In a recent article for the Harvard Law School Forum on Corporate Governance and Financial Regulation, Diane Lerner, Managing Partner for Pay Governance LLC, examines how public companies compensate their outside Directors. In her article, Ms. Lerner (1) analyzes several factors that have contributed to the evolution of Director compensation over the last two decades, (2) discusses current and emerging issues related to Director compensation, and (3) predicts how Director compensation will change in the coming decade.
Ms. Lerner notes that over the past 20 years, public companies have shifted their overall approach for Director compensation away from an executive model in which Directors are compensated with long-term vesting equity awards and benefit plans similar to those paid to a companys executives, and more towards an expert consultant model that emphasizes short-term awards and service retainers. Ms. Lerner observes several specific changes that have characterized this shift in approach and offers a historical explanation for each such change. For instance, many companies have abandoned Director pension and benefit programs, which a 1996 report by the National Association of Corporate Directors (NACD) suggested aligns Directors with senior management, and most companies now offer cash and equity awards as their primary forms of Director compensation. Further, in the wake of insider trading scandals and after the implementation of Sarbanes-Oxley in 2002, the majority of public companies have eliminated stock options, which enable Directors to make strategic decisions regarding company stock, instead granting Directors full-value shares less susceptible to insider-trading. Two corporate governance trends that serve to limit Director tenure - increased shareholder focus on Board refreshment and a shift toward annual (instead of staggered) Director elections - have coincided with shorter equity vesting terms that reduce a companys financial commitment to its Directors. Finally, the heightened Director responsibilities promulgated under Dodd-Frank and the increasingly frequent separation of the CEO and Chairman of the Board positions has led to greater emphasis on cash retainers for Lead Directors (the leading Independent Director on a Board with an Executive Chairman), committee chairs and other Non-Executive Directors.
Current Practices and Emerging Issues
Having summarized these shifts, Ms. Lerner notes that most S&P 500 companies offer the same basic elements of Director compensation: (1) cash retainers for Board service, (2) annual equity grants for Board service, and (3) cash retainers for committee chairs and Lead Directors. Still, many questions remain for which a consensus has not emerged, including how to compensate non-chair committee service, whether to compensate Directors for attending an excessive number of meetings and how to approach deferred compensation.
Ms. Lerner notes that while specific practice in many of these areas may vary across firms, a recent court decision reinforced the importance of having a clearly-defined process for Director compensation decisions. In Clama vs. Templeton, the Delaware Chancery Court ruled that the deferential business judgment rule did not apply to the grant of substantial restricted stock awards to a companys directors, because the award was approved by the directors themselves and the companys generic equity plan lacked meaningful limitations. In response, many public companies have adopted standalone Director Equity Plans that set meaningful limitation to Director equity awards, usually capped by an as-converted dollar amount. Companies are also providing more enhanced disclosure around their compensation decisions in their annual proxy statements.
Predictions for the Future
Ms. Lerner predicts that public companies and their Boards may expect to see developments in the following areas over the next decade:**Prerequisites* . As companies continue to move away from an executive pay model and towards a consultant pay model, Ms. Lerner projects that companies that still allow certain prerequisite benefits for Directors, including product discounts, charitable contribution matches and spousal travel reimbursements are likely to scale back or completely eliminate such benefits from their Director compensation packages.
**Executive Chair Pay for Former CEOs* . Although it is common practice for a retiring CEO to subsequently serve as an Executive Chair during his or her companys leadership transition period, generous compensation packages offered to former CEOs are likely to draw increased attention from proxy advisors and shareholders.
**Lead Director Pay* . As Lead Directors have become increasingly important in the governance of public companies, compensation for these positions has increased relative to other Directors roles, such as committee chairs. Ms. Lerner expects that the role of the Lead Director will become more important in the coming decade, and the compensation packages offered to Lead Directors will continue to rise relative to committee chairs.
**Pay Premiums for Non-Executive Chairs compared to Lead Directors* . Ms. Lerner notes that Non-Executive Chair (an Independent Board Chair) compensation continues to be substantially higher than that of Lead Directors. Among S&P 500 companies, Non-Executive Chairs are paid, on average, $100,000 more than Lead Directors. Ms. Lerner expects this premium to fall, with Lead Director compensation slowly rising relative to their Non-Executive Chair counterparts. The full text of Ms. Lerners article for the Harvard Law School Forum on Corporate Governance and Financial Regulation can be found here.