Directors' Pay: The Median Is the Message

More dispiriting news for overworked, underappreciated public company board directors: the pace of pay increases is moderating even as shareholder expectations for director performance intensify.

For the second consecutive year, Pearl Meyer & Partners' annual Director Compensation Report, which analyzes the pay practices of the Top 200 U.S. industrial and service companies, found that compensation for corporate board members has "evened out," meaning it is increasing, but only in the mid-single digits.

Median pay for directors at the Top 200 companies in 2008, according to PM&P's analysis of proxy statements, was $200,000, a 4.5 percent increase over last year. That figure includes meeting fees, cash retainers, and equity, but does not include committee service fees.

Director compensation jumped in 2005 and 2006 because of incremental work required after passage of Sarbanes-Oxley, particularly for audit committee members and chairmen. Those increases, according to Jannice Koors, PM&P managing partner, have now worked their way through the system, "so we would expect increases to return to more historic levels, somewhere in that 4- to 7-percent range."

Compensation experts, including Koors, believe what happens at the top serves as a barometer for companies of all sizes because eventually these comp trends "cascade down through the marketplace," she says. The Top 200 companies tend to be leading indicators and thus provide relevant guidance for all comp committees.

A Vast Middle Ground

Contributing to the middling trend is an increasing fear of being an outlier. "Being in the middle is the safe ground," Koors says. "Companies can attract and retain highly qualified directors and not worry about being accused of overpaying. Meanwhile, companies in the middle are perceived as not paying so much that their directors have lost the veneer of independence."

Another reality forcing director pay toward standardization around the mean is a decrease in the use of stock options, which in the past could cause large payouts. The decrease in the award of stock options as a percentage of overall compensation is being driven by external factors. According to Koors, this decrease is the result of rules mandated by the Financial Accounting Standards Board (FASB) that require expensing of options. The incentive tool has also been cast in a negative light after fallout from earlier accounting scandals and the assertion by corporate watchdogs that if you give options to directors you subject them to a focus on short-term performance. "The consensus is that options are not a good way to compensate those charged with watching the corporate henhouse. The message is: give directors real equity with real value and they are more likely to protect the corporation. Give them options and they become speculators," she says.

The prevalence of board meeting fees—which became popular more than a decade ago in an effort to provide directors with more incentive to show up for meetings—continues to moderate. The SEC requires that the identity of directors who don't attend at least 75 percent of their board meetings be made public. The result is that the threat of earning the label of a no-show director has decreased the need for meeting fees, says Koors. Plus, more companies have right sized their boards to include only those directors who have the time and inclination to devote themselves to the job.

"No longer do you see directors who are on a dozen boards, or the so-called 'celebrity' director. Today, what is the norm among the largest public companies is a core group of qualified professional board members who take their jobs very seriously," says Bruce R. Ellig, author of The Complete Guide to Executive Compensation. "Given the heightened risk of personal liability, what's at stake for professional reputations, and real financial liability, companies don't need meeting fees to make sure directors are paying attention."

The median award of equity (other than options or restricted stock) was $120,000 in 2008, representing slightly more than half of directors' total compensation. One remarkable trend is that cash is not as "meaningful." "When you look at the increase in compensation, it is coming in the form of equity rather than cash, and if I'm a shareholder, I probably think that's a good thing," says Koors.

Most companies, 58 percent, have share-ownership guidelines, which are typically a multiple of the retainer. When PM&P first began to track these guidelines in 2000, only 46 companies of the then-Top 200 included the requirement, versus 162 companies today. In less than a decade, the prevalence of share-ownership guidelines has gone from being an exception to a well-established practice of director compensation programs at the top.

Boards among the Top 200 also seem to have found a pay mix that is working. It consists of about 60 percent equity and 40 percent cash. "This is part of the rationale of having directors linked to shareholders," Koors explains. "I think companies today would have a very tough time coming up with a viable rationale why it made sense to move away from a pay structure that is at least 50 percent equity. That would be a very tough sell."

There are a few bright spots for director pay. Two places where there were double-digit increases this year over last, notes Koors, are at opposite ends of the spectrum: the largest and smallest companies on the Top 200. This year's analysis underscores how the competition for director talent among the largest Top 200 companies has pushed up the rate of compensation. "The smaller companies— in the wake of SOX and the increased exposure to directors as a result—are still playing catch-up to what is a minimum level of pay required for the agony for being on any public company board today," Koors says.

The Committee Level

Committee pay, versus pay at the board level, comprised 8 percent of the total, down from 9 percent last year. It's worth noting, too, that 98 percent of Top 200 companies provide some sort of additional pay to committee members and chairs. The median total committee compensation from 2007 to 2008 barely changed. Audit committee chairs, on average, received $25,000 a year in incremental compensation, compared to $15,000 a year for the governance and compensation committee chairs.

Among PM&P clients, Koors says there is anecdotal evidence that companies are opting to embed committee pay into the retainer for directors while continuing to give additional pay to the chairs of the audit, compensation, and governance committees. The belief is that the chairs are doing extra work and should be paid more as a result.

Boards are also adding committees in response to the increased workload. The most popular among the Top 200 companies are finance and executive committees. Koors says that the need for some companies to formalize a finance committee is a direct response to the increased paperwork required by new regulations. The audit committee is then freed up to focus on the function of financial reporting while the finance committee tends to be more treasury oriented, she says.

Of the Top 200 companies, 48 percent report having a finance committee and 50 percent reported the existence of an executive committee, according to Maureen Knowles, a PM&P consultant who worked on the survey.

An executive committee is typically composed of company insiders, including the CEO and chairman of the board, to focus on issues related to strategy and business development. Oftentimes, the executive committee will have the authority to act on behalf of the full board in the event of a crisis. "This would allow for very quick decision-making where it's not possible to get the full board together," Koors says. She also notes that while many companies have executive committees, in the normal course of business they almost never have meetings.

While meeting fees are becoming less prevalent on the committee level, the trend is not as prevalent as Koors expected at the largest companies. "What's interesting to me is that the transition from meeting fees to retainer for committees isn't stronger at the top," she states. "One theory is that it's easier for board members to accept the idea of meeting fees. Then they pretty much know what their commitment is. A lump sum seems to be fine if the work is predictable. But the level of committee work is less predictable and I think that many directors fear, 'What if I only get a retainer and something happens? All of a sudden I have 12 or so new meetings I hadn't planned on because of some unforeseeable consequence.' That, I think, is the only reasonable explanation."

Is Director Pay Fair?

The current economic environment and shareholder outcry over the apparent absence of board members who truly understood the risks, particularly among financial firms, makes this one of the most challenging times in America to be a public company director.

It is too soon yet to know if the turbulent economic conditions and the increased pressure on boards will again fuel a rise in director pay.

Robert McCormick, chief policy officer at Glass Lewis & Co., a proxy research and advisory service, believes that today's directors are, in general, earning their pay. "Given their increased responsibilities, the smaller number of boards on which they're serving, their potential liability, and the frequency with which they have meetings, directors are being compensated in an increased manner and shareholders should expect better oversight and better results," McCormick says. "I think it's only fair that shareholders should expect that for better performance there is going to be increased pay."

Compensation expert Ellig advises boards to cap their comp expenses by limiting or reducing the size of their boards. This advice pertains to companies of all sizes. "The size of your board should reflect what is needed to adequately staff your committees." Three members per committee and no more than three committees per board makes for the ideal board size. That could also be well-heeded advice as the competition for qualified, experienced, and willing director candidates intensifies.

"Being a director is no longer a perk," says Ellig. "And for some, I don't think a company can pay enough to offset the new degrees of risk."

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