Gaining Independence

By Yale D. Tauber, Independent Compensation Committee Adviser, LLC

 

The critical issue regarding the application of good corporate governance to executive compensation processes is how best to assure the independence of the compensation committee from management and from compensation consultants hired by management.

 

Several commentators have questioned - I think correctly - how independent compensation committees with no management director members really are, and whether they have the necessary information to make decisions in the shareholders’ best interests, if they rely exclusively on compensation consultants hired by management. 

 

Some have gone so far as to suggest that the compensation committee should hire and control all executive compensation consultants and even actively manage these consultants in the process of gathering data and analyzing executive compensation. 

 

While it is hard to disagree with the proposition that, in addition to being more proactive in the executive compensation process, compensation committee chairs and members should have the knowledge and information necessary to fulfill their role diligently, I believe that these suggestions overshoot the mark.. 

 

The compensation committee’s job is to maintain vigilant oversight on management and to determine the CEO’s pay after considering the company’s performance against goals and objectives set by the board. Despite the pressure of heightened public scrutiny and legal exposure, compensation committee members should not feel compelled to micromanage and meddle.

 

The CEO, as the highest-ranking member of the management team, is accountable to the board and its compensation committee for the company’s management and performance. It logically follows that the CEO and the senior management team — not the compensation committee — should retain responsibility for designing executive compensation programs in order to have the tools they need to achieve the board’s strategic goals and objectives.

 

What every company needs is a strategy for the vigorous and constructive engagement of its compensation committee that is neither too passive nor too intrusive. There must be an appropriate balance between the powers of the compensation committee and those of the CEO. The ability of the committee members to discuss, debate, and act objectively and on an informed basis on issues they deem important should not be compromised. But, neither should the “hands on” involvement of the CEO and the senior management team with the company’s executive compensation programs.

 

The CEO and the senior management team typically obtain expert advice from compensation consulting firms to assist them in designing and implementing executive compensation programs. In fulfilling its vigilant oversight role, the compensation committee should often seek its own expert advice to supplement the company’s regular compensation consulting firm.  An apt analogy would be seeking a second opinion before proceeding with significant medical treatment.

 

In every situation the compensation committee should have direct contact with the company’s consultants. Committee members should be able to ask probing questions, address issues and concerns about the consultants’ data and recommendations or obtain the consultants’ reaction to alternative approaches.

 

Hopefully, such direct contact will enable committee members to get straight answers from the company’s consultants, regardless whether such answers are contrary to the CEO’s wishes.  And, such contact should enable the consultants’ evaluations to include the views of the committee. 

 

However, when the committee does not feel comfortable that such contact will provide sufficient basis for it to render its independent and informed judgment, it should obtain additional expertise and assistance (and protection) from its own independent compensation adviser.

 

Care must be taken in such event not to incite a duel between two consultants, either as to data or matters of judgment. The compensation committee must control the process and should carefully delineate the role of its independent adviser so as to supplement — rather than supplant — the company’s consultant.

 

Today, companies are judged by the independent decision-making of their board and key board committees as much as their bottom line. The compensation committee must do all it can to identify key executive compensation issues, to ensure adequate controls are in place, and to maintain vigilant oversight on management.

 

The bar has been raised for executive compensation governance. Infrequent and largely ceremonial meetings at which compensation committee members are the audience for massive doses of well-rehearsed presentations before being asked to rubber-stamp management’s proposals will not satisfy the committee’s vigilant oversight role.

 

About the Author

Yale D. Tauber is a principal with Independent Compensation Committee Adviser LLC and has been a WorldatWork member since 1996. He can be reached at yale@independentcca.com or 203/966-5271.