Executive and Director Compensation Reference Guide
Compensating Qualified
Independent Directors
Yale D. Tauber
Independent
Compensation Committee Adviser, LLC
New Canaan, Connecticut
Peter J.
Oppermann
Mercer Human Resource
Consulting
New York, New York
Directors' compensation programs at
publicly traded companies have changed dramatically over the years as the role
of qualified independent directors has evolved against a dynamic backdrop of
legislative, regulatory, and political developments. Inflation and the
passage of time have, of course, played a role in increasing the typical amount
of directors' compensation. However, specific developments in corporate
history have had a more profound impact on both the size and design of
directors' compensation programs. Recent events have quickened the pace of
change, leaving the future somewhat uncertain.
Historical Perspective
At one time early in corporate history the concept of independent
directors was virtually unknown. Most
directors were “cronies” of the chief executive officer of one sort or another
who were compensated for their time in attending meetings. In fact, the only compensation for directors
typically consisted of placing a $50 gold piece at each director's spot around
the meeting table. With inflation,
these meeting attendance fees became more substantial and were paid by check. Committee meeting fees were also paid to
directors when they came to a meeting.
Eventually, legislative and regulatory developments, such as
Securities and Exchange Commission Rule 16(b)(3)1
and, later, Internal Revenue Code §162(m),2
compelled publicly traded companies to let independent directors make most
decisions regarding the payment of compensation to executive officers. This
began a competition of increasingly global reach that continues today for
qualified individuals to serve on boards of corporate enterprises.
As a consequence of this competition, directors' compensation
increased noticeably. As board work done outside meetings became more
prevalent, board retainers were added to compensate for any time commitment not
covered by meeting attendance fees.
Equity was added when shareholders began to demand that directors
have some tie to their interests. Stock option grants became the most popular
equity vehicle for directors, but whole share awards were sometimes substituted
for some portion of cash retainers, either mandatorily or by each director's
voluntary choice. As competition for qualified independent directors continued,
various directors' benefits, including retirement plans, were added to the mix.
Several subsequent events conspired to intensify the demand and
competition for qualified individuals who could serve as independent directors
and accelerate the evolution of directors' compensation.
In 1995, a Blue Ribbon Commission on Director Compensation
established by the National Association of Corporate Directors (NACD) issued a
report, which was revised in 2000, that contained guidelines for directors'
compensation. That report encouraged publicly traded companies to compensate
directors both adequately and forthrightly for their time and efforts
exclusively with payments of cash, equity, or a combination of both.3 Since that time, most corporations have
discontinued directors' benefits in the belief that compensation in that form
does not align directors' compensation with shareholders' long-term interests.
Often, directors' benefits, especially retirement benefits, were replaced with
equity compensation.
In 1996, the SEC amended Rule 16b-3 to impose additional
independence requirements on directors who may qualify to administer a
discretionary equity plan for officers and directors. At the same time, it
removed certain restrictions that had caused most publicly traded companies
that wanted to award equity to directors to do so under a formula plan approved
by shareholders.4
With these changes, the SEC narrowed the pool of talent qualified
to serve on an independent compensation committee by excluding such people as
consultants, partners at the corporation's outside counsel law firm, and
principals of the corporation's investment banker. However, the SEC also
allowed directors broad discretion to determine the terms of directors equity
awards that could be employed to help attract and reward qualified independent
directors. Still, few boards reacted initially to grant themselves more equity
compensation.
Meanwhile, a sharp rise in the stock market, led by Internet and
biotech companies, extended from the mid-90s into the first year of the new
millennium. Compensation for senior executives continued to rise, in no small
measure as a result of the increased value of their stock options. As a result
of efforts by many corporations to attract senior corporate executives at other
companies (as well as retired executives) to accept directorships, directors
began to accept greater and greater portions of their compensation in stock
options. Equity compensation grew to
become the dominant component of the typical directors' compensation program.
As shown below, the typical directors' compensation mix has
shifted dramatically over the past five years:
Obviously, the value of the typical
directors' compensation program has risen or fallen with the market, as has the
value of the typical directors' stake in the enterprise they help govern.
2002
Data
Analysis of 2002 proxy disclosures (relating to 2001 fiscal
years) of major companies reveals other interesting trends in directors'
compensation besides a continuation of the emphasis on director stock grants.
