March 2004 - Viewpoint  

A Balanced Approach: What the NACD Overlooked

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

In its recently issued report, the National Association of Corporate Directors’ (NACD) Blue Ribbon Commission on Executive Compensation and the Role of the Compensation Committee suggests that any consultant retained by a board compensation committee and reporting directly to it “should not be retained by the company in any other capacity.” The report further states that, “to avoid ‘dueling consultants,’ any consultant hired by management should not be engaged in assignments involving CEO or senior executive pay.”

It is hard to disagree with the proposition that a critical corporate governance issue is how best to assure the independence of board compensation committees from compensation consultants hired by management. Put another way, how independent can a compensation committee be if it is relying exclusively on compensation consultants hired by management?

However, the NACD Blue Ribbon Commission appears to have suggested that board compensation committees should hire and control all consultants regarding senior executive pay. This new suggestion could be read to require compensation committees to actively manage consultants engaged in the process of gathering data and analyzing and advising on the design of senior executive compensation.

If this is the case, I believe the Commission’s suggestion overshoots the mark. It should not be the job of the independent directors who comprise the compensation committee to have “hands-on” involvement with the design and implementation of executive compensation programs.

“[T]he principal responsibility of a corporate director is to … [bring] experience and judgment into the boardroom … which means to become informed, to participate, to ask questions and to apply considered business judgment to matters considered by the board.”

— American Bar Association Section of Business Law, Committee on Corporate Laws, Corporate Director’s Guidebook (Third Edition, 2001).

The principal responsibility of the compensation committee directors is to:

n      Maintain vigilant oversight on management

n      Determine the CEO’s pay after considering the company’s performance against goals and objectives set by the board

n      Determine other senior executives’ pay after considering the CEO’s recommendations.

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 the initial, “hands-on” responsibility for designing and implementing executive compensation programs to have the tools they need to achieve the board’s strategic goals and objectives. (In recognition of the need for senior management input in the design and implementation of executive compensation programs, the NACD report states that the consultant retained by a board compensation committee “should have full access to management, their compensation consultants, in-house counsel and human resources staff.”) The CEO and senior management should be free to obtain expert advice from compensation consulting firms to assist them in this endeavor, and the board compensation committee should be free to consider that same expert advice, if it so chooses.

That is why last year The Conference Board Commission on Public Trust and Private Enterprise did not go as far with its recommendations as the NACD Blue Ribbon Commission now does. The Conference Board Commission said:

“The compensation committee should retain any outside consultants who advise it, and the outside consultants should report solely to the committee.”

— Findings and Recommendations of The Conference Board Commission on Public Trust and Private Enterprise, Part 1: Executive Compensation, Sept. 17, 2002.

But The Conference Board Commission did not recommend that such consultants be prohibited from working with management on senior executive pay assignments or otherwise.

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, obtain the consultants’ reaction to alternative approaches, and assure themselves that the consultants’ evaluations will include the views of the committee regardless whether such views are contrary to those of the CEO.

Certainly there may be situations in which the committee is uncomfortable relying exclusively on compensation consultants who also work with management.

“Accounting firms weren’t alone in the fever for cross-selling … Look at human-resources consulting and the same pattern emerges. Former pension advisers also provide benefits, compensation and other consulting services. A few … provide outsourcing for human resources administration. Others … have sister companies that sell an array of investment services.”

— The Wall Street Journal, Manager’s Journal, “Cross-Selling Will Outlast The Big Business Scandals” by Ford Harding (Collin Levey, Editor), Aug. 13, 2002.

In such situations, the committee should obtain additional expertise and assistance (and protection) from its own independent compensation adviser, who does not work for management in any capacity, to supplement the company’s regular compensation consulting firm. An apt analogy would be seeking a second opinion before proceeding with significant medical treatment.

The NACD Blue Ribbon Commission was right to want to avoid inciting a duel between two consultants on senior executive pay assignments. However, suggesting that consultants retained by a board compensation committee should be prohibited from working with management altogether, or that consultants hired by management should be prohibited from advising the committee on senior executive pay, is too draconian.

There are resources that are dedicated to providing completely independent advice and assistance to compensation committees with regard to executive compensation governance. To assure independence, these independent advisers report solely to the compensation committee and do not take assignments from management.

Compensation committees that have availed themselves of such resources have found that, by carefully delineating the role of their independent adviser so as to supplement — rather than supplant — the company’s consultant, the compensation committee can achieve an appropriate balance between its vigilant oversight role and the responsibility of the CEO and the senior management team to design and implement executive compensation programs that help the company to achieve the board’s strategic goals and objectives.

About the Author

Yale D. Tauber is the 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.

Originally published in workspan, March 2004.  WorldatWork, 14040 N. Northsight Blvd., Scottsdale, AZ 85260; phone (877) 951-9191; fax (480) 483-8352; www.worldatwork.org.  ©2004.