David O'Brian says CEOs must be trustees of a business

More from the SpencerStuart Executive Compensation panel. Here is David O'Brian:

David O’Brian, Chairman of the Board, Royal Bank of Canada and EnCana Corporation, said in his time as CEO of Canadian Pacific that executives were more like trustees of a company than the types to "game the game" just to drive up the stock price. It is better to align management with shareholders interests and that although stock options have not worked well across the board, it would be foolish to throw out the baby with the bath water. David disagreed that CEOs would hype the stock although he did agree that the stock market could be a bit of a casino.The method of pay and the level of pay both play a part of it, and CEOs have been divided about it. How much do you have to pay to attract talent? This is a societal issue too.When looking at compensation, you want to reward for performance and judge it by net income before tax, level of employee engagement. At EnCana, customer satisfaction will not play a role but oil price and low costs of production is key.

When I was a CEO, I did not ask myself every day, “How can I maximize shareholder value?” Instead, I would ask, “How can I make this business model work better?” That is the nature of that business in comparison to banking, for example.Stock options can be part of the package but these need to be long term.

As Warren Buffet said, “In the short term, the stock market is a voting machine, but in the long term it is a weighing machine”. Compensation needs to be on the long term performance of the company.Restricted stock and deferred shares are better than stock options which give huge leverage. You can remove stock options but our tax system encourages short term stock options. Long term tax deferred past three years is not allowed and this needs to be changed.Senior executives should have share options deferred, but we also have to realize that they need the benefits of the job while they are in their high spending years of their families and lives.Originally, stock options were created for start up technology firms and oil & gas exploration companies who could not afford to retain the talent of executive they needed. This deferred cash payment was not an expense as there was nothing to expense it against. For executive compensation, as part of the package, stock options should be de-emphasized.

Roger Martin, Rotman, asks whether executives "gamed the game" because of their stock options?

With the US Government’s Pay Czar taking unprecedented action in cutting bankers’ salaries and bonuses, the go-go years seem a faded memory. Executive compensation is now a hot topic. What is fair pay and how should talent be rewarded? What went right and what went so badly awry? SpencerStuart, Canada’s top recruitment company, held a fascinating panel with heavy hitters Roger Martin, David O’Brian and Tim Hockey dissecting the past thirty years of corporate performance and how this will affect executive compensation in the years to come. Roger Martin shifted my thinking on compensation and since I am designing pay for a top CFO and COO in a public company right now, even changed the compensation plan. Here are some random takeaways from Roger Martin:

Roger Martin: The evidence is damning that the stakeholders doing very well from the Standard & Poor top 360 companies listed in the New York stock exchange are not the shareholders but the managers. Roger Martin, Dean of Rotman Business School, ran the statistics of management compensation and discovered that between 1980 to 1990, CEO compensation doubled for each dollar of income produced. In other words, CEOs did unbelievably well.

No big deal, you may say, but how about shareholders? How did they fare in the same time period? The shocking picture that emerges is that, no, shareholders did not do as well. The performance of companies worsened and the returns were worse than the previous period. What happened in this time period was that there was an article written in 1976 by Michael C. Jensen and William H. Meckling, discussing the merits of stock options. This philosophy of aligning executive interests with shareholders caught fire and within years, every Standard & Poor CEO wanted stock options as part of their compensation package.

Why? Don’t stock options make sense?

On the surface, stock options seemed like a great idea but as with many well meaning programs, they had unintended consequences. Jensen and Meckling said that it was good to get employees’ interests aligned with the shareholder interests and that seems to make good sense. However, the CEOs realized that one way to get share price up (improving stock options), was to boost shareholder expectations by raising the dreams of future performance. After all, what is a stock? It is a collective expectation of future performance. This hyping of the stock soon became the top way to raise the price, not through hard work and actual growth. Smart CEOs figured this out.They learned to game the game.

Roger Martin says that this thinking clouded CEOs’ behaviour. A CEO would do a flurry of activities. Do acquisitions that never pay off. Do aggressive accounting to change the value on the balance sheet. Expectations raced ahead of value. The CEOs knew they could not beat the expectations and needed to run up the stock, cash out and get out quickly. Consequently, Roger Martin believes that stock based compensation further diverges interests of shareholders and CEOs, and should be removed as a tool from a CEO compensation. Unless the stocks can only be recouped years after retirement, stocks should not be used as a reward.

Chrystia Freeland, US Managing Editor of Financial Times, thanked Roger Martin and commented that Facebook is a stock that is priced on future expectation. The Facebook CEO says not think of it as a business but as a service, but it has yet to make a profit. I think Rotman will pull ahead to be the leader in the MBA pack because we are fortunate to have erudite and involved Dean like Roger Martin who gets out into the real world and debates with the big hitters in industry. I like Roger's gutsy style and I recommend you buy his books to get more of his views. I changed my actions and so will you.