For example, despite the emphasis on board and committee performance and
accountability, annual retainers (which constitute pay for board or committee
membership) continue to be nearly universal. Of the companies making up the
Mercer Wall Street Journal 3505 in 2002, 334
companies (95.4 percent) paid directors an annual retainer, with median and
75th and 25th percentile total retainers (including the value of cash and
shares designated as a portion of the annual retainer) of $35,000, $50,000 and
$28,000, respectively.
Of the 350 companies in the database, 319 (91.1 percent) paid
directors an annual cash retainer, with a median of $30,000 per annum, and 117
(33.4 percent) paid directors an annual stock retainer, with a median of
$25,000 per annum. Stock retainers are generally made in one of three ways:
restricted stock vesting over a single term (typically three years);
unrestricted stock with the cash portion of the retainer used to pay taxes due
upon receipt, essentially making the entire retainer equity compensation; or
deferred stock with payout deferred until retirement from the board.
Stock retainers are most often stated as a dollar amount, with
the number of shares depending on the stock price at the time the retainer is
paid. While such an arrangement causes the number of shares to vary inversely
(some would say perversely) to changes in the stock price, it is usually
intended to protect directors from market volatility. At 102 of these
companies, the stock retainer was paid in addition to a cash retainer. That
left 15 companies (4.3 percent) paying the entire annual retainer in the form
of shares.
Board meeting fees were paid at 252 companies (72 percent), with
a median of $1,500 per meeting. None of
these companies paid a portion of their board meeting fees in stock. Paying
meeting fees typically has a twofold purpose: to induce directors' attendance
at meetings and to differentiate pay for those who attend meetings more
regularly than others.
Directors were paid a fee for attending meetings by telephone by
34 companies in the database (9.7 percent). Fees range from 13 percent to 100
percent of the fee received for attending meetings in person; the most common
fee is 50 percent of the normal meeting fee.
Committee meeting fees were paid at 246 companies (70.3 percent),
with a median of $1,000 per meeting. 33
companies (9.4 percent) paid the committee chairs a committee meeting fee, with
a median of $2,000 per meeting; representing a premium of $1,000 above the
committee meeting fee received by other directors. Committee meeting fees are
usually intended to differentiate pay among directors by the amount of time and
responsibility they shoulder. Committee work, and particularly committee
chairs, involve not only more time but often greater fiduciary responsibility,
thus requiring larger compensation packages to help recruit directors to
participate.
Retainers for service on a committee were paid at 36 companies
(10.3 percent), with a median of $4,500 per annum. Two of the companies paid a
portion of the committee service retainer in stock. 196 companies (56 percent) paid the committee chairs a retainer
for service, with a median of $5,000 per annum. Fifteen of the companies paid a
portion of such retainer in stock, with a median value of $5,000.
Accordingly, 2002 proxy data on independent directors' total
annual compensation6 among the Mercer Wall Street
Journal 350 may be summarized as follows:
Total Annual Compensation1
|
|
Annual Retainer2
|
Board Meeting Fee
|
Committee Meeting Fee
|
Total Annual
Compensation
|
|
75th Percentile
|
$50,000
|
$1,500
|
$1,500
|
$71,000
|
|
Median
|
35,000
|
1,500
|
1,000
|
56,000
|
|
25th Percentile
|
28,000
|
1,000
|
1,000
|
46,475
|
|
Valid Cases
|
334
|
252
|
246
|
344
|
|
1 Each element of directors' compensation is
calculated independently. Therefore, by adding components such as median
total annual compensation plus median long-term incentive compensation, you
will arrive at a completely different figure than median total direct
compensation.
|
|
|
2 Consists of annual retainer paid in the form of
cash or shares.
|
|
|
|
|
|
|
|
While corporations review directors'
compensation programs frequently, changes to the total annual compensation
elements are typically made less frequently, e.g., once every third or fourth
year. When increases in annual
retainers or meeting fees are made, they tend to be significant; increases of
20 percent or more are common. On the other hand, the equity portion of
directors' compensation has in the recent past tended to increase annually,
mostly due to increases in stock price. Thus, as shown above, long-term
incentives continue to be the largest piece of the directors' pay mix in 2001.
