While the talent markets for executives are becoming increasingly intertwined and globalized, tax codes and regulations have shaped compensation practices that continue to differ from country to country. For example, Canadian and American companies offer distinct compensation mixes to their executives, which are primarily reflected in equity grant practices.
In a recent report featuring commentary from Solium Capital Inc. and Lane Caputo Compensation, Equilar explored the evolving equity compensation design and granting practices at Toronto Stock Exchange Composite (TSX) companies over the past five years. The results show that despite continued differences, equity grant mixes have largely been trending in the same direction in the U.S. and Canada. TSX Composite companies are now relying more heavily on restricted stock awards and performance-based equity while, to a lesser degree than the S&P 500, reducing reliance on stock options.
Contributors
LUCA CUTRONE
Director of Client Service Management
SOLIUM
MICHAEL CAPUTO
Managing Partner
LANE CAPUTO COMPENSATION
The percentage of TSX companies granting stock increased from 50.0% in 2011 to 67.4% in 2015, but these firms continue to rely much less on stock awards than their S&P 500 counterparts. In 2015, 97.6% of S&P 500 companies granted restricted stock awards. Even as Canadian companies have more commonly featured a mix of stock and options (up from 40.2% in 2011 to 51.1% in 2015), the number of S&P 500 companies that offers both stock and options still remains much higher. Furthermore, more than one-third of S&P 500 companies offer exclusively restricted stock to executives, more than double the percentage of TSX companies that follow the same equity grant practice (Graph 1).
A confluence of factors has driven the ongoing shift from stock options to restricted stock awards. One cause applying to both Canadian and American companies is the growing influence of proxy advisory firms.
“As governance policies for proxy voting among service providers continue to advocate moves away from stock options, issuers face an uphill battle maintaining or growing option programs for fear of a negative vote recommendation,” said Luca Cutrone, Director of Client Service Management for Solium.
There are also some factors that uniquely affect the grant practices at Canadian companies. For example, Canadian companies face different tax regulations on compensation elements. Tax codes can alter grant practices by providing advantages to companies granting, or executives receiving, one type of equity over another.
“A second—albeit lesser—consideration for TSX companies relates to tax uncertainty created by the Liberal government in 2016, which threatened to remove the long-standing favorable treatment in Canada of capital gains from stock option awards,” Cutrone added. “Any move by tax authorities in this direction would likely accelerate the use of restricted stock.”
Furthermore, basic materials companies are much more highly represented in the TSX Composite index than any other type of company. As a result, any factors that apply uniquely to basic materials companies disproportionately alter the TSX landscape. More than 40% of the TSX Composite Index comprises companies operating in the energy or mining sectors.
“The cyclical nature of resource-based sectors often results in stock options remaining underwater for the majority of their terms, all but eliminating the retention and incentive elements of these vehicles for plan participants,” said Michael Caputo, Managing Partner at Lane Caputo Compensation. “Companies in these sectors are shifting to vehicles that will deliver some form of value to plan participants.”
As shareholders and proxy advisory firms continue to emphasize a preference for performance-based executive compensation, the prevalence of performance equity has risen largely in tandem with stock awards. The percentage of TSX companies granting performance equity increased by 16.8 percentage points since 2011. The percentage of S&P 500 companies offering performance equity has increased similarly on a percentage point basis, rising from 65.4% in 2011 to 83.1% in 2015. However, that also means the S&P 500 has maintained a gap of roughly 40 percentage points in performance equity grant prevalence over the TSX Composite (Graph 2).
Meanwhile, options granted to executives have dropped for both indices, albeit much less so for Canadian companies, and there remains a sizable gap in option-only grants between the two countries. In 2011, about 80% of companies in both the S&P 500 and the TSX Composite offered options. Four years later, 75% of TSX companies were still offering options to their executives, while the proportion of S&P 500 companies doing so had fallen to fewer than two-thirds. Just 1.5% of S&P 500 companies offer only options to their executives, while 23.9% of TSX companies have such an equity mix.
The opposing trends of performance equity grants vs. option grants reflect influence from the major proxy advisory firms. Neither Glass Lewis nor Institutional Shareholder Services currently considers time-vesting stock options as “performance-based,” which, while not a universally held view, likely affects shareholder consideration on executive compensation and equity proposals. As “pay for performance” remains a hot button compensation and governance issue for shareholders, proxy advisors’ treatment of stock options encourages companies to grant stock awards tied to performance conditions in addition to, or instead of, time-vesting stock options.
“RSUs, unless performance-vested, cannot expire underwater and will always have some value. Without performance restrictions, RSUs will dilute shareholders and will provide some value to executives and employees, regardless of the shareholder experience,” said Caputo. “As RSUs will always carry some inherent value, institutional investors and proxy advisors are pushing for performance restrictions to ensure that minimum levels of performance are achieved prior to these vehicles vesting to executives.”
Colin Briskman is a research analyst with Equilar. For more information on the research cited in this article, please visit equilar.com/reports.html.