Director’s Compensation – Striking the Right Balance
This article originally appeared in the fourth quarter 2010 edition of Directors & Boards magazine.
It’s been a busy decade. First, there was the recession following the dot.com bomb and 9/11 that led to Sarbanes-Oxley. Then, there was the financial bust of 2008 and ‘09 that led to Dodd-Frank. In the world of board directors, there really hasn’t been a dull moment. As a result, not only are board directors finding themselves working harder, but they also are finding themselves increasingly at risk for being “voted off the island.”
There is no doubt that economic conditions have affected director compensation. Throughout the mid-2000s, director pay rose annually by mid-single digits. But by the time of the 2008 recession, board compensation had flattened, and in actual terms, took a turn for the worse with deflating equity values. Most directors felt that it would not have been right for them to have taken a pay increase as their companies struggled through the recession. But now that the green shoots are appearing, many directors are wondering whether it’s time to give board compensation another look. As they do so, they are considering a number of issues before making any changes, including:
- Should board pay be compared to an industry group, to a broader group, or both?
- How can the unprecedented workload be factored into the equation? After a decline in the incidence of meeting fees, is it time to either bring meeting fees back, make them a more important element in the pay mix, or ensure that the retainers are sufficient to reflect an ever-increasing workload?
- Are board pay increases warranted, and if so, what is the right time to institute them?
- Are board leaders (e.g., non-executive chairs, lead directors, and committee chairs) being appropriately compensated, particularly in view of the disproportionate increase in demands on their time?
- Have the vicissitudes of the stock market created special issues with respect to how directors have been compensated? Is the form of director compensation, particularly with respect to equity, appropriate?
- Should the board use the same consultant for director compensation as for executive compensation? Is there a conflict in using the same consultant for both?.
Having considered these issues across a broad array of clients, we, at Farient Advisors, a compensation and performance consultancy, have developed clear points of view on how to resolve them. Specific answers will, and should, differ by company. But all companies should have the benefit of drawing upon a sound fact-base that provides insight and helps them arrive at decisions that are balanced and defensible. Farient’s perspectives are:
Peer group(s) – Because board directors are recruited from many industries, directors should consider competitive data both pertaining to their industry and across a broader group of size-appropriate companies (Why size-appropriate? Because director compensation increases with company size).
Workload – Directors are expected to be “on the clock” for time in between “official” meetings; so it can be nearly impossible to determine the actual number of hours a director will put into the role. While number of meetings is an imperfect way to determine workload, and more importantly, to determine the value that a director might bring to the table, it nevertheless is the best information we have for comparing pay packages. As a result, it is important to assess director compensation across companies by normalizing for number of meetings attended each year. In addition, it is important to assess total director compensation, and not pay by component since companies tend not to offer all components to directors. (In this case, the sum of the parts does not add up to the whole).
The merit and timing of board pay increases – Boards generally seem to feel a bit awkward about voting themselves an increase. However, it is our experience that an increase may be justified if: (1) shareholders are doing well, and (2) work-adjusted director pay lags the market.
Board leadership compensation – Board leadership compensation is highly dependent upon the role definition and the time requirements of each role. This varies greatly from company to company. As a result, the market should only be a general gauge for setting leadership pay. In the end, each board needs to determine its own philosophy as to the extent to which leadership pay should be differentiated by role.
Equity compensation – If the form of compensation has created “haves” and “have nots” among members of the board due to differences in the timing of equity-based grants, then it may be time to re-evaluate the form of equity compensation. Many boards are now moving toward annual full value grants instead of initial stock option grants, for example, to mitigate the “vintage year” effect of joining the board.
Consultant independence – The board is determining their own pay, regardless of who the consultant is. So, the key is for boards to use a consultant who will provide the right fact-based analysis and render an objective opinion. Whether or not that consultant is working for the board on executive compensation will not make a difference in that regard.
Just as executive compensation is heavily scrutinized today, so is board compensation. There are a multitude of considerations in determining what level of board compensation is appropriate for your company. Clearly, just looking at the tabular numbers in board compensation surveys does not give a sufficiently clear picture of the market, and does not reflect the unique characteristics and operating principles of your board. A more thoughtful, fact-based analysis is needed to provide insight and offer the most balanced and defensible input on the issues. One thing is certain – just as the board is keeping watch over the company, shareholders are keeping watch over the board.
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Robin Ferracone is the Executive Chair of Farient Advisors, LLC, an independent executive compensation consulting firm which helps clients make performance-enhancing defensible decisions that are in the best interests of their shareholders. Robin Ferracone is the author of a recently published book entitled Fair Pay, Fair Play: Aligning Executive Performance and Pay, which explores how companies can achieve better performance and pay alignment. Robin can be contacted at robin.ferracone@farient.com.
