An online monthly research publication by the Ivey Business School 

Volume 14, Number 8
August 2008

Defensible compensation

Ivey professor Stephen Sapp is finding that clear corporate governance policies lead to good outcomes

It’s not just activists who get riled up about the high pay of corporate executives. In a recent speech, presidential hopeful John McCain denounced “extravagant” compensation and severance packages, and called for the right of shareholders to vote on the pay of CEOs.

Executive compensation is a hot-button issue in Canada as well. Ivey professor Stephen Sapp finds that certain CEOs in Canada get paid almost as much as those in the U.S., especially now that the dollar is close to par. “If you look at Canadian firms that are cross listed in the U.S., the differences are virtually indistinguishable,” he says.

Sapp is co-author, with Ivey Professor Murray Bryant, of the Institute of Corporate Directors Blue Ribbon Commission Report on the Governance of Executive Compensation in Canada. The Report, issued in June 2007, recommended among other things that Canadian firms adopt a six-step Compensation Analysis Process (“CAP”).

The report focused on issues of pay for performance, accountability, independence of the compensation committee and its advisors, and financial literacy of directors. “The key thing we highlighted was the need for a clear process,” says Sapp. “If you follow a logical and well-thought out process, disclose your process clearly, and are careful who you include at each stage, you should at the end of the day have an outcome that is defensible, even if it doesn’t always look as good in hindsight.”

In a follow-up study, Sapp is testing the compensation model set out in the Blue Ribbon Report, interviewing companies who have adopted it to identify strengths and weaknesses. He is also pursuing a number of other studies on corporate governance, looking at how the composition of the board of directors affects issues like executive compensation, risk-taking, performance, and firm valuation. “We are focusing on the characteristics of board members: how independent they are from the company, whether they have financial training, how many other boards they are on,” he says. “We want to learn how these characteristics influence their decisions, the direction of the firm, and how the firm is being valued by the market.”

One of the big pushes in corporate governance is to appoint directors who are independent. The idea is that independent directors will bring outside thinking to bear on decisions such as executive compensation, and prevent insiders from taking advantage of a situation. Some firms are finding, though, that independent directors are having less influence on executive compensation than was hoped. Sapp believes that the definition of “independent” is sometimes not broad enough. “There are many examples where a director and a CEO are both on the board of a country club or another organization,” he says. “Is a person really independent of the CEO if they’ve worked together for a common passion outside the company?”

He is also looking at how the major owners of a company influence the way decisions are made. For example, family owners tend to have different concerns than corporate or institutional owners. “Corporations really want to maximize profits, whereas a family-owned firm may be happy to lose a little on the profit side to make sure the company is around for the long term.”

Sapp is in the early stages of his research, but he is already finding a clear correlation between board composition and outcomes. “It’s surprising to see the extent to which there is a correlation, even though that is exactly what you’d like to see,” he says. “The reason you try to shape the Board of Directors is to ensure the company is accomplishing the right goals.”

Professor Sapp holds the Bank of Montreal Faculty Fellowship.
 

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