Make room, audit committee members; you’re about to get some company on the corporate-governance firing line.
Thanks to recent litigation, a spate of stock option backdating scandals, and revised disclosure rules that will provide new details on what Corporate America pays its top executives, the spotlight is shining brighter than ever on executive pay. That means an equally harsh spotlight on compensation committees.
Just as the Sarbanes-Oxley Act boosted the profile—and workload—of audit-committee members four years ago, observers say compensation-committee members will find themselves increasingly under a similar microscope. The scrutiny could start as early as this coming spring; the first period during which the Securities and Exchange Commission’s compensation disclosure rules must be obeyed.
“The compensation committee is the new audit committee,” says Charles King, managing director of the global board-services practice at executive recruitment firm Korn/Ferry International.
Lilienfeld
Post-SOX, “The actions of all board and committee members have been scrutinized in a manner that they hadn’t before,” says Doreen Lilienfeld, a partner in the executive compensation and employee benefits practice at the law firm Shearman & Sterling. “Other interceding developments, such as the Disney case and the stock option back dating scandals, have brought the compensation committee’s role in governance much more into focus.”
While their responsibilities largely will remain the same, the pressure on committee members to execute those duties more diligently will increase sharply. Foremost, the newly required compensation discussion and analysis, to be filed along with a company’s proxy statement. While the document legally will be issued by the company rather than the board’s compensation committee, the analysis portion of the CD&A “is in the laps of the compensation committee members,” says Stewart Landefeld, a partner at the Perkins Coie law firm, because the compensation decisions included there are the heart of what the committee does.
Serota
As a result of that added scrutiny, says Susan Serota, a partner at the law firm Pillsbury Winthrop Shaw Pittman, compensation-committee members “may need to focus more on due diligence than some may have done in the past.” And while some committee members may not have served when the company formulated its current compensation policies, she adds, the committee will need to explain why it believes those policies should continue (or be changed) today.
All of that means compensation committees will have a “substantial and increased time commitment,” particularly during proxy preparation and bonus and equity award determinations, says Landefeld.
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Investors Seek More Disclosure
Despite some criticism over companies’ use of outside pay consultants, it’s likely that compensation committees will continue to rely on them for executive pay-package advice, experts say.
A group of institutional investors recently called for an end to the dubious practice of allowing compensation consultants to work for boards of directors and the companies those boards oversee. The institutions say that double-dipping can be a conflict of interest and contribute to today’s soaring executive-pay levels.
In a letter to the compensation-committee chairs of the 25 largest U.S. companies in the S&P 500, the investors called on the companies to inform investors on “the nature and extent” of work being done for company management by consulting firms that also recommend executive-pay packages to the compensation committee. They also want companies to provide information on any board policies to prevent the same firm from providing services to both management and the board or to be willing to adopt such policies.
Under its recently revised rules, the SEC requires companies to disclose the identification, role, and hiring contact of the consultant, but it doesn’t require them to disclose whether the consultant performed other services for management.
The recent criticism of compensation committees “seems largely due to the perception that the practice of benchmarking executives’ compensation against their peers has resulted in significant increases in the level of executive pay over the last decade,” says Doreen Lilienfeld, a partner at the law firm Shearman & Sterling.
“Obviously, awareness of market practice is one of the things that compensation committees need to be apprised of in their decision making process,” she says. Lilienfeld contends that pay consultants are the “best suited” to collect and analyze the data and that compensation committees rely on them to a “significant extent.”
While she doesn’t think the new rules will change that, Lilienfeld says she’s “curious to see what impact, if any, the fact that the compensation consultants will be named in the proxy on a going forward basis will have on the tenor of their advice … It’s too soon to tell how this will resolve itself.”
In the past, compensation committees have been criticized for being “too ready to simply approve the proposal of the consultant and that proposal was initiated by management, either directly or indirectly,” says Stewart Landefeld, a partner at the law firm Perkins Coie. “The consultant’s relationship was with management rather than the compensation committee.”
While Landefeld and others say compensation committees still will rely on outside compensation consultants, “It’s more likely that the consultant will be retained by and report right to the compensation committee than to management,” he says.
Going forward, Landefeld says outside consultants will be “more a tool of the committee that they’ll use to understand what the marketplace is, to help with judgment on best practices and to assess compensation ideas.”
“Compensation committees will have to ask questions,” says Susan Serota, a partner at the law firm Pillsbury Winthrop Shaw Pittman. “They can no longer just accept what’s put before them.”
“I don’t think comp committees go forward blindly without advice from consultants,” she says. “But I expect to see more committees hire their own consultants and not using consultants that are also the same ones used by the company.”
Still, whether a committee hires a separate consultant to advise it depends largely on the size of the company and the issues on which the committee needs advice. Experts note that some smaller companies may not have the resources to pay a second consultant.
“It also depends [on] what’s coming before the committee,” Serota says. “If the committee is talking about the executive or management compensation program, it may not make sense to have a second consultant. If they’re talking about individual contracts, says for the CEO or the vice chair, I think the committee should be getting independent advice.”
Related Resources
Text Of Pension Fund Letter On Disclosure Practices (Oct. 23, 2006)
Pension Fund Press Release From Connecticut Treasurer Denise Nappier’s Office (Oct. 23, 2006)
Landefeld
He says some committees will meet more frequently in person than in the past because of the time required to conduct the analysis required by the CD&A, and because more committees now make decisions on equity awards at physical meetings rather than by consent—a standard Landefeld says has become a best practice following the backdating scandals.
Looking For Experts
Companies also can expect demand to increase for committee members with compensation expertise, although few believe demand will reach the same heights as the quest for audit committee members with financial expertise. Audit committees at least had requirements from the Sarbanes-Oxley Act to find one or more “financial experts;” no such requirement exists for compensation committees.
King says Korn/Ferry started getting calls almost a year ago from companies looking for directors with compensation expertise to serve on their compensation committees.
“Just as prior to SOX you didn’t see really CFOs or retired audit partners sitting on outside public company boards, up until recently, people with depth in compensation weren’t in demand,” he says. To fill that need, he says companies are scouting top human resource executives and board members with prior experience serving on compensation committees.
“If someone has chaired or served on a compensation committee for one or two boards already, that makes them an attractive candidate,” King says.
Smith
Edward Smith, a partner at the law firm Chadbourne & Parke, says he hasn’t seen companies hiring directors specifically for compensation expertise, although he has seen more compensation committees hiring independent legal advisers and independent compensation consultants. Outside pay consultants, however, have come under fire from critics who say they simply push up pay levels that then get rubber-stamped by the compensation committee. [See sidebar.]
Smith concedes that such criticism has “some basis,” but also adds that, “If they’re independent and they can be hired and fired by the committee, outside consultants can be a very valuable, useful tool. They can bring expertise and experience to committee deliberations.”
Then there’s the money: While they may have to worker harder than in the past, experts say compensation committee members can expect to be well-compensated for their time, as board pay overall has increased in recent years.
“All board and committee members have seen increases in their overall compensation of late,” Lilienfeld says. “Higher fees take into account that there is a lot more review and preparation time going into board service and that being a board member is a significant commitment on the part of those individuals who serve.”
King
King says many companies have already increased compensation for their compensation-committee chairs. Committee chairs generally receive $10,000 to $15,000 more than the standard retainer paid to board members, which he says is typically around $75,000.
Still, some directors may think twice before they agree to serve on the compensation committees. King says candidates are likely to do “more due diligence” before stepping onto the comp committee. “Before they sign up, I think they’ll talk to a lot of people, including the current committee members as well as outside compensation consultants. They may also look at the compensation the company pays its top executives first.”
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