Drafting a compensation plan for a CEO

Client profile

Joey, 62, has been running a successful private mining company in Calgary for the past 15 years. He plans to leave the firm in five years, so he’s looking for a successor CEO. He can groom in-house managers, but he’s also looking externally. What compensation issues does Joey need to consider? What performance goals should he set for his replacement, and how can he ensure a smooth transition?

*This is a hypothetical scenario. Any resemblance to real persons is coincidental.

The experts

Bernie Martenson

senior consultant, Gallagher McDowall Associates, Toronto

Howard Schwartz

senior investment advisor, Private Client Group, Hampton Securities, Toronto

Who do you call?

Compensation consultants and financial advisors.

What they say

Bernie Martenson: Joey should define an ideal profile by looking at how he spends his time. Is he usually working on business strategy? How often is he at mining sites with geologists? How much time does he spend at sales meetings? How much time does he spend developing people within the company? He needs to look at the major accountability areas for his company and say, “If this is where I’m spending my time, I need someone who has strong skill sets in each of these four areas.” Or, maybe he’ll find someone who’s strong in three areas but who could develop in the fourth area.

Then, he should assess his internal managers. Are they demonstrating those skills today, or do they have the potential to do so? Does he need to expand their current jobs to do a fuller assessment? If his managers aren’t suitable, he would need to look at external candidates. If he doesn’t know enough industry contacts who might be ready to move into a CEO job, he could use a search firm.

Next, Joey should start thinking about the compensation package he’ll offer. Here are some strategies.

• He could ask the search firm to recommend how much to pay the CEO. The firm’s experts may not have access to compensation surveys, but they are always looking at candidates, so they have a good sense of how much [people in] those kinds of roles are paid.
• He may also be able to purchase surveys with the information [himself]. There might be a board of trade with the data he’s looking for. He could also go through an industry association for oil and gas or mining that might keep track of executive compensation.
• He could look at comparable public companies, since they’re obliged to disclose compensation for top officers. Joey can look at a company’s assets and revenues, and then look at the CEO’s compensation.

What you learn

Defining what you’re looking for in a new CEO should happen before deciding how much to pay your successor. Offering 10% to 15% more than market rates could lure experienced CEOs, but finding someone in-house whom you can train, or someone who has potential to become CEO, could be an economical alternative.

If Joey wants to bring in another company’s CEO, he may have to offer her above-average pay. Generally, people don’t move for raises of less than 10% to 15%. But if he finds someone who’s a chief operating officer at another company who wants to be a CEO, and that person can’t get the top spot at his current company, then she may be willing to move for average or slightly above-average pay because of the ability to take on the top job. If Joey chooses to groom one of his managers to be CEO in two to three years, he might be able to bring him in at a 20% discount to market rate as he learns the job.

Howard Schwartz: There are four components to executive compensation:

• Base salary. This is relative to the market, the industry, the size of the company, the span of control and annual profit-loss objectives.
• Benefits. Large companies could incentivize the new CEO by offering benefits, such as car allowances or top-ups to the group benefits plan (e.g., 100% dental reimbursement, instead of the 90% offered to other employees).
• Additional pension. The company can create an individual pension plan, or deposit a defined contribution on behalf of the employee (more likely in a private company).
• Incentive plans/bonuses. This could be [in the form of] short- and long-term incentive plans if the CEO meets specific results. Performance goals could be related to growth or profitability—in the mining industry, these could be success in finding new pools of resources, or raising additional capital.

How much did bank CEOs make in 2015?

TD Bank says CEO Bharat Masrani was paid $9 million in direct compensation last year—a 10% increase from the year before. His total compensation was valued at $10.7 million, including stock options and his pension. Meanwhile, CIBC CEO Victor Dodig made $8.15 million in direct compensation last year, and his total compensation reached $8.54 million.

As Joey puts together the compensation package, he should factor in how it’ll affect the company’s cash flow. If the company is public, stock options could be one component of the package to reduce the cash paid out now. But if the company is private, the owners might not want to dilute its shares and give options to an outsider.

Regardless, the new CEO should generate additional revenues and profitability to support her compensation package.

Then, Joey has to decide how he’s going to exit. Is he going to become chair of the board? Sometimes a company wants a clean break and doesn’t want to keep the outgoing CEO on board. Other times, a company would welcome the outgoing CEO’s knowledge and connections and the continuity he would bring to the company as chair of the board.

And, if there’s overlap between the two CEOs, the company would need to have enough cash flow to support the old CEO’s exit package and the new CEO’s salary without going into debt.

Once the announcement is made, it’s the new CEO’s company to run. The old CEO can be there as a mentor and resource, and the new CEO is part of the old CEO’s exit strategy to ensure there’s continuity.