Senator W. David Angus, Q.C.4th Annual Director’s Governance Summit Toronto, OntarioWednesday, September 8th, 2004: Senator W. David Angus, Q.C. 4th Annual Director’s Governance Summit Toronto, Ontario Wednesday, September 8th, 2004 Session I: Balancing Compliance & Performance Section III: Matching Reward to Performance: Board and CEO Compensation and the Role of the Compensation Committee


Matching Reward to Performance: Matching Reward to Performance Current trends: Aligning incentive compensation with total return to shareholders One size does not fit all – need for flexible approach Compensation of executives who can influence bottom line Compensation for key positions which don’t affect overall results Various benchmarks (gross and net income, profit, EBITDAR, position amongst peer group)


CEO Compensation: CEO Compensation Current trends: Total compensation stabilizing at more reasonable levels Base salaries continue to rise Continued use of stock options, but not all “vanilla” Creative new and long term incentive plans are coming into vogue Options being expensed - debate as to valuation method (Black-Scholes vs Binominal and other methods) CEO compensation packages should be designed with regard to the nature of the industry the company is in


Board Compensation: Board Compensation Current trends Total compensation increasing – needs to grow more in Canada Lump sum vs composite package Use of options in rapid decline Meeting fees – pros and cons Retainer fees – premiums for committee chairs Equity based compensation – RSU’s, DSU’s, tax effective. Emerging requirement that directors own significant number of shares during tenure


Role of the Human Resources & Compensation Committee: Role of the Human Resources & Compensation Committee Current trends Terms of reference of Committee set out in Charter Majority of independent directors with independent director as Chair Hiring executive compensation consultants independent from company advisors Getting more deeply involved in the “nitty gritty” details of executive compensation packages, especially CEO’s Reviewing specific terms of employment contracts, change of control agreements, pension benefits and perquisite packages


The Air Canada Experience: The Air Canada Experience Historical summary: Board member from March 1985 to September 2004 Has served as Chair of HRCC (3 times) and as Chair of the Audit and Strategic Planning Committees Crown corporation Privatization (Air Canada Public Participation Act) Labour issues (pilot strike) Hostile takeover bid (ONEX) Government regulation and oversight (implications-Bill 26) CCAA Restructured entity (ACE)


The Air Canada ExperienceCEO Compensation: The Air Canada Experience CEO Compensation As crown corporation (pre-1989) Base salary (fixed by PMO): $200,000-$210,000 No stock options No long term incentives Annual target bonus based on performance vis-à-vis plan Company pension plan No contract of employment Industry standard perquisites Post privatization (1989-1992) Base salary: $400,000 - $450,000 Short term incentive bonus scheme Long term incentive stock option plan Company pension plan Top Hat pension plan (SERP) Industry standard perquisites


The Air Canada ExperienceCEO Compensation (continued): The Air Canada Experience CEO Compensation (continued) Post Taylor/Jeanniot Era 1992-1996 Base salary: $550,000 (paid in U.S. dollars) Employment contract Stock options Annual incentive plan Company pension plan (accelerated) Top Hat (SERP) Industry standard perquisites 1996 – 1999 Base salary: $450,000 - $500,000 1999 to date Base salary: $650,000 – $1,150,000


The Air Canada ExperienceIncentive Plans: The Air Canada Experience Incentive Plans Short term incentive plan: Bonus Executives have target bonuses as percentages of their base salaries plus special premiums where corporate financial plan exceeded Paid out depending on degree to which corporate financial plan achieved No pay-out below 80% Targets as high as 120% at CEO level if plan exceeded (eg two times basic target bonus of 60%) No bonus pay-outs since 2000 Long term incentive plan: Stock option plans – options vested over four years and had to be exercised within 10 years. They were granted at market value with no discounts. Not expensed before 2002 Historically, the majority were under water and since 2002 all have been under water and are now canceled with no value No more shares available 2001 Performance Point Plan introduced for 2002 to 2004 with points to vest at the end of a three year cycle. There was never any pay-out under this plan


