NFPCC Original Article: The Discussion on Director Pay
Not to be left out of the transformative world we are living in today, corporate governance norms, board compositions, and board compensation are undergoing material change. As many companies are entering the time of year where they review their director pay programs, we thought it timely to touch on this topic, review some trends taking hold and put forth some thoughts to consider. In an homage to the fast approaching election season – can you imagine this topic being addressed on the political debate stage?!
Transition in Board Composition
First, a review of the changes taking place in boardrooms across the country. With demographic trends in the boardroom, a bull market that has grown long in the tooth, and the transition in strategic focuses of boards necessitating expertise in technology and cyber-security, the composition of boards of directors in U.S. companies is shifting. As the next level of leadership in corporate America secures its footing in the C-suite ranks, this crop of talent is tooled with the skills boards are looking for to support fiduciary responsibilities in the future. As noted in this article by Agenda (paid subscription required), tech-savvy leaders are being increasingly sought after, creating a highly competitive market for securing their coveted skills on boards.
The diversity trend is adding to this recruiting challenge facing boards. This trend, and in some states – the legislation, is pushing companies to increase gender and racial diversity on their boards. Further supporting this is proxy advisory firm pressures beginning in the 2020 proxy season where they will recommend voting against chairs of nominating committees, and potentially other members of the committee, at companies with no women directors.
Director Compensation Trends
It is important to understand current director compensation trends when evaluating programs to see if they are competitive or need adjustments. At a high level, we note the following prevalent practices across most companies in the publicly traded market:
- Annual cash retainers for general board service, committee chair roles, and board chair or lead director roles. We also note increasing prevalence in recent years of cash retainers for audit committee members (due to SOX) and compensation committee members (due to introduction of Say on Pay and increasing focus on executive and director compensation).
- Elimination of normal course meeting fees as directors are increasingly expected to maintain attendance records of at least 75%. While this trend has long been evident, we note that a newer trend to adopt conditional meeting fees is taking shape to appropriately compensate directors for unexpected and temporary increased time commitments.
- Value-driven equity retainers for general board service, and to a lesser degree board committee service. This shift away from a determined number of shares correlates to the broader trend of homogenization of director compensation, as boards look for ways to ensure their pay does not become outlier in relation to peers.
- Increased prevalence of one-year vesting periods for equity retainers. This is in response to the general shift in the market from staggered board elections, where director equity retainers were typically vested over three years, to annual elections. The shift also helps encourage board replenishment.
- Equity retainers are now generally delivered via full-value shares, as opposed to past practices that saw a greater use of stock options. This trend represents the reinforcing of a “pay for governance” philosophy for boards of directors, intended to reduce temptation for excessive risk-taking.
- While not a compensatory practice, we note stock ownership guidelines are now generally a mainstay in the public market, as investors and governance advocates want to ensure directors are effectively aligned with the shareholders they are elected to represent.
- Another practice growing in prevalence that, to date, has had little impact on board compensation decisions is the adoption of compensation limits (~65% of S&P 500). Limits have become increasingly commonplace as a means to mitigate the potential for shareholder litigation on director compensation, which has shown up in some high profile case studies (see: Goldman Sachs, Facebook, Citrix, etc.). While historically set at such high levels that they were highly unlikely to ever come in to play, recent data shows actions taken by companies that didn’t have limits adopting progressively lower limits, and some companies further lowering limits previously in effect.
Potential Changes to Director Compensation
Recognizing the director compensation landscape has been devoid of radical shifts in recent years, there is a growing potential for some changes to consider in the near future. First, on the topic of “pay for governance” being the philosophy du jour for director compensation programs, and with the overlay of a potential move out of the bull market of the last decade, an argument could be made that a bigger portion of director compensation needs to be paid in cash. As demographics on boards begin to shift, newer board members may not be in a financial position to sustain an environment where they pay to work on a board. The pay to work dynamic may become a reality if current norms are upheld – majority of director compensation in stock, expectation or enforcement of no selling of equity when vested, and current tax rates – and the equity markets begin to contract. To counteract this potential, boards may consider allocating more of total compensation to fixed cash arrangements. Doing so would limit realized pay variabilities in connection with stock price performance, and ensure these highly talented individuals are truly compensated for their time and efforts devoted to the boards and shareholders they serve.
Second, expect to see a greater adoption of conditional meeting fees. We consider this practice to be well-suited to directors given the complexities of their jobs in today’s corporate environment and the variability of demands they may be subjected to on a periodic basis. Those individuals that are skilled and qualified to serve on boards should seek to minimize the dilution of the value of their time. Similar to our view on executive compensation, a spreadsheet at the beginning of a fiscal year may not be the best indicator of proper consideration for an individual’s efforts at the end of the year. We view conditional meeting fees as a much better practice than post-hoc compensation decisions that may be wrought with the perception of self-interest.
Third, as investors and corporate governance advocacy groups expand their focus on compensation from executives to directors, the market could see an increased adoption of director pay shareholder proposals. Such proposals are limited in prevalence in today’s market, but even when done on an advisory, non-binding basis, provide an added layer of insurance and protection from potential shareholder litigation. The work that would need to be done to prepare justification and rationale in proxy statements is typically already being done (if not, call us!), so we see this as a natural progression given the current market.
Similar to its counter-party topic of executive compensation, director compensation is now sharing a spot in the limelight. As shifting tides impact corporate governance broadly, director compensation will need consistent review to ensure programs are best tailored to recruit the right talent needed for the future while also paying mind to investor and governance advocate views.
Don’t hesitate to reach out to the team at NFP Compensation Consulting should you have questions or concerns on board compensation. »