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Hydro One Compensation
However, as Hydro One was planning to go public, the compensation system was under discussion in order to get more effective and motivated for senior officers with fair and reasonable rise in pay aligning with market level. With regards to Canada’s electricity industry, it was becoming more open and free. This divested government ownership and encouraged a lot more new entrants into this market, which resulted in stronger competition among electricity generator within and outside Ontario.
The restructuring of the electricity Industry and the coming free arrest would make It more urgent to reveals Hydro One’s compensation system and turn this Into a competitive position as compared to Its comparator firms. Key Issues First, as Hydro One was planning to launch an PIP, how to design a competitive compensation plan to attract, motivate and retain competent staff as well as satisfy the current and prospective shareholders was one of the key issues.
On one hand, to retain the senior officers of the company, Hydro One’s compensation has to be as competitive as its counterparts and aligned with market practices. On the other hand, if the managers are overpaid, under the new transparent and shared culture, the public will perceive Hydro One as bureaucratic as it used to be, and the current and potential shareholders will feel unfair and unreasonable. The overpayment, therefore, will hinder Hydro One’s PIP process.
Second, the electricity industry in Canada was In the middle of reforms. The market Is expected to be more competitive and open, and power suppliers in this market have to strive for greater profitability by aggressively generating revenues and lowering the costs. In this situation, how to develop an effective compensation plan to motivate the managers to act at the best interests of the company becomes another key issue. The performance measurement was based on several metrics, including the expenditure, safety and outage.
Nevertheless, to survive and develop its business in the upcoming new business environment, Hydro One should try the best to raise more revenue and better serve the customers as well. The compensation plan should also be able to recognize performance and penalize non-performance to improve the company’s competitive abilities in the changing marketplace and secure its long-term development, which will turn Hydro One from a bureaucratic image Into an entrepreneurial and high-energy corporation.
Last, as critical parts of compensation plan, we believe that performance goal setting and goal evaluation are also one of the key Issues. The performance goals must fit In the company’s current situation, which Is still government-owned and planning to go public. Furthermore, the performance goals should be transparent and objective, and be acceptable by majority of the senior management and shareholders, which requires efficient corporate governance and effective communication within the organization.
Recommendation The need for a good compensation plan in situation where ownership is divested from a company has been described as the principal agent problem. An effective compensation plan for senior management will solve this problem and align the interests of management with those of the shareholders. As Hydro One is about to go public, we divide our recommendation for executive compensation into two phases. Phase 1 will deal with executive compensation before the initial public offering. Phase 2 of our report will briefly discuss the guidelines for executive compensation after PIP.
Phase 1: Pre-PIP Executive Compensation As a crown corporation which is planning for prevarication, the primary objective of the provincial government, the sole shareholder of Hydro One, is to launch a successful PIP and to raise as much cash as possible for its investment. To achieve this objective, the company has to be in a strong financial position, with very good growth prospects. The compensation plan that we recommend will motivate the management of Hydro to achieve this objective. First, the compensation plan will place emphasis on company performance.
Management will be paid a relatively good base salary but will be offered an opportunity to gain much more with performance bonuses. As we see in Exhibit 1, in 2000 the CEO of Hydro One made the second highest base salary among the 5 utilities we surveyed even though Hydro One was not yet public. Our compensation plan will change that. The base salary of the senior executives will be pegged at the 25 percentile level of the publicly traded utilities. This also requires good communication between the board of directors and the Enron management, effectively conveying the corporate future goals.
Second, the CEO of Hydro One had the second highest compensation among the group surveyed. This is going against the fact that the financial performance of Hydro One measured by the return on assets and return on equity is the poorest in the group. We recommend that the opportunity for additional compensation for senior management be more directly tied to the financial performance of the company. Management will have the opportunity to make very high bonuses but this will be erectly related to improvements in shareholder value measured by return on assets and return on equity.
Third, to have a successful PIP, it is important that the company is profitable and has a business model to sustain this in the long run. Investors look at measures such as gross profit margin and net profit margin to Judge this potential. In 2000, Hydro One had the second highest operating profit margin among its peers surveyed in Exhibit 1 . However the company had the second lowest net profit margin. This suggests that the company was spending a lot of money on general and administrative overheads.
Before the PIP, we recommend that the bonuses of Hydro One executives be more directly tied to improvements in the net profit margin. Phase 2: Post-PIP Executive Compensation One of the challenges of determining what is a fair and reasonable executive compensation for a crown corporation is the fact that the decision becomes politically charged because of its ramifications for the government in power. This restriction recommend that executive compensation at Hydro One become fully competitive with compensation at similar sized corporations in North America, not Just in Canada.
The executive salary comparative benchmark can also be derived from both the public sector and private sector. The idea will be to broaden the executive pool to be able to attract the best talent in order to increase shareholder value. To this end, the base salary of Hydro One executives will be increased to 50 percentile range for similar organizations in North America. Second, to better align the interest of senior management to those of shareholders, the remaining part of executive compensation be paid in stock options.
The stock-based compensation will motive senior officers to CT at the best interests of the company to create greater value to its investors which in return will increase their payoffs. Last, from the long-term perspective, we believe Hydro One can introduce a well-defined pension plan to attract and retain competent staff. In addition, in order to ensure the objectivity and fairness of the compensation allocation, the individual performance could be evaluated by his/her supervisor and peers who work closely with to minimize subjective components in appraisal and strengthen corporate governance.
Conclusion In the progress of transformation into a publicly traded corporation, Hydro One needs a reasonable and appropriate compensation level given the current environment in which the company operates. The challenge Hydro one will face after prevarication is to be active in the labor marketplace and compete for those skilled workforces worldwide, which needs a competitive compensation. In return, this will drive the long-term success of the company through common interests and boosted morale of the staff. Exhibit 1: Analysis of Performance and CEO compensation [pick]