Death of Macho?

Not since the movie Wall Street, have financial bankers been tarred with such an ugly brush as during this recession. The shock waves have sent cracks into the foundation of the world of finance and there is definitely a great deal of self examination going on in Board rooms, and universities. Some are calling for the end of macho, saying it was this aggressive, male-dominated attitude of Wall Street that took us on this wild and devastating ride.

It is true that 80% of job losses in the US are male dominated roles in manufacturing and construction, leaving women to step into the bread winner role within their families. Reihan Salam believes the end of macho began years ago and that there has been a quiet revolution where power has shifted from men to women in the Western world. He says the Great Recession has sped up this transfer, “The consequence will be not only a mortal blow to the macho men’s club called finance capitalism that got the world into the current economic catastrophe; it will be a collective crisis for millions and millions of working men around the globe.”

Having seen financial instruments level their economy, Reihan Salam points out how the people of Iceland replaced their President with a woman who some say, brings a calmer and more level headed approach.

When it comes to Toronto's finance world, there has always been a wide spread between the type of males who dominate. Tim Hockey, President & CEO of TD Canada Trust, describes the range as Patriots and Mercenaries, with Patriots being the people at the branches working for their communities, while investment bankers need to seek out the revenue which requires a more "Mercenary" nature. Tarring them all with a macho brush is simply not valid.

Financial men are very diverse in character. Sure, you have the macho cowboys; but there are many intelligent, hand firmly on the rudder types too, who are strong, determined and have the energy to do the long hours. Ironically, their positions may be the first roles to get filled by women in the future because in my experience, these men help women get ahead. They want the skills for their teams and are not threatened by smart women. I have also observed that the finance community in Canada does work hard to get women up the career ladders.

I believe the trading floor where the adrenaline flows, will be the last position to be filled for women. It's not because men keep women out, it's because women self-select themselves out of direct sales and trading positions. Again, a trader needs to be more mercenary and aggressive; they are paid to take risks within the boundaries. The ability to take risk is what gives a competitive advantage.

I have two sons so I am very aware of the feminizing of boys in our culture. And I have to work hard to make my boys happy to be aggressive through sports, debating and martial arts, etc. Girls in Canada are now getting sports training too and are encouraged to debate and compete, so young females are changing. There will be female Madoffs in the future too. Women are not perfectly behaved, thoughtful, compassionate creatures who will not want to be greedy. We are just getting going because the birth control pill only started in our life times. Give it a few more decades.

So maybe Reihem Salam is right and that macho is at an end but I think that is a rather idealistic and sexist view and ask if women will prove to be any different in the long run?

blog at http://www.moneymagnetbook.blogspot.com

Jacoline Loewen, (jbloewen@loewenpartners.com) is a partner in a private equity firm, Loewen & Partners, dedicated to raising capital for family business owners and developing their growth strategies.

If a family business wants to remain competitive

Family business is profitable and brings many rewards, but it can also be very tricky when bumping into bottlenecks caused by gaps in staffing.

Family-owned companies present special challenges to those who run them. The reason? They can be quirky, developing unique cultures and procedures as they grow and mature. That's fine, as long as they continue to be managed by people who are steeped in the traditions, or at least able to adapt to them. But what happens when a firm grows to a point that it must hire outside professional help to remain competitive? That can be a difficult task for all involved.

Just ask Melanie Kau.
Stewart Thornhill at The National Post has a great case study. Read here for more details:

Contributing experts weighing up the case are Jacoline Loewen, author of Money Magnet and a partner with Loewen & Partners as well as Rick Howard of Zodiac Swimming Camp.

http://www.financialpost.com/scripts/story.html?id=2176257

We swaggered and rode high but not any more...

Private equity used to be the Gods of the world of finance but that has changed.

Now, the US Government knows better than a Board of Directors and the CEO how much to pay staff. These changes in public attitude and more about the business world are topics of discussion with Tony James, the head of Blackstone, private equity's leading investor over the past decade.

See Video below:

http://www.ft.com/cms/8a38c684-2a26-11dc-9208-000b5df10621.html?_i_referralObject=11076613&fromSearch=n

Jacoline Loewen

The next hit to the economy could be private equity debt

The next hit to the economy could come from the debt used by private equity to buy ownership in companies. With cheap debt readily available from the banks, many large private equity firms used leverage as their main tool in their box to grow companies. What this meant was that private equity would put in 20% and use up to 80% of bank debt to build a massive war chest to grow a company's market share by acquisitions, not organic growth.

