Director pay: what makes sense today; Compensation received should reflect the work done. Here is a model for the new corporate governance era.OUTSIDE DIRECTOR COMPENSATION has increased significantly over the last few years in response to increased visibility and accountability around the directors' role in safeguarding shareholders. However, during this time there has been very little discussion about the structure of director compensation--that is, until Coca-Cola shook things up in April 2006 with its announced new director pay plan. Given the importance of the role of directors to corporate governance and shareholder value creation and the difficulty of recruiting top talent to play this increasingly difficult role, we believe a review and assessment of director pay is in order. First, a word about Coke's new plan. The plan will pay the same amount (initially $175,000) to all directors regardless of their individual roles, in stock, based on the company's achievement of a specified three-year EPS growth target. If the target is not achieved, the directors are paid nothing. While we applaud the Coke board for originality, commitment, and boldness, and for inspiring a discussion that is long overdue, we do not believe the plan is appropriate for many companies, primarily because it blurs the line between management accountability and board accountability. More on that below. In this article we will not address the amount of director pay (which for the largest 250 publicly traded companies is surprisingly tightly clustered around a median of $170,000). Rather, combining our experience working with boards on director and executive pay with an analysis of trends over the last five years among the 250 largest publicly traded companies and interviews with a number of directors about their roles and pay plans, we will explore the structure of director pay plans in the context of directors' role and work processes. Over the last few years we have noticed, and confirmed statistically, a quiet but inexorable shift away from meeting fees toward board/committee retainers of varying amounts. We will address the question of whether meeting fees still make sense or whether retainers should be the primary mode for delivering pay, as well as other basic questions: How should "pay for performance" be structured, if at all? Does equity provide the right alignment with shareholders? What is the right mix of cash and equity? Mix of elements and structure The accompanying sidebar, "Watchdog/Helpdog: What Directors Told Us," addresses the issue of director pay in the context of changing work processes to support good governance, due diligence, and shareholder alignment. It is appropriate to look critically at the structure of outside director pay in this context to ensure that it compensates directors for being effectively engaged in today's corporate governance environment. Generally, there are six elements of director compensation that can be paid in some combination of cash and stock. (Perquisites that serve no business purpose, such as pensions, have been eliminated.) -- Board retainers, -- Board meeting fees, -- Committee retainers, -- Committee meeting fees, -- Committee chair retainers, and -- Committee chair meeting fees. These six elements, which can be paid in cash or stock, are combined in three basic ways: 1. Retainers and meeting fees: This is the most common and traditional structure for outside director pay. Under this format, some combination of a flat retainer and per-meeting fee is established for the board and for some or all committees and/or committee chairs. 2. Multiple retainers, no meeting fees: This is the next most common structure. There is a retainer for board service and some combination of a standard or variable retainer for service on some or all committees plus a retainer for the committee chair. 3. Single retainer: This is the simplest yet least common structure, more typical of small boards with an even distribution of committee service among directors. All directors receive the same retainer regardless of their role and committee memberships. Our analysis of director pay plans in the 250 largest publicly traded companies in 1999 and 2004 shows a shift from the first model above (retainers and meeting fees) to the second and third (all retainers). In 1999, 28% of the largest companies had retainer-only compensation structures (multiple or single). By 2004 that number grew to 40%, including nine of the largest 10 companies. At the same time, the newest form of compensation, extra pay for chairing certain committees (such as audit and compensation), is almost exclusively in the form of a retainer, with no extra meeting fee. Interestingly, in 2004 one of the most prevalent pay structures in our large company sample included only two components: a board retainer and committee chair retainer. The addition of committee chair compensation is understandable in the context of the extra workload that position has taken on in recent years. But how can the trend away from meeting fees be explained in the context of directors' increased workloads? Aren't meeting fees an effective way to differentiate pay based on actual participation and committee membership? Yes, but they may not be the most effective way to differentiate pay on the basis of total engagement or time spent, as shown by the fact that committee chair pay has been structured as a retainer rather than an extra meeting fee. Directors' perspectives We interviewed outside directors representing more than 20 companies spanning the full Fortune 500 range of size and industry, as well as the head of a leading search firm's director practice. Our objective was to understand how they view the director's role, how board and committee work is actually done, and how they think the compensation program should be structured. Several themes emerged from our interviews that help to explain the movement in director compensation from the traditional structure of retainers and meeting fees to an all-retainer structure. * Outside directors feel a sense of responsibility to be fully engaged not only in ensuring compliance and good governance but also in adding value to management. They want to be engaged members of a fully engaged board; in fact, their decision to join a board is based at least as much on whether they believe they can add value as on their assessment of the risk and