Stock options continue to be the
dominant long-term incentive vehicle for directors, but most companies balance
stock option grants with some kind of full value share awards.
Among the 232 companies that disclosed
annual stock option grant amounts, the median number of shares granted was
4,000 shares, or about .002 percent of common shares outstanding. Among the 45
companies that disclosed annual unrestricted stock grant amounts, the median
number of shares granted annually was 797 shares. Among the 44 companies that
disclosed annual restricted stock grant amounts, the median number of shares
granted annually was 694 shares. Among the 30 companies that disclosed annual
deferred stock grant amounts, the median number of shares granted annually was
798 shares.
A number of companies that make annual
equity grants to directors also make an initial or one-time equity grant to new
directors upon their election to the board or when a new equity-based plan is
adopted. The typical amounts of such grants are as follows:
|
Initial Equity Grants to Directors
|
|
|
Stock Type
|
Percent of Companies Making Initial Grants
|
Number of Shares Granted
|
Initial Shares Granted As A Multiple of Annual Shares
Granted
|
|
|
|
Typical Range
|
Median
|
|
|
Stock
Options
|
32%
|
5,000 – 15,000
|
10,000
|
2.0
|
|
Restricted
Stock
|
36
|
1,425 – 2,325
|
2,000
|
1.8
|
|
Deferred
Stock
|
23
|
1,000 – 3,850
|
2,000
|
1.0
|
|
Unrestricted
Stock
|
13
|
1,000 – 1,425
|
1,100
|
1.0
|
|
|
|
|
|
|
Of the 350 companies in the database,
178 (51 percent) disclosed that directors may voluntarily elect or are required
to convert all or a portion of cash-based compensation into stock-based
compensation. Depending on whether there is a voluntary election or a mandatory
requirement, the form of such “stock replacement” grant may vary between
unrestricted stock, restricted stock, deferred stock, and stock options.
Unrestricted stock is the most common form of stock replacement grant.
Stock Replacement Grants
|
|
Percent of
Database
|
|
Form of Stock
Replacement Grants
|
All Companies
(178)
|
|
Unrestricted Stock (UNRS) Only
|
39.3%
|
|
Stock Options (SOP) Only
|
14.6
|
|
Deferred Stock (DS) Only
|
13.5
|
|
Restricted Stock (RS) Only
|
10.1
|
|
UNRS + SOP
|
9.6
|
|
RS + SOPS
|
3.9
|
|
UNRS & RS
|
3.4
|
|
UNRS & DS
|
2.2
|
|
DS & SOPS
|
1.1
|
|
DS + SOPS + UNRS
|
1.1
|
|
Other
|
1.1
|
A number of companies grant directors a
“conversion premium” incentive to encourage stock replacement or to compensate
for a possible risk of forfeiture. For those companies disclosing premium
incentives, the premium ranges from 10 percent to 67 percent, with a median of
25 percent. A number of companies also offer directors the opportunity to elect
to receive discount stock options (i.e., granted at 75 percent of grant date
fair market value per share) in lieu of annual retainers or meeting fees.
Adding the grant values of annual
equity grants reported in 2002 proxy statements, plus the annualized value of
initial or one-time equity grants assuming six years of board service
(corresponding to two typical terms of three years each), to the total annual
compensation described above, total direct compensation among the Mercer Wall
Street Journal 350 may be summarized as follows:
|
Total Direct Compensation1
|
|
|
Total Annual Compensation2
|
Long-Term Incentive Compensation3
|
Total Direct Compensation4
|
|
75th Percentile
|
$71,000
|
$114,602
|
$164,796
|
|
Median
|
56,000
|
61,568
|
115,687
|
|
25th Percentile
|
46,475
|
35,974
|
85,370
|
|
Valid Cases
|
344
|
298
|
350
|
|
1Each element of directors' compensation is
calculated independently. Therefore, by adding components such as median
total annual compensation plus median long-term incentive compensation, you
will arrive at a completely different figure than median total direct
compensation.
|
|
|
2Total Annual Compensation is defined as the sum of
annual retainers paid in cash or shares, meeting fees and annual service fees
paid for board and committee service. To facilitate meaningful comparison
across companies, the following assumptions were employed: each director
attends 8 board meetings; is a member of 2 committees; attends 8 committee
meetings (4 of each committee); and is a Chair of 1 of these committees.
