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C O M M E N TA RY
Are stock options
still ideal for mining execs?
BY PAUL PITTMAN or even hype about the future value of Stock options were initially widely fa-
SPECIAL TO THE NORTHERN MINER the company, leaving shareholders hold- voured as there was no cost to the com-
In the smoking ruins of the global finan- ing the bag when the lack of sustainable pany in terms of funding, as there was no
cial crisis, renewed attention has been earnings became apparent. requirement to expense the cost, and the
focused on executive incentives and The Enron and WorldCom accounting market funded any unlimited upside gain.
whether efforts to earn higher compen- debacles resulted in the Sarbanes-Oxley However, the expensing shortfall has
sation promoted executive behaviour Act in the U.S. and forced corporate now been addressed with companies re-
that created excessive, and in some cases, boards to address weaknesses in financial quired to capture the cost of granting
enterprise-jeopardizing risk. controls. stock options in annual financial
This focus has led to new regulatory The more recent Toxic Asset Relief statements.
initiatives intended to limit risk and af- Program controls in the U.S. and the Pro- When expensing rules were first intro-
fecting executive compensation in a mul- ductivity Commissions’ proposals in Aus- duced, the software industry lobbied
titude of jurisdictions and industries. But tralia and punitive incentive tax in the against them on the basis that in start-up
what does this mean for the mining U.K. attempted further expansion of con- mode, there were no other affordable
sector? trols on executive compensation. choices for them to both reward and re-
To answer that question, first we have Indeed, risk is now required to be ad- tain creative designers working on a value
to ask: what is risk? dressed in the “compensation discussion proposition that would not emerge for
In compensation terms, there has tra- and analysis” portion of proxy statements. some time.
ditionally been far more concern with the
downside perspective of risk — i.e., the
failure of an executive to achieve corpo-
rate goals and the resulting impact on Junior mining companies continue to depend
competitive compensation.
As is now glaringly apparent, little con-
heavily on stock options as a cash-effective way of
sideration was given to limiting the up- incentivizing their senior teams for the long term.
side potential of variable compensation
programs. In the financial services sector,
overly leveraged pay programs led to in-
stitutions being destroyed or losing inde- Risk that can damage an enterprise in- The mining industry was no different
pendence. The Economist Intelligence cludes: exposure to criticism or damage in this respect, but was and continues to
Unit found about 70% of financial com- of image with shareholders and custom- be largely silent on the matter. Junior min-
panies surveyed viewed “risk manage- ers; difficulty with proxy voting on pro- ing companies continue to depend heav-
ment failures” as a leading cause of the posals regarding executive compensa- ily on stock options as a cash-effective
world’s current economic problems. tion; board embarrassment; and risk of way of incentivizing their senior teams
Compensation systems without a limit unintended payments. for the long term.
on total potential earnings from variable The consequence of this controlling Should we expect more executive-
pay encouraged executives to pursue movement has been a fall from grace of compensation regulation? Perhaps, but
strategies at the expense of shareholders. stock options as an incentive for there will also be changes to customary
These strategies increased expectations executives.
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best practice. Longer time horizons will units (PSUs) and/or restricted share units greater use of business-modeling tools so
impact the design of executive compen- (RSUs), stock options remain an effective that compensation committees can better
sation programs and the use of longer instrument that rewards both sharehold- see the potential impact of compensation
holding periods for exercised or granted ers and executives consistent with the decisions (e.g. “what if” scenarios and the
stock will focus on sustainable real long- company’s long-term goals. anticipated result of the proverbial
term value rather than short-term folly. Boards or their compensation com- “home run,” and the question of whether
Expect also more “bonus banks” or mittees will be under scrutiny for com- severance, change-in-control or incen-
claw-backs to enable recovery of incen- pliance with both best practice and tives would motivate actions that trigger
tive pay if a longer time horizon shows commercial trends. Not just stock op- large payouts at the expense of share-
performance results require a tions but any compensation instrument holder value).
restatement. should be accompanied with enhanced Generally, it’s best to avoid compen-
Elements of compensation design internal controls and insights into their sation programs that reward executives
today that are broadly considered to be use as a compensation instrument. as highly as successful entrepreneurs if
high-risk in nature, and therefore suspect, To ensure that total compensation is they do not take board-approved entre-
include: low salaries relative to potential aligned with strategy, we need to consider preneurial risks.
incentives; annual rather than multi-year the mix of short- and long-term compen- We also need to understand how pay-
performance incentives; uncapped up- sation. Long-term is intended to retain for-performance or “say-on-pay” initia-
side incentives; and excessive use of stock and reward. Short-term annual incentives tives may shape the junior and mid-tier
options as a short-term incentive. are usually cash awards for achievement company space, and how independent is
Wait a minute — this looks very much of metrics that are milestones to strategic the compensation consultant to the com-
like the typical compensation plan at most objectives. Cash is usually in short supply pensation committee if their compensa-
junior and many mid-size miners. So how for junior and mid-tier companies and tion is reliant upon a favourable relation-
should companies respond? RSUs and PSUs with long-term vesting ship with the CEO.
Stock options are falling out of favour could be an additional or alternative in- — The author is managing director of The
because they have no real downside. centive tool. Human Well (www.thehumanwell.com),
However, in companies where there is as We need to use a balanced scorecard a collaborative human capital consulting
yet no sustainable value, they continue to when assessing the performance of the group assisting companies in transition
be the optimal choice to align executives top team with respect to attaining mul- with a special focus on the resource sector.
and shareholders on the long run for ju- tiple objectives such as growth, manag- Paul Pittman has 25 years of experience
nior and mid-size mining companies de- ing the board, succession, coaching and working with boards and leading human
pendent upon a single or limited number mentoring. capital teams with global companies
of orebodies. Understanding all potential scenarios is including Alcan, Varity Corp. (Massey-
If combined with performance share also crucial. We can do this through Ferguson), and Laidlaw.
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