Given slow economic recovery and continued debate over executive compensation practices, it’s not surprising that the 11th annual NACD Director Compensation Report finds board pay levels flat or down compared to a year earlier. However, given renewed economic growth and the escalating risks demands and responsibilities of board service, 2010 is likely to see a moderate rise in pay and, in 2011, even further increases.
Highlights from this year’s survey of non-employee director compensation conducted by the NACD and The Center for Board Leadership, and produced in collaboration with compensation consultancy Pearl Meyer & Partners (PM&P) include:
- Minimal change in board compensation levels following a year of very modest growth.
- A smaller proportion of directors’ Total Direct Compensation delivered in equity, largely due to depressed share prices.
- A shift toward granting annual equity awards based on a fixed value, rather than a fixed number of shares, to ameliorate the impact of share price volatility.
- Continued increase in companies providing equity incentives in the form of full-value shares, rather than stock options.
To put this year’s compensation into perspective, PM&P managing partner Jannice Koors says that with the exception of double-digit pay increases in the two years immediately following the passage of the Sarbanes-Oxley Act of 2002, director pay typically has increased on average five, six or seven percent a year. “Director comp doesn’t tend to change. It goes up once every three or four years rather than on an incremental basis…In 2008, we saw comp levels flatten and go down among smaller companies, but that was largely driven by equity. The numbers for 2009 are negative for all but the Top 200 companies so it’s flat, but none of this represents decreases in compensation,” Koors says. Retainers and meeting fees are not being cut and companies of all sizes are following the NACD’s best practice that recommends that half of a company’s director compensation be paid in equity to align directors with shareholders.
Board Composition
For the first time, a majority of companies in four of the five revenue groups studied now have declassified boards (one-year terms), with the small-revenue group close to that standard. Declassified boards were first adopted by the Top 200 largest companies, where they are the practice at 76 percent of companies, slightly higher than a year ago. There was relatively little change in other aspects of board composition.
As has historically been the case, board practices tend to be differentiated by company size. Among the entire survey group, median board size increases with revenue size and ranges from eight to 11 members. Likewise, the percentage of female directors and the prevalence of a disclosed mandatory director retirement age increase with company size.
Despite increased governance pressure to separate the roles of the chief executive and board chair, a combined CEO/chair leadership structure is still the majority practice among virtually all size groups.
TAKEAWAY: Board composition continues to be under fire on two fronts: the maintenance of a combined CEO/COB role and expanded shareholder access to board seats. Absent adoption of a regulatory requirement to separate the executive and board leadership roles, we expect to see an evolutionary increase in the separation of CEO and COB positions, rather than a revolutionary changeover, given the difficulty of taking away the chair title from a sitting CEO. On the second front, governance watchdogs are making a strong move to open up the director nomination process to significant shareholders. Ironically, the unintended consequence of such a change might be increased resistance from directors to annual elections—after all, few directors will want to wage a contested campaign for re-election annually.
The down economy resulted in decreases in median director compensation across all groups but the Top 200 (see chart, page 57). The last major growth in director pay levels occurred in the 2004 and 2005 proxy seasons in response to SOX, when companies adjusted pay programs to reflect significantly increased oversight demands.
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 the level of pay per individual director. While the total cost of board oversight increases with company size, it represents a progressively smaller percentage of company revenues. The median price tag for board oversight at smaller companies was $489,304, or 0.21 percent of revenues. Among the Top 200, total board costs were four times higher at nearly $2.1 million, but accounted for just 0.01 percent of revenues.
TAKEAWAY: In general, director compensation has leveled off in the past two to three years, following a post-SOX “bump.” This year’s report finds pay down slightly or flat compared to a year earlier, despite an increased workload for directors, largely due to depressed stock prices and concern over the poor optics around increasing pay. As company financial results begin to improve, with a corresponding rebound in equity values, we expect director pay levels may show above-average increases over the next year or two.
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.
Compared to last year, the median value of traditionally cash elements of board pay—consisting of annual retainers and fees for board and committee service—represented a greater proportion of total board pay. As a proportion of TDC, board cash retainers ranged from 33 percent to 38 percent; board meeting fees between 3 percent and 13 percent; committee pay between 8 percent and 15 percent; and equity awards between 34 percent and 54 percent.