Do remember that the smaller funds were more into rolling up their sleeves and doing the sweat equity of sales and marketing to find customers and make them very happy, earning revenue and loyalty. Here is the rest of the story about the leverage kings of private equity:

The debt piled on companies amid the decade's $1 trillion buyout boom is coming due. The only question is about the extent of the fallout. The day of reckoning could simply be disruptive for the parties involved, or it could bring down the whole economy in much the same way bad mortgages broke confidence in the credit markets, effectively grinding them to a halt. Witness Hilton Worldwide, a portfolio company of Blackstone Group LP. Like almost every private-equity buyout, Blackstone acquired Hilton by putting down about 20% of the deal price. The rest was financed by borrowing, except Blackstone didn't assume the debt, Hilton did. Now Blackstone is in talks with Hilton's creditors to cut $5 billion from the $20 billion debt load carried by hotel and resort chain. Blackstone may pay down some of the debt at a discount in return for taking a bigger equity stake. (See WSJ story on Hilton.)

Jacoline Loewen, author of Money Magnet and partner in a private equity firm based in Toronto.

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Private sector credit demand required to grow an economy

"From a technical perspective, the recession is very likely over at this point, but it's still going to feel like a very weak economy for some time." Ben Bernanke, September 2009

Green Shoots. What Green Shoots? Even Chairman Bernanke admits that signs that the North American economy has resumed growing are modest at best. In the US the bleak jobs picture shows that job hunters now outnumber openings six to one, the worst ratio since the government began tracking open positions.

A key feature of the Postwar North American economy has been the intimate relationship between credit growth and economic activity. It takes money to finance economic growth. Indeed, by late 2006 the available statistics showed that approximately six dollars of debt was needed to finance every one dollar expansion in the US GNP. The lesson is this: without growth in private sector credit demand, sustainable growth in the real economy cannot be maintained.

Read the Full Blog Here: www.recoverypartners.biz/blog

Office 416 644 1567

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We are in a brave new private equity world

I recently had lunch with an expert in private equity who shared his helicopter view of the Canadian scene. He believes that we may be sitting calmly seeing the markets recover, but there are severe clouds on the horizon. Here are a few of his points - see if you agree:

• Power has swung from Wall Street to Washington. Government is now where the power lies because business has proven to be dangerous. Between melting down the global economy to Bernie Madoff outrages, business is not seen to be capable of making clear headed decisions.
• Tax payers’ money is funding auto industry and GM pension funds. The government is setting bankers’ pay. Government believes it is more capable than business experts to run companies.
• Increased regulation is now a given by government officials. For example, pension Funds in California are being asked to be completely transparent about their investments. Any private equity fund with pension fund money will need to operate like public money. The logic is that it is tax payer money in pension funds and transparency is to be expected.
• The European private equity associations are developing transparency codes before they are regulated to do so.
• Government used to be open to how to help business, but that door has slammed shut. Now Government wants legislation and regulation. The same regulation for big business applies for small business and that is too bad if the costs are too onerous.
• The swing away from America to the East will remove the US $ from being the currency. The dollar will drop to 70c and money will be printed like crazy, boosting inflation. The US dollar will be lower than the Canadian dollar which will rise because of increased demand for raw materials. Companies manufacturing using the Canadian dollar and selling to the US will be pinched.
• Obama is moving his focus away from Europe to the East. Brand America is broken and this has tremendous consequences for society.
• Improved technology to hold virtual meetings means that business travel will drop and all industries feeding into travel.

Jacoline Loewen, author of Money Magnet and partner with Loewen & Partners, private equity.

No more cash for trash

"No more cash for trash," says Tom Trimble, CIBC Wood Gundy. This catchy theme tracking through private equity investing is explored below by CIBC Wood Gundy's investment expert, Tom Trimble:

It is hard to believe that it has been just over a year since the collapse of Lehman’s and the ensuing market maelstrom. At one point it appeared that the whole financial system was at risk, but the concerted effort of governments around the globe staved off disaster. While conditions have improved markedly, the sheer volume of conflicting information and opinion on what the future holds is staggering.

What we do know is that both the credit markets and the equity markets have roared back from a near death experience. Over the past month we have been conducting a number of annual reviews with clients that have their birthdays in the fall. Part of the meeting has been a discussion of the performance of the portfolios from a year-to-date, one year, and two year perspective. This coincides with the beginning of the meltdown in the U.S. and includes the worst days of 2008 and 2009. It has been encouraging that over this time period the “total” return has been only modestly negative, much better than most expected.

So what now? We would like to discuss several themes that are shaping our current thinking.