time demands. They talked about what it takes to be an effective, engaged director, and it is clear that much of the time spent occurs outside the boardroom--in ad hoc meetings, on the telephone, e-mailing, reading about legislative and regulatory changes, gaining an in-depth understanding of what drives the company's success by spending time with business unit heads or going to company functions, such as sales meetings. As several directors said in one way or another, "It's not about attending meetings." * Outside directors understand that the variability in workload makes compensation difficult to structure. The demands placed on directors varies widely from company to company and year to year, based on the issues the company is facing at a given time. From the extreme of scandal to more commonplace issues such as recruiting a new CEO, variability of time and effort is significant and complicates the compensation issue. Moreover, directors universally recognize that certain committees have more complex and visible issues that require more director time (e.g., audit, compensation) and that certain leadership roles (e.g., committee chair, lead director) have significantly more responsibility than other directors. * For outside directors, it's not about the amount of money, it's about fairness. Directors want to be paid fairly for their time. It is probably safe to say that most directors in our large company sample are not in it for the money, since the $170,000 median pay represents a small percentage of their net worth. Nevertheless, the compensation must seem fair relative to what companies in the same industry pay and relative to the workload and accountabilities. For example, our respondents believe that members of certain committees and those in certain leadership roles should be paid more than others. Another issue raised was "times of crises," when directors might have to work very long hours under high pressure as a result of scandal, bankruptcy, or an M & A transaction. Under these circumstances, directors believe that additional compensation should be paid but that this situation occurs only about once in 10 years. Most directors believe that, over a three- to five-year period, they would see a few heavy workload years and a few light ones and that the director pay program should reflect the average workload over this normal cycle. * Outside directors believe in equity as an effective compensation vehicle. Stock is a powerful motivator, owing less to the financial implications than to the directors' belief that they can influence the price. It's psychological, not economic, and it works to reinforce engagement, whether in the form of stock options or restricted stock. * Meeting fees are one way to get to the answer but seem to generate little enthusiasm. Meeting fees have some utility as an easy way to reflect variability in workload and to impose discipline in calling and attending meetings, but they are largely seen as irrelevant, since most of the work takes place outside of the boardroom. Moreover, engaged directors do not need a meeting fee to motivate them to show up, and disengaged directors should be asked to leave the board. * Variable retainers by committee seem to make sense. There is a sense that paying a fair fee for service on the board or on a committee is the best way to encourage engagement and to compensate holistically for the expected job to be done. As one director put it, "If directors feel fairly paid with retainers, the onus is on them to be fully engaged." Our conclusions The objective of director pay is to attract, retain, and motivate engaged directors. The mission is to set clear expectations of engagement and pay for it--or ask the director who doesn't meet the expectations to leave the board. Now let's return to the questions posed at the outset. * Do meeting fees still make sense? No. They are not necessary to motivate attendance, most work is done outside of meetings, there are better ways to reflect variable workloads, and they could potentially discourage directors from doing extra work (e.g., ad hoc informal meetings) that they perceive they are not getting paid for. * Should retainers be the primary mode for delivering pay? Yes. If carefully constructed to reflect the parameters/scope of the elements of the job each director takes responsibility for, some combination of retainers is the simplest, most straightforward way to tie pay directly to the market value of the job. Just as retainers have been established to introduce compensation for committee chairs, so too can retainers be effective as the sole pay mechanism for board and committee members. Retainers should be structured in a way that reflects the distribution of work among the directors. For example, if every director has similar committee service--say, audit or compensation committee plus two other committees of similar complexity--then perhaps a board retainer with no separate committee retainers is sufficient. Conversely, if only certain directors are doing the heavy lifting in terms of service on the tough committees or on more than the average number of committees, separate retainers should be offered to members of each committee, in varying amounts to reflect the work required of each one. If the chair of a particular committee does a lot more work than the committee members--helping to shape management's recommendations to the committee, digging into the background issues, etc.