Human Resources: Sibson''s Survey of Board Pay

The unrelenting spotlight on corporate governance is profoundly affecting the roles and accountabilities of board members. To meet raised expectations, directors can expect to devote more time to their board seats and consequently are likely to serve on fewer boards. In addition, boards are likely to require more stringent qualifications and credentials of their directors. At the same time, the risk profile for directors is increasing. This risk will continue to extend beyond financial risk (which can be hedged with D&O insurance and the new "gap" insurance products) to include personal reputation or credibility risk. Taken together, these factors will make it more difficult to recruit qualified directors from an increasingly scarce talent pool.

In order to understand whether and how companies are changing board pay plans in order to keep pace, Sibson recently conducted a survey of actual and anticipated changes to board compensation at 69 companies.

We found that approximately two-thirds of the survey participants are currently making or planning to make material changes to their director compensation programs. More specifically:

One-half of survey participants plan to modify board compensation for regular board service (i.e., for service on the board irrespective of Committee service).

Exhibit 1 shows the prevalence of the three most common pay modifications for regular board servic, among all survey participants:

Exhibit 1: Most Common Changes to Board Compensation (among all survey respondents)

Among companies modifying board compensation, increases in retainers were more common than increases in per-meeting fees (nearly a 3:1 ratio)

Approximately 23% of all survey participants intend to change the mix of cash and equity. Interestingly, these companies are fairly evenly split in the type of shift-45% will increase the proportion of equity, and 55% will increase the proportion of cash

In regard to committee service, the most common change is to increase pay for service on the audit committee.

Exhibit 2 below shows the proportion of survey participants who are going to change audit and compensation committee pay:

Exhibit 2: Committees Affected by Compensation Changes (among all survey respondents)

Changes to the audit and compensation committee are the most prevalent. Clearly companies are changing pay to reflect the increasing prominence and responsibilities of these two committees.

Of companies making any changes to committee pay, 100% are making changes to audit committee pay, and 69% are making changes to compensation committee pay.

The survey participants are increasing committee pay through various means.

In Exhibit 3 below, we highlight the three most common methods:

Exhibit 3: Most Common Changes to Committee Compensation Prevalence and Dollar Value (among all survey respondents)

Approximately 25% of the participants plan to increase the retainer for the committee chair, split evenly between those introducing a retainer for the first time (median retainer of $10,000) and others planning significant increases (median increase of $5,500).
Regardless of the committee type, participants are roughly split in their approach to increasing committee pay: about 13% favor retainer increases, and about 13% favor per-meeting fee increases

Our Perspective on Director Pay

It is not surprising that many of our survey participants plan to increase pay packages for directors, given the increased requirements, demands and risks associated with the role. However, we believe it is important to recognize that directors join boards for several reasons, and pay is only one of the reasons. Consequently, companies should focus on the total set of rewards-versus-costs, what we call the director value proposition.

As companies improve their governance practices, often they will be simultaneously improving the value proposition to their directors (e.g., formal ethical guidelines and qualification standards reduces the risk to all directors); this achieves a "win-win" between shareholders and directors. In light of this total perspective, we outline below the ways in which companies can improve their overall director value propositions, as well as director pay:

Improve governance practices in ways that will both improve directors´ rewards and potentially reduce the risks of directorship:

Improve the board´s level of expertise

Upgrade standards for board membership to ensure that the board has the right talent and leadership

Provide ongoing training and development

Institute performance standards and conduct formal board evaluations to identify areas for improvement

Develop clear ethical guidelines

Update the corporate ethics guidelines and code of conduct to specifically include outside directors

Develop clear policies regarding interlocks and other affiliations with the company

Avoid doing business with, or making charitable donations to, organizations which have director affiliations

Ensure that directors are completely comfortable affiliating with the company

Improve and formalize governance practices and guidelines to reduce personal risk

Communicate these guidelines to all stakeholders to reduce perceived risks

Maximize the board´s effectiveness:

Disseminate timely and relevant information

Consider implementing a director intranet page to keep directors informed and up-to-date (e.g., meeting agendas and schedules, past decisions, back-up detail)

Continue to compensate directors fairly and competitively. Use pay to acknowledge the time, effort and expertise required of active board membership. For most companies, pay packages will need to be increased for the following reasons:

Higher standards-including formal qualifications-and greater responsibilities will attach to Board memberships

More time will be required of directors; i.e., to prepare for meetings and develop a fuller understanding of the issues facing the company and the industry

Directors will be exposed to greater personal risk

Boards will compete for a smaller pool of qualified candidates, and therefore, supply/demand will tend to increase the level of competitive pay

Consider providing business-based perquisites that support the board´s role, by focusing on such items as:

Subscriptions to industry- or governance-related periodicals

Expense reimbursement for relevant training/seminars or other continuing education

Board retreats that focus on team building and discussions about key business issues.

Continue to align the interests of directors and shareholders through the use of equity

Require Stock Ownership: Implement a formal requirement that directors hold a specific level of stock or retain a predetermined proportion of equity grants until they leave the board. This ensures that directors maintain a long-term perspective.

Reevaluate the Type of Equity Granted: Consider replacing stock options with restricted stock or restricted stock units, which offer the following benefits:

Avoids the need for cash to exercise options, which is an important consideration if directors are required to hold stock

Eliminates the need for transactions (exercise or sale of stock from options), which the market may misinterpret and/or perceive negatively

Avoids the high leverage (including the possibility of no payout) inherent in stock options, which may not be appropriate for board members

Identify the Right Balance Between Equity and Cash:Provide reasonable level of current income, especially for:

Directors who are encouraged to hold their stock

Board members who are not independently wealthy

Pay more to those board members who assume a greater burden of responsibility. This can be achieved in the following ways:

Decrease emphasis on board retainers and increase the emphasis on committee compensation and meeting fees. This will more directly reflect effort and contribution*

Differentiate pay according to the committee, based on more demanding assignments (e.g., pay more for audit committee service). The chart below illustrates some alternatives to differentiating pay at the committee level:

Some companies, who do not pay meeting fees, appear to have resorted to discounting retainers for Directors who do not attend all meetings. We think this is overly complicated and believe per-meeting fees are more direct and effective.