As companies increase in size, full-value equity awards represent an increasing portion of total compensation; ranging from 22 percent among smaller companies to 45 percent at Top 200 com-panies. There is more uniformity in median option value across size groups. Among smaller companies, options represent 12 percent of total compensation, compared to 9 percent at Top 200 companies.
Prevalence of Pay Elements
As implied by the pay mix comparison, the prevalence of pay elements differs very little across company size groups. There are two notable exceptions to the uniformity that highlight continuing trends in compensation structure.
First, there is a steady, although modest, decline in the use of meeting fees across all size groups. While board-meeting fees are still majority practice among most size groups, fewer than 40 percent of Top 200 companies provide board-meeting fees. 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.
Second, there is a continued trend to favor the use of full-value equity awards over stock options. For the first time, full-value share grants are majority practice among all size categories. In contrast, the prevalence of stock options continues to decline and now hovers at around one-third.
Cash vs. Equity
Due largely to lower share prices, there was a drastic decline this year in the number of boards in each revenue group that provided at least 50 percent of board compensation in the form of equity, a key NACD governance recommendation. While a year earlier only the smaller and small companies failed to meet that standard, prevalence plunged to fewer than 50 percent of companies in all but one revenue group. Even in the Top 200, where a year earlier 74 percent of companies reported that at least half of board pay was in the form of equity, compliance with the NACD standard fell to 63 percent.
The median cash/stock board pay mix among the companies in the study was much closer to the NACD recommendation, with every revenue group except smaller companies providing close to or more than 50 percent of board compensation in equity. As has historically been the case, cash accounted for the greatest proportion of total compensation at the smallest companies, and was the smallest part of pay at the very largest companies.
Full-Value Share Grants Favored
There has been a significant retreat from the use of stock options in board pay programs since mandatory option expensing removed the perception that such grants offered a “free” means of rewarding employees and directors. At the same time, governance critics increasingly have blamed stock option grants for engendering an excessive focus on short-term performance gains. Among the Top 200 companies, which historically have set the pace in board pay practices, the use of stock options peaked at 75 percent of companies in 2002, falling to 51 percent by 2005 and 27 percent in the 2009 proxy season.
Over that same period, the proportion of companies providing full-value board equity awards has grown steadily. In terms of prevalence, a majority of companies in every revenue group in 2008 made full-value board equity awards, increasing with company size from 57 percent of the smaller companies to fully 92 percent of the Top 200. Full-value grants were also favored over options within each revenue group.
TAKEAWAY: A gradual move by all revenue groups to adopt Top 200 equity practices and move toward increased use of full-value equity awards is expected, given an environment of heightened scrutiny of compensation, combined with a growing focus on the need for more stringent risk management and oversight. However, the NACD does not expect stock option use to cease altogether. On the cash side, more com-panies are also likely to follow the lead set by the Top 200 by simplifying their cash compensation structure and eliminating meeting fees. The continued reluctance by companies to start paying their committee members solely in the form of a retainer could reflect uncertainty about their future work demands, or a desire to compensate directors in direct proportion to their time commitment. Regardless, more companies will move to a more fixed-cash pay structure.
Equity Grant Practice: Fixed Values vs. Fixed Shares
While the decision by boards to calculate equity grants on the basis of a fixed number of shares or as a fixed-dollar value also correlates with company size, in every revenue group there was increased use of the fixed-value equity grant approach when compared to a year earlier. The proportion of companies that provided fixed-share grants ranged from 56 percent of the smaller companies down to 24 percent of the Top 200. Conversely, board equity awards were provided as a fixed dollar value at 35 percent of the smaller companies, increasing to 62 percent of the Top 200.
