Director Compensation Alignment

Dr. Earl R. Smith II
Managing Partner, The Federal Circle
DrSmith@Dr-Smith.com
Dr-Smith.com

Board of director responsibilities are increasingly being scrutinized in the face a new round of financial mismanagement and high profile corporate failures. The Sarbanes-Oxley Act of 2002 attempted to address many issues to inhibit corporate finance mismanagement, however many corporations did not correctly align directors pay with both appropriate corporate financial management and with reaching the corporation’s strategic goals. Corporate director’s actions, loyalties, corporate director pay, and ethics are being reviewed. This process is driven by issues raised by Congress and the media.

Director’s compensation generally involves a combination of meeting attendance fees, annual equity bonuses, retainer fees and other compensation as deemed appropriate by the board’s Compensation Committee. The Sarbanes-Oxley Act of 2002 required an annual assessment of the board’s performance. However, many boards failed to tie the annual assessment to the board’s actual performance. In many recent high profile failures, directors, CEO’s and other top management received large bonuses without regard to the financial performance of the company or the company’s stock price. Decisions to pay large bonuses to top executives when obvious poor management of corporate affairs has occurred, leads to a lack of confidence by stockholders in the board’s governance ability.

Good board governance and diligent oversight could avoid many of these problems. The granting of stock options is one common practice used to align the interest of the directors with those of the shareholders. This practice of paying directors with equity in the company motivates directors to make decisions that will enhance the stocks long-term value. One noted problem with this form of compensation is the practice of equally distributing options to all directors. Stock options can certainly be effective in motivating directors to work to enhance stock value, but the Compensation Committee should evaluate director’s contribution to decisions that enhance stock value as well as decisions that have negative impact on the company’s performance.

A strong Compensation Committee will evaluate director participation in committee meetings and the ideas generated by committees. The Compensations Committee can review strategies and tie performance bonuses to achieving strategic goals. The Compensation Committee can review minutes and other documents and highlight participation in discussions that work to further the objectives of the committee and the board. The research done can then be used to evaluate individual performance of directors and bonuses awarded based on this evaluation. Promoting this thorough evaluation will build confidence in shareholders and should entice investors wishing to invest in well-managed companies to buy the company’s stock, thereby enhancing its value.

Directors charged with management assessment and oversight and with setting strategies for corporate growth should receive particular recognition. The Compensation Committee evaluates corporate management’s performance and issuing recommendations for management bonuses based upon their assessment of corporate managements reaching the goals and milestones set by the board. A strong strategy gaining in popularity is to apply the same principal to director bonuses. Many boards perform only a cursory board assessment designed to meet the Sarbanes-Oxley assessment requirement. However, boards following the same assessment model for directors as is followed for management generally return higher dividends to stockholders than companies with minimal assessment criteria. Corporate governance is too complex and to closely scrutinized to not have documented evidence of excellent service by directors when paying large bonuses.

Directors are compensated for their time and expertise. Companies cannot operate in a complex environment without a wide set of business experience to draw on. However, in a society accustomed to instant detailed news companies must be able to justify director and management assessments and bonuses.

© Dr. Earl R. Smith II

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Related Articles:

• Risk Governance – Managing Safe Companies
• Characteristics of a Task Oriented Director
• Non-profit Board Compensation Practices
• Some Notes on Board Compensation Norms
• Determining Board Compensation Structure
• Board Compensation – Cash versus Equity

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