Board members are giving themselves raises at many companies, recent studies show, but compensation experts don't expect a backlash from shareholders—at least not yet.
Pay packages for board directors at mid-market companies rose by an average of 7 percent in 2010, according to an analysis of 600 mid-market companies by accounting firm BDO. The increase, which brings average director compensation at these companies to $110,155, reflects “the increased responsibilities, time commitment, and regulatory issues—such as the Dodd-Frank Act—that boards face today,” says Randy Ramirez, regional practice leader in compensation and benefits with BDO. The rebounding stock market also helped, given that most directors are partly paid in equity.
Pay levels varied greatly by industry, and to a lesser extent, by the size of the firm, according to the study. For example, directors at healthcare firms with revenue of $650 million to $1 billion took home $205,000, “substantially higher than any other group,” the BDO study noted.
The uncertainty in the healthcare industry, largely due to changing regulations, drove the increases, Ramirez says. Given the industry's state of flux, some companies have delayed hiring executives and instead are focused on building a stable board. “They want seasoned directors who are committed,” Ramirez says.
Across all sizes of companies, directors at technology companies earned the most, making an average of $149,000. Bank directors earned just one-third that amount. Many banks, to ease criticism of following the financial crisis and the government-funded Troubled Asset Relief Program, scaled back new grants of equity, Ramirez says. Instead, the directors are expected to boost the value of any equity they've already been granted. “Banks instituted a kind of pay for performance with members of their boards,” he adds.
Another study, by compensation consulting firm Pearl Meyer & Partners and the National Association of Corporate Directors, found median pay up 5 percent at larger companies and 20 percent at the smallest. Again, technology companies had the highest-paid boards. And differing pay levels for the audit, compensation, and governance committees, depending on their workloads, also remains a majority practice. The study includes 1,400 companies with revenues of $50 million to $10 billion.
Scrutiny Coming?
Although director pay has increased steadily over the last decade, it hasn't drawn nearly the same type of investor scrutiny as executive management pay. “Except in rare cases, I don't see [much criticism]. Director compensation just doesn't have enough zeroes behind it,” says Jannice Koors, managing director with Pearl Meyer.
That may change, Ramirez says. Taken together, the members of an average corporate board earn an amount topping seven figures—yet they really haven't had to meet many performance criteria, he notes. “I think companies will start linking board pay to company performance.”
“If directors are elected to be fiduciaries of shareholders, they should have some meaningful skin in the game.”
—Jannice Koors,
Managing Director,
Pearl Meyer
Proxy advisory firms like ISS Corporate Services and Glass Lewis & Co., which focus on corporate governance, want directors' compensation to include “a meaningful percent of equity,” Koors adds. “If directors are elected to be fiduciaries of shareholders, they should have some meaningful skin in the game.”
To be sure, pinpointing the percentage at which the equity portion of a director's compensation package becomes “meaningful” is difficult, Koors acknowledges. But a 50-50 split between cash and equity tends to be about the midpoint, and also is the ratio supported by the National Association of Corporate Directors, Koors says.
Companies also are moving away from stock options, which can encourage excessive risk-taking, in favor of restricted stock, she says. For instance, a director may be prohibited from selling some portion of his or her stock until after leaving the board. Restricted stock tends to make people a little more risk-averse, re-enforcing the idea that directors should first preserve the value already in the company, she adds.
Another trend is the move away from fees for attending individual meetings, to a retainer structure, Koors says. In part, that's because it's easier to administer. Moreover, the nature of a board work has become more fluid; it no longer is limited to just a quarterly meeting, but also includes regular phone calls, e-mails, and committee meetings.
In fact, the jump in directors' responsibility and time commitment, along with concerns about legal exposure, may make finding willing board members that much harder, says Andrew Oringer, partner and lead of the executive compensation practice with the law firm of Ropes & Gray—which could lead to an increase in pay. “As the regulatory environment gets more focused, you'll get people around the edges who are less willing to serve,” he says. That has precipitated a move to professional directors who seek to take on these roles for multiple companies, he adds.
OUTSIDE COMPENSATION ADVISERS
Pearl Meyer & Partners Managing Director Janice Koors and Anthony Eppert, a lawyer with Winstead PC talk on the use of outside compensation advisors:
In March, the SEC issued proposed disclosure rules regarding the use of compensation consultants and conflicts of interest. While the rule allows the use of compensation consultants or advisors, the compensation committee is directed to consider several factors. One is whether the consultant also provides the company with other services. The concern is that in order to maintain the additional income stream, the advisor may avoid recommendations that are not to the benefit of the management team.
To head off this type of concern, many firms in the compensation advisory industry that were part of larger consulting groups firm have already spun themselves off, says Anthony Eppert, a lawyer focused on executive compensation with the law firm of Winstead PC.
Questions about independence also can arise when an compensation advisory assignment makes up such a large portion of the advisor's revenue that “they'll say what they have to so that they don't lose that client,” says Jannice Koors, managing director with the consulting firm Pearl Meyer & Partners.
Independence Days
In March, the Securities and Exchange Commission proposed a rule to implement Section 952 of the Dodd-Frank Act, spelling out independence standards for members of the compensation committee. The proposed rule directs public stock exchanges to establish listing standards that require each member of the board's compensation committee to be independent of management. The exchanges were to define the term “independent,” taking into account such factors as the source of the member's compensation, including any consulting or advisory fees from the company, and any affiliation between the board member and the company.
The final rules are likely to be a “non-issue for most public companies,” says Koors. “It's largely an issue where the regulations are catching up with current practice.”
What's more, the SEC and the Internal Revenue Service already have rules in place regarding director independence, says Anthony Eppert, an attorney focused on executive compensation with the law firm of Winstead PC. “Dodd-Frank is just bolstering that.”
Indeed, if the scrutiny and regulatory oversight becomes too severe, potential board candidates may decide not to take on the jobs, Eppert says. Companies and shareholders likely would be the losers. “Directors bring a host of skills that companies need and that increases shareholder value,” he adds. “They have personal experience they can bring to help the company.”
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