Contrary to conventional wisdom, a CEO’s fixed salary, or non-contingent pay, has not increased in recent years. In fact, a CEO’s fixed salary, as a proportion of his or her total compensation, has been decreasing. Moreover, the greater the independence of a compensation committee, the more a CEO’s salary will be tied to performance. Read on to discover more surprises about executive compensation.

It is a widely held belief in some quarters-a belief frequently articulated in the business press-that CEOs of Canadian corporations are paid too much. Some commentaries even refer to such excessive CEO compensation as “obscene.” Notwithstanding the degree of criticism, the critics all seem to agree that one overriding factor leads to such excessive compensation-the boards of Canadian corporations are not effectively pulling in the reins on CEO compensation.

Consider the following. According to a 2004 survey by The Globe and Mail, Canada’s top executives received an average increase in bonuses of 30 percent in 2003; at the same time, their base salaries increased by 6.3 percent. Moreover, the same survey revealed that including all forms of compensation, CEOs took home an average of about 8.3 percent more in 2003 than in 2002. A 2002 survey by the Globe had gone a bit further, concluding that boards of Canadian corporations are failing shareholders when they grant higher compensation to CEOs despite weaker profits. Obvious as it may seem, such survey results seem to cast traditional governance mechanisms as entirely inadequate.

Two factors have contributed not only to the spate of criticism of CEO compensation, but to the growing involvement of various stakeholders and intermediaries in the governance of Canadian corporations. First, in October 1993, the Ontario Securities Commission (OSC) amended Regulation 638 to enable investors to monitor the pay of corporate executives. Accordingly, the OSC made it a requirement that all firms listed on the Toronto Stock Exchange disclose the amount and composition of compensation of their five highest-paid executives. Second, the Pension Investment Association of Canada (PIAC) decided to include executive compensation as one of the key areas in its list of corporate governance standards. Moreover, executive compensation has become a key governance issue for the non-profit organizations dedicated to the promotion of shareholder interests, such as the Canadian Coalition for Good Governance (CCGG), Shareholder Association for Research and Education (SHARE), and the soft-dollar intermediaries, such as Fairvest. Given these reasons, it is not surprising that key stakeholders, such as institutional investors and the PIAC, demand a voice in the determination of CEO compensation, and that other intermediaries, such as CCGG and SHARE, want CEOs to be compensated fairly so that shareholder interests are safeguarded.

During the past year we conducted a study of executive compensation. Our purpose was twofold: First, we wanted to present empirical evidence to verify the extent to which CEO pay has been increasing, or not increasing, in Canadian corporations over a period of six years. A six-year time frame provides a good window to observe the pattern of increase, if any, and arrive at reasonable conclusions based on such evidence. Second, we wished to relate three important board characteristics-separation of the roles of the CEO and the chair, a majority of outside members, and the independence of compensation committees-to six-year CEO compensation data. This would enable us to verify the anecdotal assertion that boards are curbing traditional agency problems and, as a result, stockholders are losing their value. As this article describes, the findings were surprises indeed.

The paper is organized as follows. First, we explain the rationale for examining the topic and for choosing the governance variables. Next, we provide the methodology for our study. We provide our findings in the third section.

1. Rationale

Key stakeholders of a public corporation, especially its shareholders, oppose pay packages that are independent of performance, since exorbitant CEO pay hurts the ultimate profitability of a corporation. CEOs, on the other hand, press for as much compensation as possible. This conflict is rooted in two related, but distinct, factors. First, firms operate in a dynamic arena that presents constraints or systemic risks, such as general economic conditions, the labour market, interest rates, inflation, and political turmoil, just to name a few. These forces are intertwined, their relationships are complicated, and they are mostly beyond the control of CEOs. Therefore, when pay is tied to performance, CEOs’ expected pay is likely to vary substantially. CEOs want to avoid such variations by keeping pay independent of risks. As an indirect manifestation of managerial opportunism in Canadian corporations, Park, Nelson, and Huson find that, “in the absence of oversight, managers choose pay packages that do not provide the level of incentives shareholders would choose.” (Park, Y.W., Nelson, T. and Huson, M.R., Executive Pay and the Disclosure Environment: Canadian Evidence. Journal of Financial Research, Vol. XXIV, No. 3, 2001, pp. 347-365). Second, a link between pay and performance, measured in stock returns, may limit managers’ ability to trade stock returns for firm growth without harming their personal incomes (Gray, S.R. and Cannella, A.A., The Role of Risk in Executive Compensation. Journal of Management, Vol. 23, No. 4, 1997, pp. 517-540).

