapes
Dans les prochains mois, nous prévoyons que le gouvernement du Canada publiera d’autres directives et des mesures de suivi. L’équipe de défense des conservateurs poursuivra sa couverture de perspectives sur la défense au Canada en publiant une analyse supplémentaire pour donner des précisions sur l’incidence de la Stratégie sur de multiples secteurs.