The Air Canada ExperienceCompensation Constraints During Restructuring Under CCAA: The Air Canada Experience Compensation Constraints During Restructuring Under CCAA The following permanent compensation reductions were introduced in 2003 for non-union personnel. (Filed for CCAA April 1, 2003) Base salary: CEO (15% reduction/another 5% cut in 2004); executives (10% reduction/another 2.5% cut in 2004); senior management (5% reduction/another 2.5% in 2004) Incentive plans: no pay-outs 2003/2004 Other: vacation entitlement reduced by one week; work day increased by ½ an hour; a majority of management and clerical overtime practices eliminated; elimination of two holidays; plus miscellaneous cost cuts


The Air Canada ExperienceDirectors’ Compensation: The Air Canada Experience Directors’ Compensation Prior to CCAA (Revision with consultants every 3 years) Attempt to keep at industry mid-point or below Retainer fee: $37,000 ($17,000 cash and $20,000 stock)(payment in stock commenced in May 1997) Committee chair premium: $4,000 Meeting fees: $1,000 Travel day: $1,000 Travel privileges per industry practice During CCAA 15% reduction across Board Meeting fee: $1,000 to $850 Retainer fee: $37,000 to $31,450 Stock: $20,000 to $17,000 Stock payments to cash only in February 2004 Despite reduced compensation, there has been hugely increased board workload, legal responsibility, etc.


The Air Canada ExperienceDirectors’ Compensation: The Air Canada Experience Directors’ Compensation Since April 1, 2003, there have been 66 Board meetings and the following Committee meetings: Human Resources: 7 Restructuring: 32 Investment Policy: 10 Corporate Governance: 3 Audit: 13 Similar onerous role for Air Canada Directors during ONEX take-over bid in 1999: Board meetings: 41 Audit Committee: 6 Corporate Governance: 1 Strategic Planning: 4 HRCC: 14 Special ONEX Committee: 19 In both ONEX and CCAA situations much complex documentation to absorb and understand for each meeting Never any stock options, DSU’s or other equity-based compensation for Directors


The Air Canada ExperienceThe Human Resources and Compensation Committee: The Air Canada Experience The Human Resources and Compensation Committee The Charter: Adopted late 2002 to replace previous terms of reference and to comply with Sarbanes-Oxley directives Provides for composition of a majority of independent directors, including the Chair Requires a minimum of 4 meetings per year without the CEO present Requires mandatory in camera sessions at every meeting Provides for retention by the Committee of independent executive compensation consultants, having expertise in the airline industry and unrestricted access to all necessary financial and operational performance data Requires corporation to have in place a sensible and articulated compensation philosophy and a modern succession planning and talent management mechanism Requires a process for regular and effective performance monitoring Recognizes the need for a fair and reasonable retirement and pension policy


The Air Canada ExperienceThe Human Resources and Compensation Committee: The Air Canada Experience The Human Resources and Compensation Committee The Main HRCC Activities: Assessing and approving if appropriate: compensation packages for the CEO and key senior executives; terms of employment contracts; terms of severance packages; terms of change of control and related special agreements Reviewing and approving, where applicable, stock option plans Working with consultants to develop short and long term incentive plans Pension matters (AC has many pension plans plus two Supplemental Executive Retirement Plans - SERPS)


The Air Canada ExperienceThe Human Resources and Compensation Committee: The Air Canada Experience The Human Resources and Compensation Committee The key challenges: The high profile nature of the company in particular and the airline industry in general have led to a very high degree of public, labour union and other stakeholder scrutiny of CEO and senior executive compensation arrangements. During difficult times, very difficult to establish fair and just compensation packages to attract and retain the executive talent needed to bring about successful turn-around As with other leading public corporations today, we have found the toughest compensation issue to resolve is finding the right mix of incentives necessary to motivate the kind of performance by the CEO and his Executive team that will drive long term total return to shareholders (TRS)


The Air Canada ExperienceSome Air Canada Realities: The Air Canada Experience Some Air Canada Realities The Case for Flexibility in designing compensation plans: Company generally had good corporate governance Company compensation – nothing exorbitant No frauds or scandals Good disclosure, transparency Still failed (into CCAA) – many difficult external factors Macroeconomic factors Major labour issues (five major Canadian unions, two international unions) Fuel price (wide fluctuations) Government restrictions (Competition Bureau) Non level playing field SARS 9/11 attack Pension Plan Deficiency – $1.2 billion early 2003. Caused OSFI to take action which arguably triggered the CCAA filing (Note: during the restructuring negotiations a critical achievement was obtaining government agreements to change the five year rule to ten years on a straight line basis.)