Assessing the performance of CEOs and determining their appropriate compensation packages is one of the central monitoring functions of the board. It is, indeed, the board of directors that has formal power over the incumbent CEO. Therefore, careful utilization of the CEO compensation process should serve to align a CEO’s interest with the firm’s shareholders. This utilization-based alignment mechanism implies that, in order to constrain excessive CEO compensation and safeguard stockholders’ interests, a board of directors needs to employ appropriate control mechanisms over which it has discretion. In fact, it is through a set of internal mechanisms that it constrains its CEOs.

The separation of the roles of the CEO and chair (the opposite term is CEO duality), the independence of boards, and the independence of compensation committees are some of the common, desirable mechanisms that constitute an efficient control system in a corporation. Because they are so pervasive and effective in the board’s role as a trustee we consider only these three mechanisms to determine the extent to which they are effective in controlling CEO compensation.

CEO duality is said to exist when the same executive of a firm serves as its CEO and chair of the board. Although empirical support for CEO duality is mixed, academics, observers in the financial communities and board reformers have tended to endorse the separation of the role of board chair and the CEO. A glance at the type of shareholder proposals normally filed in a given year confirms the importance that shareholders attach to the separation of these two roles. The UK’s Cadbury Committee also recommended against combining both roles. When the roles are separated, an independent board chair can facilitate an objective assessment of the top management team performance. The California Public Employees’ Retirement System (CalPERS) has made the elimination of CEO duality a top priority in its negotiations with some major U.S. corporations.

Board independence is important in that it serves as the first line of defense against an executive team where the interests of the stockholders are involved (Jensen, M.C., The Modern Industrial Revolution, Exit, and the Failure of Internal Control Mechanisms. Journal of Finance, Vol. 48, No. 3, 1993, pp. 831-880). The importance of a remuneration committee lies in its mandate to influence the determination of an appropriate executive compensation package.

2. Methodology

We selected the sample firms from the Toronto Stock Exchange Composite Index (TSX 300). Because large, more liquid public corporations are more amenable to having their CEO compensation and board characteristics observed, we considered the TSX 300 appropriate as the universe of firms for this study. Approximately 90 percent of all stock transactions in Canada take place on the TSE 300.

We focused on the firms that were consistently in the TSX 300 between 1995 and 2001, inclusive. There were two reasons for the selection of this timeframe. First, in October 1993, the OSC issued a new regulation requiring all companies traded on the TSE to disclose the amount and composition of individual compensation of the five highest paid executives. This new requirement made it possible to conduct research on CEO compensation in Canadian firms in relation to other performance and governance variables of interest. Second, with particular attention to better safeguard stockholder interests, the TSE began undertaking measures for bringing different structural changes in the boards from the early 1990s. Accordingly, a number of TSX guidelines relating to sound corporate governance are now accepted practices in the largest Canadian corporations.

Based on the criterion mentioned above, we ended up with 109 firms. Of these, we dropped14 from the sample because data on them were missing for some years during the period 1996-2001. Some of the 14 companies were taken over and ceased to exist as separate entities. It is to be noted here that although some companies changed their names (not due to a merger or acquisition) during these years, their ticker symbols for the TSX remained the same. We did not exclude such firms from our sample.

We included three measures of CEO compensation in our analysis: non-contingent pay (salary), contingent pay (bonuses, stock options, value of restricted shares, long-term incentive pays, and all other compensation as disclosed in the proxies), and total pay (the combination of non-contingent and contingent pay). We obtained data on CEO compensation for years 1996-2001 from the proxy statement of each company as listed in the System of Electronic Document Analysis and Retrieval (SEDAR). SEDAR is a comprehensive on-line archive of securities documents filed by publicly traded companies in Canada. We also used CanCorp to fill in any missing data on CEO compensation. We used the Black-Scholes method for standardizing the values of stock options. The effect of dividends on option value is also considered. The total value of a CEO’s compensation is thus equal to the sum of salary, bonus, stock options, value of restricted shares, long-term incentive pays, and all other compensation as disclosed in the proxies. Data on compensation committee composition and CEO duality were also gathered for the years 1996 through 2001.