Bullish On Equity

As most of you are aware, at the height of the crisis we chose to move into corporate and high yield bonds as they offered the best risk-adjusted return at the time. If the number of bond issues that have come to the market since then is any indication, then credit markets have experienced a rapid thaw from the frozen conditions of March. The difference between Government of Canada bond yields and low grade bond yields has narrowed to almost pre-Lehman levels. At the same time the yield on cash assets have shrunk to almost zero.

While nobody wanted bonds in March, we now find that there is tremendous demand for any type of income product regardless of quality and yield. We are no longer buying much fixed income due to low interest rates and are thus more interested in equity that offers attractive yields and potential for capital appreciation. We feel that equity offers us the best risk adjusted return opportunity, especially the high quality companies that have lagged the market over the past six months. That being said we are very careful about what equity we wish to own. See “cash for trash” below.

In our last commentary we mentioned that we had created four CPMS branch portfolios. We have been meeting every Tuesday as a group to review the portfolio and to make any changes we deem necessary. Since we started on April 1^st we are happy to report that the CPMS portfolios have been excellent performers. Over the next few months we will be integrating the companies highlighted in these portfolios into our accounts. Stay tuned.

No More “Cash For Trash”

We have talked about this issue before, but it is worth repeating. In fact, CPMS has analyzed the characteristics of the best performing stocks over the past six months and it was clear the only positive attributes for these companies have been a low price to book ratio and high earnings expectations in the future. Once the governments stepped in and guaranteed the financial system, these companies were tossed a lifeline and their stocks moved up. This “hope trade” helped move these stocks through several technical barriers and many speculators/investors piled in for the ride. This ride has continued, especially with the commodity based stocks.

We feel that with the third quarter results being posted now, there will be a shift away from these higher risk stocks to the less risky, more consistent companies with steady growth in profits, and good balance sheets. It is our opinion that, in times like this, these are the companies that deserve a premium valuation. There may be a few extra innings on the “cash for trash” trade, but we are beginning to position our portfolios into the companies that offer steady profits, solid balance sheets and may not have moved with the market.

Currency, Commodities And Gold, Joined At The Hip

We are bullish on materials, energy, and agriculture over the long-term based on the age old supply/demand principle. Unfortunately, the U.S. governments’ ballooning deficit adds another dimension to this investment thesis. Since commodities are priced in $US, the movement in the dollar affects the price of commodities, but this does not necessarily improve energy, material, or agricultural companies bottom lines.

For example, if the $US declines by 10% and oil prices go up 8%, the net affect to a Canadian oil producer’s net income is actually negative as they have to convert their income into $CDN and most of their costs are in $CDN. Unfortunately most investors focus only on the price of oil and bid up oil shares as the price of oil goes higher without factoring in the effect of the currency. We don’t like investing in commodities that are inflated by short-term movement of the $US and would prefer to buy them when it is clear that demand is increasing faster than supply.

While we have seen some “green shoots” in the economy, we need to see sustainable demand in the developing world for the rally in commodities to continue based on supply and demand. At the moment, 40% of the China’s GDP is government stimulus spending. This kind of stimulus is not sustainable forever so we would like to see more growth coming from the consumer. If we see a correction in the $US and thus commodities we would add to our positions.

The World, It Be A Changing

Two years ago, all the talk was about the decoupling of the developed economies from developing economies. During the financial crisis this theory was put to the test and failed as all markets declined together. Now that we are in the recovery phase it is becoming abundantly clear that 2008 and 2009 were bumps in the road for these economies of China, India, Brazil, and Latin America.

Their balance sheets and banking systems are in solid shape. They have tremendous potential for consumer growth, they are great savers, and they did not see the asset bubbles from too much leverage that the OECD nations experienced.

If we look at the U.S. we see exploding public sector debt, a huge inventory of homes in foreclosure or about to be foreclosed, decreased consumption and increases savings by consumers, which would indicate a slow rate of recovery.

It is our opinion that we will gradually see a shift from the U.S. being a consuming nation to one that grows through exports. Meanwhile China, India, Brazil, Latin America, and Asia will generate less of their GDP growth through exports and more through domestic consumption. Growth in these economies will place demands on the supply of materials, energy, technology, agriculture, infrastructure and specialized services/industries.

Canada is well positioned to benefit from this economic shift through our commodities, however, our manufacturing sector will suffer with the continued decline of the $US. Our banks have done well recently, but will likely trade sideways for a while until there is visible proof that Canada’s economy is recovering with some strength.

CIBC Wood Gundy

Lisa Applegath Tom Trimble

Investment Advisor Investment Advisor

Contact: Fossati, Susy mailto:Susy.Fossati@cibc.com