An economic recovery…increasing stock prices… new regulatory requirements. We’re not talking about 2010. We’re talking about the early-to-mid 2000s, with an economic rebound after the 2001 recession, a stock market recovery after the dot.com bubble had burst and Sarbanes-Oxley at the top of everyone’s mind.
This environment led to a two-year period of annual increases in director compensation—in the 10-20 percent range—well above the “normal” 5-10 percent annual increases seen in prior years.
Editor’s Note: What follows is an excerpt from the NACD and NACD Center for Board Leadership’s 12th annual survey of non-employee director compensation, produced in collaboration with Pearl Meyer & Partners.
Move the clock forward to 2010, with greater director accountabilities and increasing regulatory requirements, such as the Dodd-Frank Act, and director time, attention and expertise are in even greater demand. We are seeing the beginning of an economic recovery and unemployment is no longer increasing.
Stock prices have fully recovered from March 2009 and are approaching levels not seen in almost two and one-half years.
Directors are once again asking the question, “Does the improving economy, combined with relatively stagnant director pay levels over the past two years, suggest that director pay is ripe for the kind of above-market increases we saw in 2004-05?”
The Impact on Director Pay
We believe directors can stop asking. Our study suggests that the anemic increases observed in 2007-2009 are gone and we are back to the level of annual increases seen in the early-to mid 2000s. This is evidenced by:
- Mid-single-digit increases in Total Direct Compensation (TDC) for larger companies, in part driven by programmatic changes and increasing stock award values
- Increases of 20 percent in director compensation for the Micro companies, primarily driven by large increases in stock award values
Additionally, high single-digit to low double-digit increases are expected in director compensation over the next few years due to:
- The release of some pent-up demand at the board level to review director compensation
- Increases in time commitment, expertise and accountabilities
- Greater regulatory requirements
As observed for the first time last year, a majority of companies in four of the five size categories studied have declassified boards (one-year terms), with the Small revenue category increasingly close to the majority standard this year. The use of declassified boards increased slightly across all revenue sizes from one year ago, with prevalence up to 81 percent for the Top 200 companies. The median reported age of board members also increased slightly across all company sizes, to 62 years for the Small companies and 63 years for all others.
As has historically been the case, board practices tended to be differentiated by company size. Among all companies surveyed, median board size increased with revenue size and ranged from eight members in the Micro and Small companies to 12 members in the Top 200 companies, which was the only size category that experienced a change from the previous year, when the median board size was 11 members. Likewise, the prevalence of disclosed mandatory director-retirement age increased slightly from last year. Despite many companies’ stated commitment to increasing board diversity, few companies have more than two female directors. For all but the Micro companies, it is the majority practice to have at least one female director; furthermore, more than 50 percent of the Large and Top 200 companies have at least two female directors.
Not surprisingly, the prevalence of a combined chief executive officer/chairman of the board role decreased across all size categories versus the prior year. This is likely driven by general shareholder concerns over corporate governance and board independence. The practice of combining the two roles increases as company size increases, with 40 percent of the Micro companies reporting a combined CEO/chair and 70 percent of the Top 200 companies combining the roles.
A Return to Growth
The early to mid-2000s saw rapidly increasing director pay in response to Sarbanes-Oxley, when companies adjusted pay programs to reflect significantly increased regulatory demands. Additionally, a rising stock market after the 2001 recession resulted in increasing equity awards, as most companies were still delivering fixed-share director equity awards.
Growth rates slowed down and then went below zero as the economy entered the recession in 2007 and 2008, and companies postponed increases and even reduced director compensation in light of broad-based employee pay freezes and pay reductions. Furthermore, equity award values were hit particularly hard by falling stock prices. Figures from 2010 show that growth in director compensation levels has returned. The median director pay increase ranges from 20 percent for the Micro companies down to 5 percent for the Top 200 companies).
