Are You Paid Enough?
from November/December 2002
by Randy Myers
Tod Hamachekpocketed an annual retainer of $10,000 last year for serving on theboard of Northwest Natural Gas Co. in Portland, Oregon. He also earned$1,000 for each board meeting he attended, $800 for each committeemeeting, and an additional $3,000 for serving as chairman of theboard’s organization and executive compensation committee. That adds upto about $32,000 for what Hamachek estimates was 12 full days ofmeetings, plus travel time and weekend hours spent preparing for thosemeetings. It’s hardly chump change, but still, he says, he isn’t sureit’s enough.
“If you’d asked me a year ago whether I was paid enough, I would havesaid yes,” says Hamachek, who also earned $461,976 last year aschairman and chief executive of Penwest Pharmaceuticals Co. inPatterson, New York. “Today I question it. With all this talk ofholding the CEO, the CFO, the directors, and audit committees far moreaccountable for the performance of companies, it means you as adirector have to take on vastly increased responsibilities. You have toask if it is really worth it.”
Hamachek’s director pay is indeed low—less than half the average$75,000 to $80,000 compensation package that Fortune 1,000 boards pay,according to Charles King, managing director and head of global boardservices at Korn/Ferry International. And a study of 390 boards ofvarious-size companies by Mercer, the consulting arm of Marsh &McLennan Cos., found that average compensation for directors in 2000was over $100,000. Nevertheless, a growing number of people at all paylevels are reconsidering the price of board service. “We’re trying torecruit several new board members, and it’s proving more and moredifficult to get people to serve these days,” says Herbert P. LaddsJr., chairman of the board at Columbus McKinnon Corp., a maker ofmanufacturing equipment in Amherst, New York. “They’re worried aboutthe liability of being a director, and whether they will be steppinginto a bad situation, and whether they can learn enough to determinethat before they make a decision.”
In the Korn/Ferry International-Corporate Board Member survey, 12.7% ofrespondents said they’d turned down a board position in the past 12months because they felt the risk was too great. “There are directorsstepping down, choosing not to stand for reelection, because as aresult of Enron and some of the other things that have happened in thepast seven or eight months, they have become very introspective,” saysKing. “They’ve looked at the risks and rewards of board service anddecided the risks now outweigh the rewards.”
Would a pay raise change the minds of the reluctant recruits,especially since, as in Hamachek’s case, director income represents asmall fraction of total income for most board members? Corporategovernance experts say the possibility deserves consideration. “I thinkyou have to pay folks for the risks and efforts involved, and clearlyboard service has gotten a lot more involved than it was a few yearsago,” says Charles Elson, director of the Center for CorporateGovernance at the University of Delaware. “The risks are greater andthe expectations are greater.” Adds Ira Millstein, senior partner withthe New York City-based law firm of Weil Gotshal & Manges LLP: “Ifwe’re going to encourage directors to do what they’re supposed todo—attend meetings, read material, be available between meetings, headcommittees—we’re not paying them enough.” Millstein is not known forbeing soft on directors. From 1998 to 1999 he co-chaired the BlueRibbon Committee on Improving the Effectiveness of Corporate AuditCommittees, jointly sponsored by the New York Stock Exchange and theNational Association of Securities Dealers at the urging of theSecurities and Exchange Commission. The panel proposed, among otherthings, that audit committee members adhere to strict new definitionsof independence and financial literacy, meet regularly with theircompanies’ outside auditors, and disclose more information aboutcommittee activities in SEC filings.
Until a few years ago the directors at Vesta Insurance Group, aproperty and life insurer based in Birmingham, Alabama, earned a flat$28,000 per year regardless of how many meetings they attended or howmuch work they were called upon to do. In 1997 that was not, perhaps,unreasonable; Vesta’s board met only six times that year, the auditcommittee just once, and the compensation committee three times. Butthe company uncovered some accounting irregularities in June 1998,which led to a restatement of its financial results and, ultimately, aclass-action shareholder lawsuit settled for $61 million in October2001. Life for Vesta’s directors got decidedly more complicated. Theaudit committee met five times in 1998 and four times each in the nexttwo years. Suddenly Vesta directors were doing a lot more work for nomore pay.
