Director Compensation Under Scrutiny
For many years, the compensation paid to executives at public companies has been a topic of great interest to investors, shareholder advisory firms and the media. While the interest in executive pay has not diminished, there is a new part of the compensation puzzle that has begun to attract interest, namely the amounts paid to members of the board of directors of public companies. Unfortunately, much like reporting related to executive pay, the topic is often sensationalized and seems to miss the full extent of the responsibilities, time commitments related to such work and the background of those serving in such roles.
In the Steven Hall & Partners’ recently completed annual study of director compensation among the 200 largest public companies in the United States, as shown in Figure 1, median director pay was $268,333, an increase of 2.7 percent over the prior year, which is consistent with the growth observed over the past five years. Giving consideration to studies reporting that directors work between 250-300 hours a year, this translates to about $1,000 an hour.
As with other areas of compensation, director pay is correlated with the revenue size of the company. Companies with revenues less than $17.5 billion reported median pay of $257,083 for an average director, while companies with revenues in excess of $100 billion reported median pay of $293,333.
Structure of Director Compensation
While the structure of board of director pay has remained largely unchanged over the past five years, we have observed subtle shifts as boards move to address changing governance standards.
Pay Mix Relatively Unchanged Over Past Five Years
Almost 90 percent of director pay is comprised of fees earned for board service, with the remainder representing fees earned for committee service. As shown in Figure 3 chart below, this board /committee mix has remained relatively constant over the past five years.
Elimination of Meeting Fees Offset by Higher Retainers
One shift we have witnessed is the elimination of meeting fees, which is often offset by increases in retainers. A median board meeting fee of $2,000 was paid by 24 percent of companies in 2013 compared to 39 percent in 2008. While this shift benefits companies by simplifying the administrative process, challenges often arise when boards are faced with special situations, such as merger and acquisition activity, unplanned CEO departures or instances of financial distress. An alternative approach for those companies interested in eliminating meeting fees but concerned about unpredictable increases in workload may be to utilize a hybrid approach, in which directors will receive fees for attendance at meetings in excess of a pre-determined number.
Likewise, payment of committee meeting fees continues to decline in prevalence, with approximately 75 percent of the three major committees (audit, compensation and nominating/governance) paying no meeting fees to their directors. Among those companies that do pay meeting fees, the median meeting fee among all committees was $2,000.
Committee Chair Retainers Increasing in Size and Prevalence
Although committee meeting fees are not widely prevalent, all but 5 percent of companies pay their committee chairs additional fees for service, typically in the form of a chair retainer. In general, prevalence of committee chair retainers has increased since 2008, as has the amount paid, reflecting the increased workloads associated with committee responsibilities over the past several years. The audit committee chair retainer continues to be the highest ($23,000 at median), followed by the compensation committee chair ($20,000) and the nominating/governance chair ($15,000).
Majority of Pay Delivered in Full-Value Equity
Among the top 200, 55 percent of total pay is delivered in equity, a best practice widely believed to align director interests with shareholder interests.
Today, the majority of equity is delivered in full-value shares, not stock options. Full-value shares are thought to be the more appropriate vehicle for directors as they create an immediate ownership interest and direct alignment with shareholders.
Short Vesting Periods Mitigate Governance Concerns
More than 80 percent of equity awards made to directors in the top 200 companies vested either immediately or within one year of grant, eliminating any concern that director pay requiring future service might handcuff directors to boards they either wish to leave or situations in which they should leave.
Equity Awards Denominated in Dollars, Not Shares
Additionally, most companies (91 percent) denominate equity awards as a dollar value versus a fixed number of shares. By comparison, in 2008 68 percent of companies granting equity determined awards based on a fixed cash value rather than a fixed number of shares. This practice allows companies to provide market-based compensation that is not distorted by fluctuations in stock price.
Share Ownership Guidelines for Directors Increasing in Prevalence
The use of share ownership guidelines has increased over the past five years. In 2008, 74 percent of the top 200 utilized guidelines, whereas today, 90 percent have guidelines reflecting the desire for directors to have significant equity holdings. Almost 75 percent of the group disclosed guidelines that required ownership equal to five times or greater the cash retainer, considered “robust” by firms such as Institutional Shareholder Services (ISS).
Total Board Cost
In addition to what directors are paid individually, there is a growing focus among investors and the media on total board cost, the sum of all components (cash, equity, pension value changes and all other compensation amounts) paid to all directors.
In 2013, total board cost for the top 200 ranged from $38,800 to $8.2 million, with a median value of $2.8 million. The number of paid directors ranged from four to 20, with a median of 11 paid directors. As might be expected, we found that the number of directors sitting on a board greatly influences total board cost and that the size of the organization continues to be an important factor as higher total board costs at larger companies are the result of these organizations paying higher fees and having more directors than smaller companies.
Looking Forward: Important Governance Developments
Although director pay has historically not been a focus of public scrutiny, this appears to be changing. Recently, governance groups and some shareholder advisory firms have turned their focus to director compensation and governance issues. ISS now includes relative director pay as a factor in its governance risk scoring system, measuring average director compensation as a multiple of median pay provided at peer group companies.
Additionally, there has been increased focus on the impact of extended director tenure. Shareholder advisory firms have begun to question whether longer tenure (greater than nine years) causes a potential independence issue. While new to the United States, other countries have already begun the process of limiting director tenure. In the United Kingdom, for example, listing standards already effectively limit tenure of independent directors to nine years. But even ISS admits that views on director tenure are divergent, citing in its QuickScore 3.0 Technical Document that a new director might easily “back down from a powerful chief executive” and long-tenured boards that have worked side-by-side with the same management team may reasonably be expected to agree to the management team’s decisions more willingly.
Recent international developments should also be considered, as in our experience many international governance trends can serve as a harbinger of things to come in the U.S. While say-on-pay votes in the U.S. address only executive compensation, several countries have, or are considering, binding votes on compensation for directors in addition to executives. Under the Swiss Minder Initiative, a mandatory, binding vote on total executive and director compensation became effective in 2015. This binding vote follows in the footsteps of India, Japan and South Korea, which also have binding say-on-pay votes for non-executive directors.
Don’t Lose Sight of What Matters
Much has changed in the way directors are selected and held accountable for their performance as a board member. They are no longer golfing buddies of the CEO who serve as a rubber stamp. Today’s directors are accomplished managers and business area experts whose role is to support and challenge management when necessary. The board evaluation process seeks to weed out those who do not add value.
Those tasked with helping boards develop and administer director pay programs would be well advised to be mindful of the increasing scrutiny of board pay levels and to monitor evolving governance practices both here and abroad.
Sandra Pace is managing director of Steven Hall & Partners. She can be reached at email@example.com.
Steven Hall Jr. is a consultant with Steven Hall & Partners. He can be reached at firstname.lastname@example.org.
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