TAKEAWAY: Over the past two years, many companies have struggled with declining and/or volatile stock prices and the corresponding impact on equity grant values. The result has been that the use of fixed- value versus fixed-share equity grants to directors has been a growing topic of discussion. It is noteworthy that smaller companies are more likely than larger companies to grant equity awards based on a fixed number of shares, rather than a fixed value. A likely correlation is that smaller companies are also more likely to award stock options than larger companies, where full-value equity awards are more prevalent. The NACD recommends that whatever the structure, equity grants should include a floor or ceiling on the range of possible compensation and/or share use. While there are arguments for and against both practices, as a general principle compensation for directors should reflect their contributions to the company and expectations related to stock ownership, rather than linked to short-term fluctuations in share prices.
Committee Service
The work of the board is increasingly being conducted at the committee level, as directors seek to “divide and conquer” the volume of issues they face. Virtually all companies in this survey maintain audit and compensation committees. The prevalence of other board committees generally correlates with company size: between 79 percent and 99 percent of companies reported a governance/nominating committee, while 26 percent to 46 percent maintain an executive committee and 10 percent to 48 percent have a finance committee. Beyond that, prevalence generally drops to single digits for committees devoted to specialized topics such as pensions, nuclear, technology, etc. While there has been much discussion around board responsibilities for risk management, the study found no increase in the prevalence of separate risk committees, as broad risk oversight is best viewed as the responsibility of the full board.
It is important to note this report includes all committees in “total committee compensation” calculations, reflecting both actual committee assignments and the actual number of meetings held. The report focuses on committee fees and retainers only for the audit, compensation and governance/nominating committees, which are the only standing board committees maintained by at least 75 percent of companies in each revenue group.
Generally, meeting frequency for the audit, compensation and governance/ nominating committees was largely unchanged over the past three years. However, in a possible reflection of the troubled economic environment, there was an uptick in some committee activity among certain revenue groups. For example, compensation committees for four of the five revenue groups—smaller, small, medium and Top 200 companies—held more meetings than a year earlier.
Differentiated pay for service on the three leading board committees continues to be a majority practice among all revenue groups. More than 80 percent of companies across all revenue groups tailored some aspect of committee compensation to their level of work and responsibilities. Interestingly, most companies
limit such differentiation to the committee chair retainer.
The chairs of audit committees continue to receive the highest compensation for committee service, ranging from 51 percent to 75 percent more than that of compensation chairs. The pay differential between compensation and governance/ nominating committees is less pronounced: compensation committee chairs receive between 7 percent and 45 percent more than governance/nominating, with the smallest differential by far at Top 200 companies.
Committee member pay follows a similar pattern. Compared to a year earlier, the practice of differentiating pay through the use of a retainer increased in three of the five revenue groups to between 20 percent and 37 percent of companies. Audit committee members received a premium over compensation committee members, ranging from 100 percent among the Top 200 to 42 percent at smaller companies. The premium for compensation committee members, compared to their governance/ nominating counterparts, ranged from 40 percent at smaller companies to two-thirds among the large companies. In a departure from that pattern, the pay gap narrowed to 25 percent for the Top 200, down from 50 percent a year earlier.
TAKEAWAY: A significant majority of companies differentiate pay among committees in some way, reflecting the difference in relative workloads. It may seem surprising that outside of the committee chair role, there is not much differentiation of committee pay levels. One reason is that most companies historically paid committee members through meeting fees. As a result, pay differentials were “self-correcting”—the more meetings held by a committee, the higher its members’ compensation. As companies now consider moving to retainers for committee service, we may well see more structural differentiation of committee member pay. On the other hand, a case can be made that board members should be compen-sated for the value, not just the volume, of their contribution and that all board members are equally responsible and liable for all committee decisions. This argument would suggest that less differentiation may be the trend of the future.
Board Leadership
The practice of having a non-executive leading the board—either as chair or lead/presiding director—continues to correlate with company size, as is traditionally the case with emerging governance and compensation trends. The survey found that 74 percent to 99 percent of companies designated a non-executive board leader, with 41 percent to 53 percent of those firms providing additional compensation for that additional role.
Companies generally pay a higher premium for service as a non-executive chair than as a lead/presiding director. Non-executive chairs, at median, receive 1.45 to 1.77 times the Total Board Compensation (excluding pay for committee service) of an average director. The median premium provided for lead/presiding directors is significantly smaller, ranging from 1.13 to 1.17 times the Total Board Compensation of an average director.