|
|
|
3Long-term incentive compensation is defined as the
sum of the value of annual long-term incentive grants in the form of
restricted stock, unrestricted stock, deferred stock and stock options
(valued using a binomial option–pricing model) plus the annualized value of
initial and/or one-time grants of long-term incentives assuming six years of
board service.
|
|
|
4Total Direct Compensation is defined as the sum of
Total Annual Compensation plus long-term incentive compensation (using the
assumptions employed in footnotes 2 and 3).
|
|
|
|
|
|
|
Total direct compensation levels for
independent directors vary within individual revenue categories. The summary
statistics below indicate that a director of a corporation with revenue that
exceeds $10 billion receives median total direct compensation of 14 percent more
than a director of a $5 to $9.99 billion corporation, 49 percent more than a
director of a $2 to $4.99 billion corporation and 68 percent more than a
director of a $1 to $1.99 billion corporation.
|
Directors' Compensation by Industry1
|
|
|
Industry
|
Number
of Companies
|
Revenue
(000,000)
|
Total
Annual Retainer2
|
Total
Annual Compensation3
|
Total Direct Compensation4
|
|
Chemicals
|
20
|
$4,435
|
$40,000
|
$59,700
|
$107,216
|
|
Commercial Banking
|
26
|
6,367
|
40,000
|
59,500
|
107,698
|
|
Computer/Data Services
|
10
|
6,734
|
35,000
|
56,000
|
238,494
|
|
Computers/Office Equipment
|
12
|
6,554
|
35,000
|
60,000
|
225,724
|
|
Diversified Financials
|
11
|
22,392
|
35,000
|
66,000
|
175,373
|
|
Electronics/Electrical Equipment
|
24
|
4,266
|
30,000
|
54,800
|
175,445
|
|
Food/Beverages
|
23
|
8,443
|
40,000
|
62,500
|
113,878
|
|
Forest/Paper Products
|
9
|
4,172
|
40,000
|
55,000
|
97,851
|
|
Health Care/Pharmaceuticals
|
14
|
12,945
|
45,000
|
70,300
|
180,163
|
|
Industrial/Farm Equipment
|
20
|
4,132
|
30,000
|
50,500
|
95,984
|
|
Insurance
|
16
|
8,349
|
32,500
|
51,600
|
128,328
|
|
Metal Products
|
10
|
4,682
|
35,000
|
59,800
|
96,655
|
|
Publishing/Printing
|
9
|
3,016
|
45,000
|
65,000
|
115,374
|
|
Retailers
|
13
|
11,154
|
25,000
|
42,000
|
94,145
|
|
Scientific/Photographic Equipment
|
9
|
3,754
|
34,500
|
48,700
|
124,943
|
|
Telecommunications
|
9
|
24,130
|
50,000
|
74,000
|
183,197
|
|
Transportation
|
14
|
7,140
|
26,750
|
52,685
|
96,883
|
|
Utilities
|
17
|
9,621
|
33,000
|
55,000
|
99,561
|
|
Full Sample
|
350
|
6,199
|
35,000
|
56,000
|
115,687
|
|
1 All figures are medians.
|
|
|
2 Consists of annual retainer paid in the form of cash
or shares.
|
|
|
3 Total annual compensation is defined as the sum of
annual retainers paid in cash or shares, meeting fees and annual service fees
paid for board and committee service. To facilitate meaningful comparison
across companies, the following assumptions were employed: each director
attends 8 board meetings; is a member of 2 committees; attends 8 committee
meetings (4 of each committee); and is a Chair of 1 of these committees.
|
|
|
4Total Direct Compensation is defined as the sum of
Total Annual Compensation plus long-term incentive compensation (using the
assumptions employed in footnotes 2 and 3).
|
|
|
|
|
|
|
|
|
Total direct compensation levels for
independent directors also vary within industry groups. The summary statistics
below indicate that directors in computer/data services and computers/office
equipment companies received the largest median total direct compensation
($238,494 and $225,724, respectively, primarily due to large stock option
grants) followed by telecommunications ($183,197) and health
care/pharmaceuticals ($180,163). The least median total direct compensation was
paid to directors in retailers ($94,145), industrial/farm equipment ($95,984),
and metal products ($96,655).