That changed somewhat in 2000. The board reduced the annual retainerpaid to directors to $12,000 each, but also began paying them $2,000per board meeting attended and $1,000 for each committee meetingattended. In 2001, it went further by adding a $10,000 annual retainerfor members of the audit committee. The directors now take home moremoney, but it’s not at all clear that they’ve come out ahead. In 1997,for example, a member of Vesta’s audit committee would have earned$28,000 and been expected to attend seven meetings, six of the fullboard and one of the audit committee. That works out to an average of$4,000 per meeting. Last year an audit committee member would haveearned $44,000 but would have been expected to take part in a total of14 meetings, eight of the full board and six of the audit committee.That comes to an average of just $3,143 per meeting.
Not long ago, of course, no one would have worried about whethercorporate directors were getting paid well enough. A Mercer surveyshowed that stocks and stock options accounted for nearly 60% of theaverage director’s compensation in 2000—and many of those board membershad ridden the bull market to great wealth. At some high-flyingtechnology companies, directors’ stock options brought themcompensation packages valued at millions of dollars: $3.5 million twoyears ago for those at Tibco Software, for example, and $3.2 millionfor those at CMGI. (See “Directors’ Compensation: Cash Laughs Last”)But over the past two years, as they’ve watched their stock options gounderwater and their public reputations get battered, board membershave found themselves under fire from regulators and legislators eagerto mandate new responsibilities for them, as well as stiff newpenalties.
The average director earns approximately $42,000 a year per board,according to the proxy statements from Fortune 1,000 companies. Basedon proxy forms filed from July 2000 through June 2001, the averagecompensation figure covers annual retainers plus fees paid forattending board meetings. It does not include cash for committeemeetings, compensation in the form of stock options, or other perks.Add those, says King, and you come up with an average compensationpackage worth about $75,000 to $80,000 per year. At the least, that’s abit of a boost from times past, according to Roderick M. Hills,chairman of the Securities and Exchange Commission from 1975 to 1977and now a director of ICN Pharmaceuticals and Chiquita BrandsInternational. Back then, Hills says, all you got was “four crisp $100bills under your lunch plate, which you didn’t have to tell your wifeabout.”
Directors of companies with annual revenues under $3 billion averagejust less than $34,000 per year in annual retainers plus meeting fees,the study found, and those at companies with revenues in excess of $20billion slightly over $56,000. Director pay at the smaller companieswas up only marginally from a year earlier, but at the largestcompanies it increased 9.3%. One of the best-paying boards was PhillipsPetroleum’s; in 2001 it paid its non-employee directors an annualretainer of $125,000, or $126,500 if they also chaired a committee.Half the retainer was in stock and the other half in either cash orstock, at the director’s option.
The question of whether boards should boost director compensation couldhardly come at a touchier time. Investor confidence in corporategovernance practices is at perhaps its lowest level since the 1930s.That’s when anger over the stock-market crash of 1929 was ultimatelytranslated into passage of the Federal Securities Act of 1933, whichgoverns the issuance of securities, and later the Securities ExchangeAct of 1934, which created the SEC. Today investors are urgingcorporate boards to rein in what they consider to be exorbitant paypackages for chief executive officers; few if any are encouraging boardmembers to vote themselves a pay raise. And they are not alone in theirindifference. “I would say directors are paid appropriately right now,in general, if they’re performing their fiduciary responsibilities ofoversight,” says Roger Raber, president and CEO of the NationalAssociation of Corporate Directors. “If they’re not, they’re overpaid.”
But many directors, like Hamachek, say pay packages may need to beimproved at some companies. “Shareholders are going to have to thinkthrough this, and if they really want people on their boards who can dothe job, they are going to have to compensate them,” he says. “I’m nottalking about making them rich, but there has to be some adequate levelof compensation.”