--a separate committee chair retainer is likely appropriate. Retainers should be based on a careful assessment of the average expected workload over a normal cycle, accepting that in some years the retainer will seem too high and in others too low. Extraordinary crises that require an effort that is clearly above and beyond should be dealt with on an ad hoc basis after the fact. * How should pay for performance be structured, if at all? Through stock compensation. The board is not responsible for setting or executing against specific targets; the board is responsible for overseeing management and their processes for setting and achieving performance targets. Measurement of a director's performance should be based on engagement, focus, participation, preparation, insights, and constructive challenging, not number of meetings attended. Measurement of the board's performance should be based on total shareholder return, not specific targets. If directors' pay is tied to specific financial targets, such as the new Coke plan's three-year EPS bogey, the company is effectively saying that both the board and management are accountable for achieving specific targets. Such dual accountability could undermine the board's oversight role. We believe that paying part of the directors' compensation in company stock more appropriately aligns directors with shareholder interests. * Does equity provide the right alignment with shareholders? Yes. Stock provides the psychological link between directors' efforts and the building of enduring shareholder value. * What is the right mix between cash and equity? A portion of the retainers should be paid in stock that is deferred until retirement from the board, to allow directors to accumulate stock in a tax-efficient manner. Directors should also be given the opportunity to voluntarily defer the cash portion into stock units. There should be enough cash to pay taxes on any stock that is unrestricted/undeferred and to make directors feel fairly compensated for their time regardless of the ultimate value of the stock. There should be enough equity to get directors' attention, so as to strengthen their psychological link to shareholder value. Front-loaded equity grants (covering three to five years' worth of grants with proportionate vesting) can be an effective way to achieve the desired impact quickly. A recommended model We are encouraged by the results of both our data analysis and our director interviews. It seems that director pay is moving in the right direction. Though one size never fits all in compensation, our recommended general approach to director pay is as follows: * Retainer-only pay structure with a single retainer (if work is evenly distributed among directors) or multiple retainers in varying amounts for the expected work required for the respective service (i.e., board, each committee, chair). * Significant portion paid in stock and voluntarily deferred stock units to achieve a tangible link--financial and psychological--with shareholders' bottom line. Consider using front-loaded equity grants that cover multiple years and vest proportionately. The advantages of this model: * It's relatively simple. * It ties compensation holistically to the various components of the directors' job better than a per-meeting fee or standard retainer, which may be too low for some committee service and too high for others. * It achieves pay for performance in a way that is consistent with directors' accountability to shareholders (i.e., through stock price) rather than tying pay to drivers of shareholder value (e.g., EPS), which reflects management's accountabilities. The authors can be contacted at claudia.poster@towersperrin.com and marc.ullman@towersperrin.com. Claudia Zeitz Poster and Marc R. Ullman are principals with Towers Perrin specializing in executive compensation (www.towersperrin.com). Their expertise includes developing total rewards strategy to support business strategy, designing short- and long-term incentives for corporations and their business units, competitive pay analyses, director compensation, and transaction-related compensation programs. They are based in the firm's New York office. [ILLUSTRATION OMITTED] [ILLUSTRATION OMITTED] RELATED ARTICLE: 'Watchdog/helpdog': What directors told us In the 21st-century world of corporate governance, directors are taking their roles very seriously. While regulations and shareholder activists have forced more attention on compliance issues, directors have demonstrated increased engagement in a myriad of business issues and a desire to help management achieve its goals. Here is a sampling of what directors told us: On their role: * At the end of the day I am driven by my sense of duty and responsibility to be genuinely helpful. * I want to be both watchdog and helpdog, though the balance has shifted to check-the-box watchdog. * Directors join boards if they think it's a good fit and they can add value. The degree of risk is less of an issue, as long as they think they can help fix the problems. On variability in workload: * There is a core of duties every director must take on; beyond that the responsibilities and workload are highly variable. * Normalcy is five in-person board meetings in a year; it can go to 30-40 formal meetings and dozens of sidebars and hundreds of emails and telephone calls. * I have spent an extraordinary amount of time on crises. * I spent 12 hours just this past week on phone calls and informal meetings trying to drive consensus. * At a minimum the ratio of non-meeting to meeting time is 5 to 1. On pay philosophy: * I want to be paid fairly. * What matters is that the total amount is right for the work I've done. * It can't be far off from comparables. * If directors are to be meaningfully involved beyond meetings, compensation should be constructed around those expectations. * The objective is to have a compensation system that, without violating best practices in terms of amount, encourages engagement. * If we think stock options will buy management, then Coke's plan will buy directors. On stock compensation: * Every director should own stock. * Directors must be aligned with shareholder interests, and stock does that. * Stock encourages engagement; even though it's not a lot of money, it is a medium I think I can influence. * What's needed is a system that pays for engagement, not meetings. On retainers: * Flat fees encourage engagement in subtle but different ways than meeting fees. * If directors feel fairly paid with retainers, the onus is on them to be fully engaged. On meeting fees: * What's needed is a system that pays for engagement, not meetings. * Meeting fees are not the way to go; it's not about keeping track of meetings. * Meeting fees do impose a discipline on management when deciding to call a meeting and on directors when carving out the time to attend. * It's not about incentivizing directors to show up for meetings or meeting attendance. * Meeting fees are an old way of thinking. --Claudia Poster and Marc Ullman
EXHIBIT 1 5-Year trends in director pay plan structures
During the five-year period 1999-2004, the greatest changes in director
compensation among the 250 largest publicly traded companies were:
* Elimination of meeting fees: 21% of the companies eliminated board
meeting fees, and 18% of the companies eliminated committee meeting
fees.