Not surprisingly, the percentage of
independent directors' total direct compensation that is provided through
equity compensation varies by industry. Those industries that typically
compensate their executives most heavily in equity follow a similar path when
it comes to directors.
Equity as a Percentage of Total Direct Compensation1
|
Industry
|
Number of
Companies
|
Equity Grant Value
as % of TDC
|
|
Chemicals
|
20
|
56.5%
|
|
Commercial Banking
|
26
|
54.8
|
|
Computer/Data Services
|
10
|
71.4
|
|
Computers/Office Equipment
|
12
|
81.4
|
|
Diversified Financials
|
11
|
66.3
|
|
Electronics/Electrical Equipment
|
24
|
75.7
|
|
Food/Beverages
|
23
|
57.0
|
|
Forest/Paper Products
|
9
|
41.4
|
|
Health Care/Pharmaceuticals
|
14
|
65.0
|
|
Industrial/Farm Equipment
|
20
|
52.3
|
|
Insurance
|
16
|
69.9
|
|
Metal Products
|
10
|
50.5
|
|
Publishing/Printing
|
9
|
61.1
|
|
Retailers
|
13
|
63.2
|
|
Scientific/Photographic Equipment
|
9
|
72.1
|
|
Telecommunications
|
9
|
71.5
|
|
Transportation
|
14
|
53.0
|
|
Utilities
|
17
|
49.0
|
|
Full Sample
|
350
|
59.0
|
|
1 All percentages are medians.
|
|
|
|
|
|
While no SEC requirement exists for
disclosure of ownership guidelines in the annual proxy statement, 70 companies
(20 percent) in the database disclosed such guidelines. Director guidelines are
typically expressed as a multiple of annual retainer, ranging from three to
five times annual retainer with five times as the most common, or as a defined
number of shares. Directors are often given a specific time frame to comply
with the requirement; the majority of companies allow five years to meet the
guidelines.
Benefits for independent directors
continue to decrease in frequency and are now offered by 79 percent of the 350
companies in the database. Elective deferred compensation arrangements are by
far the most popular directors' benefit, offered by 73 percent of the companies
in the database. Excluding deferred compensation arrangements, benefits
prevalence would decrease to 27 percent of the companies in the database.
Pensions for
independent directors have declined to
only 5 percent of the database. To make
up for the loss of this benefit, the majority of corporations eliminating
retirement plans for independent directors continue to adopt a new director
equity compensation plan or increase grants under existing plans.
Prevalence of Benefits Disclosed
|
Benefits for Directors
|
79%
|
|
Deferred Compensation
|
73
|
|
Retirement Arrangement
|
5
|
|
Change in Control Protection
|
21
|
|
Charitable Award Plan
|
11
|
|
Accident Insurance
|
12
|
|
Life Insurance
|
9
|
|
Medical Coverage
|
3
|
Out of 350 companies in the database,
81 (23.1 percent) had a chairman who does not also have CEO responsibilities.
Thirty-two of the non-CEO chairmen are nonemployees. Of these 32 individuals,
63 percent were compensated by a special agreement in amounts that range from
$40,000 to $400,000, with a median of $177,500; 41 percent also receive the
typical directors' fees and equity grants received by other directors, while 25
percent disclose that they do not receive such fees.
Seven of the nonemployee non-CEO
chairmen receive special equity grants in the form of stock options or
restricted stock. Special stock grants range from 2,000 shares to 275,000
shares, or a median of 25,000 shares. Three of these seven individuals also
receive the typical directors' equity grants received by other directors, one
did not receive the typical grants, and three did not specify receiving such
grants.
2002
Developments and Sarbanes-Oxley
Recent corporate and accounting scandals have prompted a flurry
of congressional and regulatory activities aimed at, among other things,
reforming the way corporate executives and boards of directors conduct
themselves.