“Generally, no, I’m not paid enough, although for one board I’m on, Ithink the compensation is adequate. It’s $50,000 a year, and that’s acash retainer,” says Hal Logan, chief financial officer and executivevice president of TransMontaigne Inc. and an outside director of threecompanies—Suburban Propane Partners, Graphic Packaging International,and Union Bankshares Ltd. “If we’re looking for good directors andthey’re going to have to assume more responsibility, they should bepaid more. I don’t think the compensation should be as high as it wasat Enron [$380,619 in stock and cash]; that was silly. But for a smallto medium-size company, it ought to be roughly in the $50,000 range;for the really big companies, in the $100,000 to $150,000 range. I’vehad people tell me they’re not going to risk their net worth for $2,000or $3,000 a meeting.”
If it were a matter of money, “I probably wouldn’t be doing it,” saysGeorge MacKenzie, former chief financial officer at P.H. Glatfelter Co.and now a director of C&D Technologies Inc. and Central VermontPublic Service Corp. “To me, that’s not a major issue. It’s the abilityto contribute based on my experience.” Warren Batts, an adjunctprofessor of strategic management at the University of Chicago GraduateSchool of Business and a member of the boards of Cooper Industries andMethode Electronics, also says that money is not a motivator. “I don’tthink people go on boards because of the pay, so you could say yes,we’re paid enough,” he says. “On the other hand, relative to the time,effort, and liability, no.”
Most directors and compensation consultants support Logan’s view thatboard pay should vary depending upon the size and complexity of acompany. Among them is Raymond Troubh, a financial consultant andself-described professional director who sits on nine boards, includingEnron’s, where he is interim chairman. “If you’re a director of afairly large, complex international corporation with the usual troublesthat large corporations have, you should be paid more than a boardmember of a company that does a lot less volume, doesn’t have aninternational business, has a fairly simple business plan, meets fourtimes a year, and creates very few interruptions during the year wherethe chief executive calls and blasts your ear off. There’s a hell of adifference in responsibilities,” he says.
Troubh does not believe that board pay in general needs to go up. Whileeach of his boards pays him differently, he says that what he earns is“adequate compensation—not excessive—for the job done.” In fact, whenhe agreed in November 2001 to serve on the board of troubled Enron, hesays he didn’t demand any extra compensation even though he knew thejob would be time-consuming. “I ended up getting significantly lessthan would have been expected, because there were no [stock] options tobe granted; there was no equity at all,” he says. “But I wasn’t doingit for the money. I thought in part it was a public service, and thatit would be a tremendous opportunity to learn something.”
“We pay directors too much for what they do, but not enough for whatthey should do,” says Nell Minow, co-founder and editor of theCorporate Library, a corporate governance website (www.thecorporatelibrary.com).She has a formula for fair pay based on workload: “Considering that weexpect them to spend at least two days of effort for every scheduledmeeting, that comes to about 18 days per year. I would think somethingin the $70,000 range would be appropriate, with some additionalamount—perhaps another $10,000—for committee chairs. I would expect thepay to be in restricted stock whenever possible—perhaps cash to paytaxes, if the stock grants are not deferred—and that the director wouldnot be permitted to sell the stock for three years following the end ofhis term of office.”
Minow warns, “You don’t want to make directors’ compensation so highthat they will sacrifice integrity to stay on the board.” A six-monthinquiry by the Senate Permanent Subcommittee on Investigations foundthat total compensation for Enron board members in 2000 averaged about$350,000, including cash, restricted stock, phantom stock units, andstock options. In addition, some directors had hugely lucrative linksto the company, ranging from consulting fees to endowments bestowedupon charities they spearheaded. Board member John Urquhart, forexample, received $493,914 in consulting fees that year.
More than half (51.1%) of respondents to the Korn/FerryInternational-Corporate Board Member survey say they are not requiredto own stock in the companies they serve as directors. Yet 54.6%believe the majority of a director’s compensation should be in stock.Elson, like Minow, agrees. “I think paying directors in more long-termstock [rather than cash] will pay off in making directors more vigilantand more concerned about short-term shenanigans,” Elson says. “I don’tthink it’s the amount of compensation that will do that, but the form.”
Troubh is also a proponent of stock compensation—annual retainers oughtto be paid almost entirely in options or restricted shares, he says—buthe argues that directors ought to be required to buy shares with theirown money, too. “If you do a survey of proxy statements,” he says,“you’ll see a lot of directors holding so many shares, and most of themare converted from options. They haven’t put up a nickel.”
