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The propriety of retirement plans.

The Propriety Of Retirement Plans

A growing number of public corporations are offering retirement plans to their outside directors. In its 1990 Report on Director Compensation, the Conference Board notes that 27% of 805 companies surveyed provide such benefits, in contrast to only 4% in 1981.

On the face of it, providing a post-retirement cushion seems a rather small cost in exchange for the value a director provides as an active member of the board. But such cushions are receiving some scrutiny, with questions being raised about their propriety.

Recently, in Tate & Lyle PLC vs. Staley Continental Inc., a Delaware court was asked to prevent the funding of a Rabbi trust intended to protect the directors' plan benefits in the event of a change of control. The court, in issuing a preliminary injunction, commented that the use of a trust to fund the "largesse" to the outside directors seemed to serve no valid business purpose. Directors have no right to expect to continue to be paid after their term of office expires, said the court.

Why are companies adopting director retirement plans? The reasons are not always clear. Motives include having a device for removal of superannuated directors, providing tax-effective deferred compensation for directors, or ensuring that directors will continue to be available for consultation after retirement.

A more common reason is a desire to keep up with the Joneses - i.e., using director retirement plans "because everyone else does, and we must attract and keep good directors." In these instances, companies are stumbling into the pitfall of letting competitive practice dictate compensation policy.

Invaluable asset

Few would argue that directors do not deserve appropriate compensation. In fact, historically, many directors have been underpaid for the value that they bring to boards. The depth of experience they make available to management, their knowledgeable questioning and guidance of management's business and organizational strategy, their fiduciary accountability to shareholders, and their independent assessment of business prudence demand appropriate compensation. Qualified, active boards of directors are an invaluable asset to a company, and anything less than topnotch talent increases a company's, and shareholders', risk.

However, the compensation paid should reflect the value delivered for the services rendered. And compensation should be directly related to those services - both in terms of the amount paid and the timing of when the payment is earned. Any other system has the potential for creating a conflict of interest.

By definition, a director must be independent and objective in judgment and action. His or her actions must be free of personal considerations during difficult times, in a takeover situation, or while setting strategic, financial, and organizational direction. The director must actively pursue the best interest of the company and its shareholders - and no one else's.

But the existence of a director retirement plan can undermine the board's inherent responsibility to scrutinize regularly the actual contribution being made by each director and to cause the resignation or removal of ineffective members.

The prospect of a financial loss to the colleague director can be a psychological inhibitor to the directors who must take or recommend action, particularly if there is a service requirement to qualify for benefits. Similarly, the prospective financial impact of leaving can impair a director's objectivity in wanting to resign from the board, for whatever business or personal reason.

To preclude the opportunity for any conflict of interest, directors' pay must be at arm's length and based on the notion of a day's pay for a day worked. There should be no strings attached. Fully vested, voluntarily deferred pay meets that test, as do stock programs that are based on current service, but most retirement plans do not.

While plan designs vary, a typical director retirement program usually requires some minimum length of service, generally five years, and pays benefits in the amount of the annual retainer (for the most recent year) for life, or for the number of years equal to the years of service on the board.

The net effect, in most cases, is the double - at the very least - the amount received by the director for each year of service on the board. Such plans hold the potential for shareholder criticism since the directors have already been compensated for their terms of service. Retirement plans that add on to pay obscure the real costs involved and can mislead shareholders.

There are steps companies can take to effectively compensate directors. Rather than adopt retirement plans, companies should consider systems that allow directors to accumulate what they have earned and receive it following service.

This type of benefit is different from one that is built on having to stay around to get it. Directors have the opportunity to establish tax-advantage Keogh retirement plans in their own behalf to help provide for retirement financial needs. For those few directors who will provide consulting services after retirement, payments can be arranged to cover the service at the time it is performed.

Companies should establish director pay levels, and then decide whether or not to provide voluntary deferral opportunities. In that way, the director would assume personal responsibility for his or her own retirement planning and future income needs while being free of potential conflicts of interest. Most important, shareholders would know exactly what they are paying for director services. Pay would be all on the table and consistent with appropriate rewards for services rendered.

Table : Retirement Plans for Outside Directors
 No. of
Industry Companies
Category With a Plan(*) Percentage(+)
Manufacturing 103 30%
Financial 46 22%

Nonfinancial service 70 28% (*)Based on a survey of 805 companies (+)Percentage of companies in that category Source: The Conference Board

James A. Kuhns is a Principal in the San Francisco office of Sibson & Co., a human resources management consulting firm. He has had over 30 years of consulting and management experience, with a specialization in compensation and benefits planning.
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Copyright 1991 Gale, Cengage Learning. All rights reserved.

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Title Annotation:Director Data
Author:Kuhns, James A.
Publication:Directors & Boards
Date:Jun 22, 1991
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