The Sarbanes-Oxley Act of 2002 (the Federal Corporate
Accountability Act7) contains numerous
provisions expanding the responsibilities and liabilities of directors. While
most
of those changes affect the audit committee8 and the corporation's financial reports
and disclosures, the New York Stock Exchange (NYSE), the Nasdaq Stock Market
(Nasdaq), and the American Stock Exchange (AMEX) have each proposed new
governance rules that would become effective upon SEC approval and would, if
approved, profoundly alter board of directors' membership, responsibilities and
compensation.9
The proposed stock exchange listing standards would, among other
things, tighten the definition of an “independent director” (thus adding to the
proliferation of independence definitions already in effect)10 and require companies to have a
majority of independent directors on their boards, establish compensation,
nominating/corporate governance, and audit committees with specific
responsibilities11 and composed
entirely of independent directors, and adopt and adhere to corporate governance
guidelines and codes of ethics.12 Each of these
committees would be required to have written charters that defines its role,
responsibilities, and the expectations of its members (including at a minimum
certain specified purposes, duties, and responsibilities) and that are posted
on the corporation's Web site. In addition, each committee would be required to
evaluate its performance against that charter annually.
The focus on the role of independent directors was sharpened
further by the Conference Board's Commission on Public Trust and Private
Enterprise, a “blue ribbon” panel formed to address widespread abuses which led
to the recent corporate scandals and declining public trust in corporations and
their leaders.
In September 2002, the commission issued findings and
recommendations on the role of compensation committees in dealing with
executive compensation as the first in a series of best-practices guidelines to
be issued. In January 2003, the commission issued findings and recommendations
on corporate governance and auditing and accounting.
The
Likely Impact
Meanwhile, just as the Sarbanes-Oxley Act, proposed changes to
stock exchange listing standards, blue ribbon panel recommendations, and other
pressures drive corporations to seek more independent directors and, in the
case of audit committee members, more financially expert directors, the
public's outcry over corporate and accounting scandals have shaken senior
executives and other would-be directors.
Some corporate directorships have morphed from plum jobs to
rotten fruit. The pool of candidates for even the most desirable board
positions is beginning to shrink. Some individuals who serve on more than three
boards are resigning from some boards, as a number of CEOs and senior
executives are being limited by their primary employer to serving on a fixed
number of boards in order to focus on their own corporate governance.
However, it is impossible to speak with certainty about the final
outcome under the law of supply and demand as it applies to directors'
compensation. For example, the corporate and accounting scandals, congressional
and regulatory developments and other pressures might lead corporations to seek
qualified individuals who do not fit traditional profiles and, thus, replenish
the pool of candidates for independent director positions.
The greatest impact of the corporate accounting scandals on
boards of directors will likely be an increase in the time commitment,
performance expectations, and accountability of directors. Committee members will be expected to have
expertise related to the committees on which they serve, especially in the case
of the audit13 and compensation committees. In
some cases, directors may be required to obtain training or education in
particular disciplines in which they have some experience but not full
knowledge. All this will make attraction and retention of qualified independent
directors more challenging and a well designed, market competitive directors'
compensation program more critical, regardless whether the supply of qualified
independent directors ends up being diminished or replenished.
The
Likely Impact: Some Predictions
As the role of independent directors changes, companies are
beginning to rethink once again the current components of directors'
compensation (i.e., retainers, meeting fees and substantial equity
awards). As the way in which a board
conducts its business changes, so shall the way in which directors are
compensated for both board and board committee service.
With the focus on board and committee performance and accountability,
there may be renewed interest in meeting fees. As a result of the recent
corporate scandals, the number and length of board meetings and many committee
meetings, particularly in the case of the audit,14
compensation, and nominating/corporate governance committees, will increase.
Meeting fees may be the simplest way to reflect more directly the time and
contribution of various directors.
However, as meetings become longer, more significant preparation
work is required, and increasing fees for both board and committee meetings may
prove insufficient to fairly compensate the most dedicated independent
directors. The recognition that board and committee membership entails more
than just attendance at meetings may result in an increase in board and
committee retainers, especially for audit and compensation committee chairs.
In addition, telephonic meetings are becoming more popular. This raises a need to define more clearly
the fees for these types of meetings. Those corporations that differentiate pay
between in-person and telephonic attendance at meetings may have to create a
new level of pay if videoconferences begin to replace face-to-face board
meetings.
Currently, the differentiation in retainer and fees for committee
and chair work may not justify the added responsibility for members of the
audit, compensation and nominating/corporate governance committees.