TAKEAWAY: There are two items of particular note in the findings on board leadership compensation. First, it is striking that only about half of non-executive chairs/lead directors received additional compensation for the role. Contrast this prevalence to the virtually universal practice of providing additional compensation to board members who serve as chairs of any of the major standing committees. It suggests that the board chair/lead director position at many com- panies is still evolving into a position with meaningful leadership responsibilities.
Also of interest is the differential between the premium paid to non-executive chairs versus lead directors. The premium for the lead director title is significantly lower, even though from a governance perspective, it would seem by definition that many of their responsibilities are similar. While this may just reflect a perception by directors that the two roles are meaningfully different, other studies have shown that, in practice, the non-executive chair role often has considerably greater responsibilities.
Lastly, many of the governance-related proposals currently before Congress include a provision to require mandatory separation of the CEO and chair positions. If this requirement is enacted, directors can expect dramatic changes in the structure and prevalence of compensation for board leadership.
Share Ownership Guidelines
After years of steady increase in the prevalence of ownership guidelines, this year’s prevalence dropped in four out of five groups, ranging from 24 percent among the smaller companies to 84 percent at the Top 200. Ownership guidelines generally require a minimum equity value, typically expressed either as a multiple of the annual board retainer or as a fixed number of shares (a formal guideline). Some companies instead require that stock awards be deferred to retirement, and other companies maintain both ownership and deferral standards. Additional methods used by companies to ensure stock ownership by directors include holding requirements and retention ratios.
Typically, directors have a stated period within which to acquire stock equal to the minimum requirement and must maintain that level of ownership during their tenure. That standard has been fairly consistent over time, with new board members typically given five years to comply.
TAKEAWAY: Notwithstanding this year’s decline, the NACD expects a continued long-term increase in the prevalence of stock ownership guidelines among all size groups. Two issues in terms of compliance are noteworthy. First, at companies where minimum ownership is based on value, the volatile market has caused some board members’ stock holdings to fall below compliance levels.
There are a number of design features that can alleviate this issue, such as calculating ownership levels based on an average stock price measured over a specified period (e.g., one year) to reduce the effect of volatility on compliance. Second, companies should be aware that RiskMetrics Group (RMG) does not count retention ratios and/or holding requirements as a stock ownership guideline in its evaluation of companies’ governance practices. In fact, RMG expects a minimum ownership multiple of three times the annual retainer.
As with many board pay practices, disclosure of perquisites and benefits for directors tends to increase with company size, from 3 percent of smaller companies up to 56 percent of the Top 200. Prevalence of disclosed perquisites and benefits declined from a year earlier in every revenue category, reflecting widespread shareholder and media criticism. Corporate matches for directors’ charitable gifts was the most common perquisite, reported by 14 percent of all companies, and was also most prevalent among the medium, large and Top 200 companies. Among smaller and small companies, life and health insurance for directors was most frequently reported, at 3 percent and 6 percent of companies, respectively.
TAKEAWAY: At this point, most companies have significantly curtailed or eliminated “status” perquisites to outside directors. The NACD expects that both the prevalence and value of benefits and perquisites will continue to decline over time. That said, other perquisites such as reimbursement for director-education programs will continue to be perceived as of value to the company and its shareholders.
CHARTS AND TABLES*:
Board Composition and Structure
Historical Year-Over-Year Total Direct Compensation Trends
2009 Prevalence of Premium Pay for Board Leadership and Prevalence of Perquisites/Benefits
2009 Prevalence of Full-Value Stock and Stock Options
2009 Median Total Compensation for Committee Members
2009 Median Total Direct Compensation*Source: The 2009 2010 NACD Director Compensation Report
Now available: The 2009-2010 NACD Director Compensation Report produced with Pearl Meyer & Partners. Please visit the Governance Resources section of www.nacdonline.org to obtain a complimentary copy (NACD members only) or to purchase a hard copy.
I have reviewed some proxies in an attempt to determine a company that discloses following the advice below and have been unable to find one. Anyone know of an actual company that does this?
equity grants should include a floor or ceiling on the range of possible compensation and/or share use