A Closer Look
A closer examination of the director compensation elements reveals even more interesting results. The median annual cash retainer increased by at least 5 percent for all size categories, except the Large companies (no increase). The annual retainer for Micro companies increased to $26,325, up 5 percent versus prior year and increased to $75,000, up 7 percent versus prior year for the Top 200 companies.
Equity award value increases ranged from 58 percent at the Micro companies down to 8 percent at the Top 200 companies. Since smaller companies are more likely to grant fixed-share awards, equity award values significantly increased along with stock prices. It is important to note that the increase in total direct compensation for smaller-sized companies is due in large part to the practice of granting fixed-share equity awards as opposed to structural changes in compensation practices.
Total board compensation (compensation excluding committee fees and retainers) also demonstrated strong year-over-year growth, led by the Micro companies with a 21 percent year-over-year increase, closely followed by the Medium companies with an increase of 16 percent versus the prior year. Interestingly, compensation for committee service fell by 6-12 percent across all size categories except at the Top 200 companies. We believe this is largely a result of slight reductions in the number of committee meetings in 2009 relative to 2008 and more companies reducing pay for committee service and shifting it into the cash retainer or equity grant, which the Top 200 companies began doing a few years earlier than the rest of the market.
The Cost of Board Compensation
Total board compensation expense—including all fees and equity grants for board and committee service for all non-employee directors—is a function of both board size and TDC per individual non-employee director. This benchmark data can be used to assess whether a company’s total board compensation cost is reasonable.
As expected, the cumulative cost of board compensation accounts for a smaller proportion of total revenue as company size increases. The median price tag for board oversight at the Micro companies was $519,411, or 0.22 percent of revenues.
Among the Top 200 companies, the cumulative cost of board compensation was more than four times higher, at nearly $2.3 million, but accounted for just 0.01 percent of revenues. As with the total cost of board oversight, director compensation on a per-meeting basis increased with company size, ranging from $5,337 per meeting at the Micro companies to $10,915 at the Top 200 companies.
Board Pay Mix
Public boards of all sizes generally rely on the same menu of cash and equity components: a combination of a board cash retainer; board meeting fees; committee pay; full-value stock; and stock options.
Company size affects pay mix practices, with larger companies having a larger portion of their total compensation delivered in equity. The Micro companies only delivered 40 percent of total compensation in equity, compared to 57 percent at the Top 200 companies.
The median value of equity compensation has also increased, due in large part to the stock market recovery, rather than structural changes in director compensation.
Compared to last year, committee pay as a portion of TDC has decreased. As a portion of TDC, committee pay also decreased as companies increase in size, ranging from 12 percent for the Micro companies to 7 percent for the Top 200 companies. As previously mentioned, we believe this is based on a combination of fewer committee meetings and shifting pay from committees to the board.
Prevalence of Pay Elements
The annual cash retainer has long been a virtually universal element of board compensation programs, provided by between 94 and 98 percent of companies, depending on revenue category. In contrast, there is an ongoing decline in the use of board meeting fees. While board meeting fees were still a majority practice among most size categories, fewer than 40 percent of the Top 200 companies provided meeting fees for attending board meetings. One reason: as board oversight expands and remote communication becomes more sophisticated, companies have struggled to define what constitutes an official “meeting” for purposes of compensation.
To eliminate that issue, more companies are providing an increased board retainer in exchange for eliminating board-meeting fees. There is a continuing trend to favor the use of full-value equity awards over stock options. Full-value share grants were a majority practice among all size groups. This year, the Small companies’ full-value shares prevalence increased by 8 percent (from 70% to 78%).
Conversely, the use of stock options continued to decline or remain flat, with prevalence at 35 percent or less in every revenue category. Providing compensation to committee members and chairs continues to be a majority practice; however, there has been a slight decrease in chair fees/retainers. While committee member pay was typically provided in the form of meeting fees, committee chairs were more likely to receive an additional retainer. In general, the use of committee member retainers and additional chair retainers increased with company size, while the prevalence of meeting fees declined.
Both electronic and hard copies of the complete 2010-2011 Directors Compensation Survey are available for purchase at NACDOnline.org.