Accordingly, compensation for chairs and members of these vital board
committees may increase substantially, perhaps in the form of substantial
restricted stock grants for committee chairs.
As corporations take a more pointed look at directors'
compensation, they will likely be making a continued effort to provide the
appropriate mix of cash and equity compensation to achieve a suitable balance,
taking into account the company's performance, its industry and any special
challenges for its directors. Corporations that have had a significant portion
of their directors' compensation program in equity are revisiting the balance
of equity and cash and may shift a portion back to cash. On the other hand,
corporations that currently provide an unusually large portion of directors'
compensation in cash are likely to continue to shift to equity.
Director candidates are likely to seek increased use of equity
compensation programs, particularly in smaller and new industry companies. Of
course, in view of all the recent turmoil, boards of directors and compensation
committees may be unwilling to accommodate these demands. Some corporate
observers and the media have raised the concern that too heavy an emphasis on
equity compensation, and particularly stock options, leads to bias towards
short-term results and negative behaviors by directors (and management).
The outcome may depend on several factors, including whether the
director candidate or the corporation has greater leverage. For example, in
times of a possibly sputtering economy, many businesses may need proven
director expertise more than ever. To obtain it, special directors' compensation
may be critically needed. Corporations whose stock is currently depressed may
find this a good time to attract and retain special turn around talent with new
directors' compensation programs based on current stock prices.
In any event, equity grants, including both options and full
value stock awards, exceeding half the total directors' compensation may become
a rarity. Accordingly, there may be reduced emphasis on equity over cash, more
equal balance between cash and equity, and more reliance on full value shares
and less on stock options in directors' compensation.
Balancing stock options with full value shares, as shown above,
is a common practice among the Mercer Wall Street Journal 350.
To remove any perception that long-term performance is being
sacrificed for short-term stock price movement by preventing directors from
capitalizing on short-term corporate performance, rather than value creation
over a longer period of time, it is likely that a long-term focus and
consistent approach to director stock grants will become more widespread. Thus,
while options have dominated in the past, increased use of restricted stock (as
had previously been recommended by the NACD's Blue Ribbon Commission on
Director Compensation) to support stronger alignment of directors' and
shareholders' interests and to increase director share ownership is likely.
Significant restricted stock grants for directors with key responsibilities,
such as committee chairs, are particularly likely.
The vesting schedules of director stock grants will also be
revisited. Vesting of stock option grants will typically be deferred until the
end of a typical three-year term. For the same reason, vesting of full value
stock awards will increasingly be deferred until retirement from the board.
Along these same lines, the prevalence of ownership guidelines
for directors is likely to increase. And, these ownership guidelines are likely
to be set as a multiple of the amount of equity awarded annually, e.g., three
to five times annual equity compensation. This represents a departure from the
typical past practice of setting ownership guidelines as a multiple of
retainers. As director equity compensation grows, it seems appropriate to
measure director stock ownership in relationship to the opportunity they
receive for their board service. As an alternative, some corporations may
require that part of each year's retainers must be used to purchase stock until
the required level of ownership has been obtained. Most companies will allow two three-year terms for directors to
reach the level of required ownership and will count unvested restricted stock
or units as ownership.
Corporations that believe that directors' compensation should not
be influenced by general market volatility may seek to provide a more
consistent level of compensation to their directors under volatile market
conditions. For example, such corporations might change the method for
determining director stock grants, with a shift towards a defined market value
(e.g., Black-Scholes value of options or face value of restricted stock) versus
a set number of shares, reviewing that value every two or three years. On the
other hand, corporations that believe that directors should have a fixed equity
stake in the corporation, and thus “take their licks” with other shareholders
and receive an appropriate reward for an increasing stock price, might prefer
to determine director stock grants by a set number of shares.
The
Likely Impact: Some Early Signs
To gauge the early reaction that these changes are having on
remuneration, Mercer Human Resource Consulting reviewed the proxy statements of
50 companies, whose fiscal years ended either in June or September of 2002.
Of the 50 companies in Mercer's sample, 15 or 30 percent had
increased or were increasing directors' compensation arrangements. Eight
companies (16 percent) revised annual retainers, four (8 percent) revised board
meeting fees, and three companies (6 percent) revised committee meeting fees.
