Ontario's new Hydro One board will have to pay equal attention to ratepayers and shareholders

A nasty public boardroom brawl at Hydro One Ltd. was averted because Ontario's new Progressive Conservative government played the activist card.

Blindsided by an executive compensation package designed to enrich management, the newly elected government of Premier Doug Ford flexed its muscle as the utility's single largest shareholder and forced the ouster of Hydro One's chief executive officer and its 14-member board of directors last week.

This was a showdown that drew to an unavoidable conclusion. The move by the Conservatives to force the departures of Hydro One CEO Mayo Schmidt and the board was the kind of revolt that occurs when shareholders become either disenchanted with management or attempt to influence the way a company or entity operates.

Given Ford's campaign promises, it's not hard to figure how much this move was motivated by the latter.

Still, despite the unique governance challenges involved with operating a semi-private utility, the degree of tone-deafness in the board's behaviour at Hydro One — and the extent to which it contributed to its own demise and helped advance the new premier's cause — should not be understated.

Not only did Hydro One's board appear to have kept its largest single investor — the provincial government owns a 47 per cent stake in the electricity transmission and distribution utility — in the dark about significant changes to the way senior managers are compensated, but it did so during the run-up to one of the most highly contentious provincial elections in decades.

The saga began last year when Hydro One's board approved changes to the company's executive compensation policies that essentially sought to make it more difficult for Queen's Park to intervene in the utility's affairs.

The revisions were the culmination of a review of the board's governance policies that began last year, after the former Liberal government slashed hydro bills by 25 per cent in an attempt to quell mounting public fury.

Perhaps concerned about future political meddling — and the likelihood of a change in government at Queen's Park — Hydro One's board sought to increase the amount of severance paid to the utility's chief executive officer if he were to be fired in the event the directors at the major Canadian utility were replaced.

The revisions also applied if the government passed legislation to limit executive pay or crimped Hydro One's ability to meet its corporate performance targets. 

At the same time, Hydro One directors voted to give themselves generous increases of between $25,000 and $70,000 to their annual director fees for attending about 20 meetings a year.

A few points are worth noting:

• The revisions appeared to sidestep the governance agreement the province established in November 2015, when it partially privatized the electricity transmission and distribution utility.
• All 14 directors on Hydro One's board were appointed by former premier Kathleen Wynne's government.
• Although the board hired top-notch external compensation consultants to advise on the proposed changes, the directors didn't appear to have consulted with its largest shareholder, typically considered a best practice in corporate governance.

The controversial changes were approved by Hydro One's board in November 2017, but were publicly disclosed five months later in a shareholder proxy circular released on March 29.

That's when Ontario taxpayers also learned that Hydro One's CEO took home $6.2-million in salary and bonuses in 2017 at a time when provincial electricity rates were so high that some Ontarians were having to choose between eating or paying their hydro bills to keep the lights and heat on.

Of course, it doesn't matter that what the top management brass earns has little correlation with the numbers on your hydro bill. Hydro One doesn't set electricity rates. That's the purview of the Ontario Energy Board, the province's energy regulator.

When the proxy circular became public, former premier Wynne's Liberal government was clearly caught off guard. Even though they threatened to vote against the plan, the Liberals abstained on the assurance from Hydro One's board that it would revisit its contentious pay scheme for senior executives.

In fact, Queen's Park could have complained all it wanted: shareholder votes or so-called "say on pay" are non-binding in Canada. Essentially, the government could vote against the controversial proposals, but it would not change the course of the plan already approved by the board.

So it was hardly a surprise that once elected, Doug Ford would walk the campaign talk and find a way to oust the "$6-million man."

Thus, faced with the potential loss of Hydro One stock options and other equity compensation currently worth about $9-million, Hydro One's embattled CEO Schmidt opted to "retire" last week with a lump sum payment of $400,000 and millions more from stock options and pension benefits.

At the same time, the utility's board of directors resigned as a group, and their raises were rolled back.

There's the rub

"Premier Doug Ford and the government for the people will always put the ratepayers and taxpayers first," declared a government release, underscoring his respect-for-the-taxpayer mantra.

But there's the rub. Hydro One may be a publicly listed company whose shares trade on the Toronto Stock Exchange, but its largest single shareholders are provincial taxpayers. The majority of the utility — 53 per cent — is owned by private investors, such as large pension funds.

It's important to note that there is a distinction between the stakeholder interests that politicians talk about and shareholder or investor interests — and the two are rarely in sync.

Executive compensation at Hydro One became a lightning rod, because electricity bills in Ontario have more than tripled since 2003 and today are the highest in Canada. The tension exists because taxpayers as stakeholders, who want the utility to clamp down on rates as they were promised by politicians that privatization would deliver, figured they didn't get much value from that $6-million CEO.

Conversely, shareholders — who expect profits and ultimately healthy dividends — are generally accustomed to paying high-priced talent to deliver those returns, which is why 92 per cent voted in favour of the contentious executive compensation revisions.

Transparency, accountability

For them, low electricity bills don't help the bottom line achieve those goals or enhance value creation. To wit, investors knocked off almost five per cent of Hydro One's market value at the end of last week after the departures of the board and the CEO.

In short order, the provincial Conservatives unveiled legislation on Monday that would give the provincial government authority to approve executive pay at the utility in future.

A newly constituted board of only 10 directors will be named by Aug. 15. Four will be nominated by the provincial government and the other six by Hydro One's largest institutional shareholders, which include Bank of Nova Scotia and Mackenzie Financial Corp. Together the board will choose a new CEO.

In the aftermath of the board cleanout, the provincial government has vowed to butt out of Hydro One's affairs.

But as long as it has a legislative cudgel, we can assume the new board will be expected to be as accountable to ratepayers as it is to shareholders if Premier Ford has any hope of achieving his promise of a double-digit per cent decline in hydro rates.