3. Findings


The results of the study reveal certain interesting facts. Figures in Table 1 (All tables in Appendix at end of article) show that, first, consistent with the criticism of some quarters, on the whole, CEO salary in Canadian corporations has been increasing yearly, and from an average of $1,030,925 in 1996 to an average of $3,616,559 in 2001.

Second, when the annual increase in compensation is broken down into contingent and non-contingent proportions, a totally different scenario emerges. While the proportion of contingent pay has been steadily increasing over the period, from 64.14 percent in 1996 to 85.51 percent in 2001, the corresponding proportion of non-contingent pay has been continuously declining. This is contrary to most of the criticism. In fact, if tying CEO compensation to a corporation’s performance is what stockholders really want, it is the opposite movement of contingent and non-contingent compensation that really reflects their wishes. Therefore, the harsh criticism against excessive CEO compensation is somewhat misplaced and unwarranted.

2. Compensation committees

Among the three governance variables considered, the compensation committee appeared to be the most important. Our results produced a positive association between the independence of the compensation committee and CEO compensation. In other words, the higher the proportion of outside members on the compensation committee, the higher the CEO’s pay. However, this association was due largely to a significantly upward movement in contingent pay.

3. The CEO and chairman: One and the same or two individuals?

Our results did not produce any significant association between CEO duality and CEO compensation. This is indeed intriguing, as in the business press, CEO duality appears to be the most frequently considered governance variable in need for a drastic overhaul. A recent survey by GPC International, the public affairs and consulting firm, found that the same executive held the CEO and chairman roles in 50 percent of the companies listed on the TSX. The survey also found that 67 percent of the respondents want those two roles split. Parenthetically, our results show that the majority of the companies in our sample have already separated the two roles.

Whether such a split is sound or not remains to be seen. Our results corroborate those of some empirical studies with both UK and U.S. data, which also found no association between the separation of these two roles and CEO or executive compensation. It may be that the attention generated by the popular press with regard to the relationship between CEO compensation and CEO duality has greatly neutralized such an association.

4. The influence of outside directors on executive pay

The results produced no evidence of a meaningful association between the proportion of outside directors and CEO pay. The independence of a board does not necessarily have an impact on a CEO’s compensation package. Nor does a higher ratio of outsiders on the board necessarily imply board independence. Outside board members may have significant business interests in a firm, and close social ties with the firm’s CEO, both of which they may be unwilling to jeopardize. To find out whether an outside director is truly “unrelated” to the CEO, it would be necessary to interview all 95 boards that we covered in our study; this exercise would, in no way, ensure that they were completely independent. According to the TSX guideline, it is up to each respective board to define whether an outside director is “unrelated” to management and is free from any interest and any business or other relationship which could materially interfere with the director’s ability to act in the best interests of the corporation. Therefore, it was not possible to measure the degree of true independence of the outside members on the board. (See Table 4).

However, we found a clear association between the independence of a compensation committee and CEO compensation. Although in most of the cases all members on the compensation committee were from the outside, there were also inside members in a few cases. (See Table 5).

Results indicate that CEO salary has been increasing on a yearly basis. What is revealing is that, while the proportion of contingent pay has been steadily increasing over a six-year period, the corresponding proportion of non-contingent pay has been decreasing over the same span. This finding is contrary to the popularly held belief. Because contingent pay is supposed to be tied to company performance, it is desirable to increase its proportion of total pay. Therefore, critics of excessive CEO pay may wish to consider this dimension carefully. Moreover, the sample companies demonstrated some of the features of good governance, such as a separate board chair and CEO, a preponderance of outside directors, and independence of compensation committees. There is a clear link between an increasing proportion of contingent pay and the independence of a compensation committee, whose role it is to link CEO compensation and company performance.

Acknowledgment: The first author gratefully acknowledges the financial support from the J.W. McConnell Family Foundation at the Schulich School of Business, York University, for this research. Both authors thank C. Fong and M. Safa for their assistance in the collection of data.



About the Author

Shamsud D. Chowdhury is professor of strategy and competitiveness at the School of Business Administration, Dalhousie University.

About the Author

Eric Wang is Assistant Professor of Finance, School of Business, Athabasca University

About the Author

Eric Wang is Assistant Professor of Finance, School of Business, Athabasca University