Special audit committee compensation was disclosed by 10
companies (20 percent), with nine (18 percent) disclosing chairperson
retainers, ranging from $5,000 to $140,000 per year with a median of $10,000.
Committee members at five companies (10 percent) received special retainers of
$1,000 to $5,000 or received special meeting fees.
Special compensation committee compensation was disclosed at four
companies (8 percent), with all four disclosing chairman retainers, ranging
from $5,000 to $120,000 per year with a median of $10,500. Committee members at
one of these companies received special meeting fees of $4,000.
None of the companies in the sample changed its method for
determining director option grants, but six companies (6 percent) revised stock
option grants to all directors. While four companies (8 percent) revised
restricted stock or restricted stock unit grants to all directors, only one
company changed its method for determining director restricted share grants
from a set number of shares to a specified face value of the grants. New
director stock ownership guidelines were added by two companies (4 percent).
Only one company disclosed a lead director, paid $60,400 plus
restricted stock or deferred stock valued at $5,000 and 4,500 stock options.
While this is a small sample and many corporations continue to
take a wait-and-see approach, the impact of corporate governance on the time
and effort required by independent directors is evident. Typically, only about
20 percent of the 350 top U.S. companies change any part of their director
compensation plans in any one-year period. Early results indicate that a much larger
number (perhaps more than double the usual number) will change their programs
this go-round.
Conclusion
With 2002 having served as a wake-up call to directors
everywhere, corporate governance is now the focus of every publicly traded
company and its directors. Expect to see a new emphasis on the performance of
the board and its committees (if not also the individual directors). Listing
standards will require each committee to evaluate its performance annually
against its charter, with the results published in the corporation's annual
proxy statement. This should make directors more cognizant both of their own
and of their committees' diligence.
While annual pay for performance may not yet be considered as
appropriate for boards as it is for management, a nascent movement of longer
term pay for performance in the boardroom has already started with a small but
growing group of corporations tying equity award grants to the achievement of
financial or total shareholder return targets. Add in the effects of heightened
awareness of shareholder activist groups, and who knows where the pay for
performance trend may take independent directors' compensation.
Changes in directors' compensation have historically been
evolutionary. If past practice is any predictor of the future, change in
compensation will be slow. However, the
effect that the events of 2002 will have on the pace and depth of changes in
directors' compensation remains to be seen. The shrinking pool of qualified
independent directors
is also influencing the outcome. For many companies who are
working to restructure their boards and committees to conform to anticipated
new independence requirements, this is an urgent issue.
One thing is certain: as independent directors' compensation more
closely reflects the pay-for-performance approach that most corporations have
adopted for management, the value of independent directors' compensation
programs will better reflect the time, effort, performance, and exposure to
liability of directors and the performance of the corporations whose
shareholders they serve.
|
|
Revenue (000)
|
Net Income (000)
|
1 Year TSR
|
|
75th Percentile
|
$14,430,100
|
$635,950
|
23.4%
|
|
Median
|
6,199,115
|
230,470
|
3.6
|
|
25th Percentile
|
2,998,542
|
33,402
|
-13.9
|
15 Proposed NYSE listing rules would
require designation of a lead director to preside over meetings of independent
directors without management present. An independent director typically takes
on the role as the “lead” director, setting up meetings of all nonmanagement
directors, being the key contact with the CEO and possibly having a key role in
overseeing changes in internal controls or ensuring that all corporate
governance procedures are being followed. In addition, the Conference Board
Commission on Public Trust and Private Enterprise has recommended that any
company that does not have the roles of CEO and chairman of the board performed
by separate individuals, with the latter being an independent director under
stock exchange standards (e.g., a company whose founder or major stockholder is
chairman), should name a lead independent director or a presiding director, in
either case with carefully delineated responsibilities. Findings
and Recommendations of The Conference Board Commission on Public Trust and
Private Enterprise, Part 2:Corporate Governance (Jan. 9, 2003), 8,
21-22.
Reproduced with permission from Benefits Practice Center, "Compensating Qualified
Independent Directors", http://benefits.bna.com/.
Copyright 2003 by The Bureau of National Affairs, Inc.
(800-372-1033)
