Oct 112014

Dr. Earl R. Smith II

A board’s primary responsibility to the shareholders of the company is to protect and enhance the value of the shareholders interest in the company. This responsibility has not changed with the business environment today’s boards operate in, however the work boards engage in and the scrutiny directors now fall under has changed drastically. Sarbanes-Oxley ensures that directors now face legal consequences for board decisions as SOX attempts to codify good governance policies. Corporate governance demands more from directors than ever before, while at the same time a negative wind blows against the compensation levels directors enjoy for their services. As part of governance activities, boards assess compensation policies, set benchmarks for the level of director compensation and document its method for future compensation assessments.

As a first step in determining a director compensation policy or beginning an assessment of current compensation policies, the board should establish the framework for director compensation. This will address several issues including:

  • How should the directors be compensated
  • Meeting fees
  • Retainers
  • Equity options
  • Cash bonuses
  • Additional compensation for officers or chairman

Most for-profit board members today compensate directors for their services, and most boards have a mixture of some or all of the above compensation practices. Compensation Committees often determine the exact mixture and the total compensation by reviewing the board’s performance. Equity and cash bonuses are usually tied to specific goals to be achieved. By offering equity-based stock options, boards attempt to align the interest of individual board members and stockholders. Often times the CEO receives additional bonuses for his/her leadership of the board and the company’s corporate management team.

Once the compensation framework for how directors is set, the next step is to benchmark the level of compensation. Every company strives to have the best leadership and offer professional governance for its stockholders and stakeholders. Corporate boards must attract talent to the board just as corporate management must attract engineers or machine operators. Sarbanes-Oxley addresses board member mix of insider and independent directors, but leaves it up to the board to decide in a very broad sense which directors qualify as independent and which do not. Otherwise, boards must determine how to attract talent and what role compensation plays in attracting the highest level of talent needed to meet the organizations strategic goals. The board should consider the following as it addresses compensation levels:

  • What is the desired talent pool?
  • How many industry professionals are needed with specific high-demand skills?
  • Should high-demand skills command more compensation?
  • Should corporate performance affect director compensation?
  • Should employee directors receive a higher bonus than independent directors?

Boards come under intense scrutiny when stockholders, analyst and news media question director compensation versus corporate financial performance. To combat this scrutiny and to erase any ambiguity board members may have regarding director compensation, boards should have a written director compensation policy. Any bonuses tied to obtaining specific strategic goals should be documented and provided to the Compensation Committee prior to awarding any bonuses or other compensation. These guidelines should be posted publicly on the corporate website and become a part of the company’s annual statement to shareholders.

Most boards today hire outside advisers to assist with appropriate director compensation policies. Corporate ethics and culture often are major factors in setting director compensation, and determining compensation for the CEO and corporate management. Good governance dictates that boards should attempt to attract the best talent to achieve the company’s mission and attracting the best talent needed by the board should play a major role in establishing the company’s compensation policy.

If you are dealing with issues surrounding board compensation, send me an e-mail and we will arrange a time to talk.

© Dr. Earl R. Smith II

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