* Addition of a committee chair retainer: 24% of the companies added a
committee chair retainer
Total sample--Summary of changes
Board
Retainer Board Meeting Fee Committee Retainer
Added
% 2.9% 4.5% 7.8%
# of Co's 7 11 19
Eliminated
% 0.4% 21.0% 6.2%
# of Co's 1 51 15
Net Change
% 2.5% -16.5% 1.6%
# of Co's 6 -40 4
Committee Committee Committee
Meeting Fee Chair Retainer Chair Meeting Fee
Added
% 7.4% 24.3% 3.3%
# of Co's 18 59 8
Eliminated
% 17.7% 1.2% 3.7%
# of Co's 43 3 9
Net Change
% -10.3% 23.0% -0.4%
# of Co's -25 56 -1
EXHIBIT 2 Retainer-only pay models
Prevalence
Model Pay Elements 1999 2004 Examples
1 Board retainer, Committee 6 38 Exxon Mobil, JPMorgan
retainer, Committee Chair Chase, Safeway, DuPont,
retainer Clear Channel, Xerox,
Cardinal Health, General
Mills
2 Board retainer, Committee 1 4 GE, Capital One, Publix
retainer
3 Board retainer, Committee 25 48 Wal-Mart, IBM, Ford,
Chair retainer Citigroup, Microsoft,
Boeing, Merrill Lynch,
Allstate, PepsiCo, 3M
4 Board retainer 34 5 Dell, Time Warner, Archer
Daniels Midland, Aon
TOTAL Retainers only 66 95
Increases in retainer-only 44%
companies
Total retainer-only companies as 28% 40%
% of total
EXHIBIT 3 Examples of retainer-only pay models
Retainer
Committee Member
Company Equity Board Audit Comp. Other
Board / Committee / Chair Retainers
Exxon Mobil 198,889 75,000 15,000 15,000 8,000
JPMorgan Chase 170,000 75,000 10,000 0 0
Safeway 75,000 62,500 7,500 5,000 5,000
Dupont 80,002 50,000 9,000 9,000 9,000
Clear Channel Communications 122,512 50,000 7,500 3,000 3,000
Xerox 73,750 65,000 5,000 0 0
Cardinal Health 129,943 40,000 2,000 0 0
General Mills 145,936 50,000 5,000 0 0
Board / Committee Retainers
General Electric 165,000 5,000 10,000 10,000 5,000
Capital One 53,335 60,000 20,000 10,000 10,000
Publix Super Markets n/a 40,000 10,000 0 0
Board / Committee Chair Retainers
Wal-Mart Stores 106,477 60,000 0 0 0
IBM 218,486 40,000 0 0 0
Ford Motor 120,000 80,000 0 0 0
Citigroup 150,000 75,000 0 0 0
Microsoft 104,358 50,000 0 0 0
Boeing 130,000 60,000 0 0 0
Merrill Lynch 185,000 75,000 0 0 0
Allstate 151,175 40,000 0 0 0
PepsiCo 68,453 100,000 0 0 0
3M 94,500 55,500 0 0 0
Board Retainer Only
Dell 199,904 60,000 0 0 0
Time Warner 153,995 100,000 0 0 0
Archer Daniels Midland 100,000 100,000 0 0 0
Aon 50,000 30,000 0 0 0
Retainer
Committee Chair
Company Audit Comp. Other
Board / Committee / Chair Retainers
Exxon Mobil 10,000 10,000 7,000 Audit/Comp higher
JPMorgan Chase 15,000 15,000 15,000 Only Audit member,
all chairs equal
Safeway 5,000 2,500 2,500 Audit higher
Dupont 16,000 9,000 9,000 All members equal,
Audit chair
higher
Clear Channel Communications 12,500 7,000 7,000 Audit higher
Xerox 10,000 10,000 8,750 Only Audit member;
Audit/Comp
chairs higher
Cardinal Health 13,000 8,000 8,000 Only Audit member;
Audit chair
higher
General Mills 5,000 0 0 Only Audit member/
chair
Board / Committee Retainers
General Electric 0 0 0 Audit/Comp higher
Capital One 0 0 0 Audit higher
Publix Super Markets 0 0 0 Only Audit
Board / Committee Chair Retainers
Wal-Mart Stores 15,000 10,000 10,000 Audit higher
IBM 2,000 2,000 2,000 All equal
Ford Motor 5,000 5,000 5,000 All equal
Citigroup 35,000 15,000 15,000 Audit higher
Microsoft 10,000 10,000 10,000 All equal
Boeing 10,000 5,000 5,000 Audit higher
Merrill Lynch 25,000 25,000 15,000 Audit/Comp higher
Allstate 10,000 10,000 10,000 All equal
PepsiCo 10,000 10,000 10,000 All equal
3M 7,000 7,000 7,000 All equal
Board Retainer Only
Dell 0 0 0
Time Warner 0 0 0
Archer Daniels Midland 0 0 0
Aon 0 0 0
|
|
||||||||||||||||||||
Printer friendly
Cite/link
Email
Feedback
Reader Opinion