A recent report created by the Canadian Policy Alternatives found that: Within the start of the first working day of the year (on December 2nd), and within the first three hours from 9-12pm — Canada’s Elite 100 CEOs already pocketed $44,366 dollars. This is roughly what it takes an Average Canadian to generate an entire year, after working full time. By the end of 2010 Canada’s Elite CEOs had pocketed an avg of $8.38 million. In 2009 the top 100 CEOs pocketed 6.6$ million.
See the emerging pattern? As social inequality rises, the gap between the rich and the poor will widen. Data across an historical period demonstrates this in a clearer manner. The avg of Canada’s Elite 100 make 189 times more than average Canadians…yet in 1998, the highest paid 100 Canadian CEOs earned 105 times more than the average wage. The think-tank stated that no comparable data could be compiled from the 1980s.
Within the report, the inequality between Canada’s richest and the rest has been growing since the mid-1980s, reversing a trend since the 1930s that saw increasing equality between the rich, middle and poor.
The report says, “Corporate compensation for executives has been a major driver of income inequality in Canada. Canada’s tax system has made it worse.“
Let’s explore how they make this claim. When you add up the CEO elite 100’s average total copensation, base salary, cash bonuses, grants of company shares, stock options, other compensation and pension compensation value increase, you get 838$ million. That would be enough to wipe out the deficits of Manitoba, New Brunswick, Nova Scotia, or PEI. The report says a large chunk of CEO pay is derived from grants of shares and options. Out of the Elite 100, 70 CEOs received part of their pay in grants of stock and 73 in stock options. For those who received share grants, the average grant was valued at 2.64$ million; for those awarded options, the avg award was valued at $3.22 million.
The way it works: When a corporation grants stock options to an executive, it gives the executive the right to buy a given number of shares of the corp at the pre-determined price – known as strike price. The strike price is normally
the market price of the stock on the day the option is granted. When the price rises ABOVE the strike price, the difference represents the value of the option because the CEO could exercise his/her option at the strike price and sell at the higher price.
The wealthy Elite 100 can explore many tax advantages through loop holes in our system: One of the loopholes is exploited by stock options and the financial reporting of them.
Stock options are taxed as if they were capital gains, rather than ordinary income. That means that every dollar of income from exercising a stock option is taxed as if it is 50 cents. Because of this : 1/4th of CEOs 2010 reported income is taxed at half the rate paid on wage and salary income. Another reason they like stock options is because the amount that is disclosed in their companies proxy circulars (corporate documents) is a conservative estimate of their total value. Boards of directors don’t know and can’t know, what these stock options will be worth when they pay off, which could give the CEO a paycheque with no theoretical limit.
However, there were efforts to ensure greater transparency and comparability in executive compensation, and financial reporting rules applicable to stock options were changed in Canada for periods beginning in 2008. But instead of
reporting the amount executives *actually* saw when they cashed their options in, executives began to report a statistical *estimate* of what the options might have been worth in the market when they were granted.
But we never learn what they were actually worth…which makes the actual compensation of Canada’s CEO Elite 100 a mystery. And the estimates that are given, tend to be on the conservative side becausee they are based on historical volatility in share prices and partly because they cannot take into account the fact that a CEO chooses a time to exercise his or her options for max benefit.
Problem # 1 – Accounting Loop Hole
To give an example of just how conservative the estimates provided by the big corporations are, the article analyzed the options granted to the CEOs of Canada’s “big 5″ major chartered banks in 2008.
In 2008, Bank of Montreal issued 219,749 options to its CEO in 2008 with a strike price of $34.13. In its compensation disclosure document for 2008, it reported a value for these options of 1,800,000. Based on the number of
options and the strike price, that value would have been realized at a share price of $42.32. As of Nov 4, the share price was $58.07 – a price that translates to an option value of 5.3 million… nearly 3 times the amount reported.
Thus, based on Nov 4, 2011 share prices, the combined value of their 2008 option grant as reported in their proxy statements was understated by $16 million,… an avg of 3.2 million, even after allowing for a zero value for RBC’s options granted in 2007. So…not only is it likely that the 2008 pay of the bank CEOs was massively understated, the income actually realized by these executives from the exercise of these options may never be disclosed. This is a loophole in Canadian executive pay accountability that needs to be remedied.
Results from the Accounting Loophole:
By the end of 2010, the entire Canada’s CEO Elite 100 group, were sitting on a grand total of 2$ billion in unexercised in-the-money stock options. This is options to buy shares where the current market price had already exceeded the strike, or purchase, price. The running total tax subsidy outstanding is 23% of that amount, or a staggering 475$ million.
Also worth noting is that in 2007, StatsCan found that the rate of tax went down between 1992 and 2004 for the richest 5%, with the biggest gain going to the richest 1/100 of 1%, whose effective tax rate dropped from 40% to 30% over the period. As great as their before-tax income gain was, the after-tax gain was, in relative terms, even greater – paid for by the rest of us in reduced public services as a result of trying to “balance the budget”.
Now even with the accounting loopholes, these big corporations have made workers pay the price by making claims that they cannot afford high quality pension plans ala the Defined Benefit Pension Plan. Many Canadian corporations have
frozen membership in their defined benefit pension plans, and converting to Defined Contribution Savings Plans instead, that shift the risk to employees, or they have been reducing benefits or simply not offering a pension plan at all. Interestingly however, 46 of the Elite 100 CEOs were members of Defined Benefit Pension Plans.
Roger Martin dean of Rotman’s school of management analyzed, that compensating CEOs on stock prices through share grants or stock options just compensates them for the wrong thing. Instead of compensating CEOs for aspects of corporate performance over which they could conceivably exercise some influence like business strategy, sales, or profit…. share based compensation systems pay CEOs based on something they cannot influence or control which is the market price of their companies’ shares. Because stock markets are expectation markets, the price of a company’s shares is based not on the performance of the company in the past, but on what investors expect the performance of the company to be in the future. In his view, CEOs should receive bonuses based on how their companies perform in their businesses rather than on how the bets placed by investors influence the value of their shares.
Henry Mintzberg, had another idea. He has advocated in scrapping the entire idea of executive bonuses. This is because, with the compensation game of granting out executive bonuses through the form of stock and option grants represents a form of legal corruption that has been undermining large corporations and bringing the global economy down.
In a 2009 Wall St Journal piece, Mintzberg wrote, “the failings of the current system and the execs who live by it are painfully obvious. Although these executives like to think of themselves as leaders, when it comes to their pay practices, many of them haven’t been demonstrating leaership at all. Instead they’ve been acting like gamblers – except that the games they play are hopelessly rigged in their favour.”
The article proposes several counter arguments that are used by those in defense of corporations. Amoung them, is that the Board of Directors can set the price of pay for CEOs and that Shareholders have much power to voice their opposition should they find any. Both of these arguments are firmly debunked.
In any company, the Board of Directors are totally dependent on the CEO they hire. The hiring of the CEO is probably the most important decision a board of directors gets to make. Thus there is a bit of anxiety and fear on their part in order to attract the best suitable candidate for the job. This is akin to a prisoners dilemma. Every corporation would be better off if they paid their CEOs less, but there is a concern that the company will be less attractive place to work than all of the other corps so the board has a fear that stepping outside the norm (of offering tremendous salaries) will lead to be unable to hire the very best.
With respect to shareholders, shareholders can say they are unhappy with executive compensation but it does not mean they can realistically do anything about it. There is no viable mechanism for corporate governnace that would enable shareholders to exercise actual control over pay practices except through the corporation’s directors.
Solutions Put Forward:
With the inaction of Board Director members and powerlessness of Shareholders, the only other remaining actor left in this is the government. The government two approaches available to it: regulation, and taxes.
1) Regulation: The article states that there is two problems with this approach. For one, it is next to impossible to separate legitimate, carefully thought out rewards from other payments as it could create outrage from the business sector and ultimately threaten the govt in question’s political viability. And two – any regulatory regime would simply kick off an elaborate game of evasion and entrapment between the regulated and the regulators
2) Taxes: The article favours this approach. If Canadians as a society concluded that excessive pay is unacceptable, Canadians could tax a portion of that excessive pay package back. Corporations could still pay their senior execs what they wish and the public will have made a clear statement of its view on excessive compensation practices. The impact of excessive pay on income inequality will be moderated…and the public will benefit from the public services that can be funded with this newly generated fiscal capacity.
Bottom Line: The problem of public subsidy towards excessive CEO pay packages could end by getting rid of the loophole that allows the proceeds from cashing in stock options to be taxed as if they were capital gains – at half the normal
rate – rather than as ordinary income.
The full article can be found here: http://www.policyalternatives.ca/publications/reports/canada%E2%80%99s-ceo-elite-10