Directors should own enough stock, says Raber, so that they feel thesame pain shareholders feel when the stock price goes down. “The bestway to ensure that directors work hard is to require them to make anoutright purchase of the company’s stock,” he says. “That, to me, is abetter motivator than an extra 10% or 20% of cash, or whatever theamount might be.”
“I think stock should be part of the compensation package, but not inthe form of options,” says Millstein. “Stock grants are fine; if adirector gets paid $100,000 a year, with $50,000 in stock and $50,000in cash, that’s fine. But I don’t think the director should be able tosell the stock until they leave the company.” Batts agrees—but he wouldallow directors to sell stock in special circumstances that mightrequire cash, such as a health emergency.
While 45.6% of board members surveyed say a director’s stockcompensation should be primarily in the form of options (41.6% wantstock grants), that preference runs against new realities. Reformerscomplain that stock options, unlike stock grants, don’t have to bereported as an expense on a company’s balance sheet. By not expensingoptions, they say, companies mask the true cost of those options andget to report overly rosy financial results. Also, there’s been apublic backlash against stock options because of examples like that offormer AOL Time Warner CEO Gerald Levin, who earned $152.6 millionexercising stock options in 2000, a year in which the company’s stockprice fell from $83.37 (on January 3, 2000) to $34.80. If companieswere expensing options, as a handful of firms have started to do, thosebonanzas would shrink, say critics.
The adverse publicity is taking its toll. “We are beginning to see amove away from options as a form of director compensation,” saysCharles King. “People have criticized boards for being overpaid becausethey rode the wave with their stock options. So boards are going tostock grants instead of options.”
When they receive stock grants, says Elson, directors suddenly findthat their own interests are much more closely aligned with those ofshareholders than if they were being compensated with options. “Withstock, directors are riding the stock on the way up and riding it onthe way down,” he says. “With options, they don’t ride it down, becauseall they have is an expectancy.” In short, stock grants may not makedirectors as rich as those who hit the big options jackpots, but theycan give directors much more of a personal financial stake in thelong-range performance of their companies.
“Good board members,” says Troubh, “have to be industrious, work hard,have the time to do the job, and be reasonably intelligent. If theyhave that, you’ll get the performance, whether you pay them $50,000 or$75,000 or $100,000 a year.” He, like all others interviewed, couldgive no specific example of a director whose work was diminished by lowpay or enhanced by high compensation. And yet there is a strong feelingamong most of them that it’s only natural to pay more rapt attention toentities whose fortunes flow with yours.
In the survey, 54.1% say audit committee chairs should be paid morethan the heads of other committees. Raber opposes the idea, because hesays it could impose more liability on them than on others for theboard’s actions. “Keep in mind,” he says, “that the responsibility atthe end of the day is the board’s; the committee reports to the board.”Elson, too, warns that increasing the fees paid to some committeemembers could create increased liability for them that would not becommensurate with the pay.
But Millstein says that people who work more or work harder, or whohold positions of greater responsibility, should get paid more. And heisn’t worried about increased liability: “It seems to me the courtwould say these men and women were paid more, and therefore paid moreattention to their responsibilities.”
To measure the typical audit committee member’s changing workload,consider the experience of Barbara Alexander, a former investmentbanker and now a senior adviser to UBS Warburg who chairs the auditcommittee at Centex Corp. “We had good governance and good auditcommittee practices at Centex a couple of years ago, by the standardsof a couple of years ago,” Alexander says. “We had three face-to-facemeetings a year, each one lasting a couple of hours. Now we are meetingface-to-face a minimum of four times a year—we’ve already met fourtimes this year, and I expect we’ll have one or two more—and eachmeeting is lasting three to four hours.” Because of the new rulesrequiring senior executives to personally attest to financialstatements filed with the SEC each quarter, and the advice of legalcounsel that those executives should be asking questions about thosestatements in the context of an audit committee meeting, Alexander saysher committee will now convene over the phone each quarter for thatpurpose too, and may also meet by telephone on other issues as theyarise.
One of the biggest challenges confronting her and others in herposition, says Alexander, is simply keeping pace with the regulatorychanges that prescribe their duties. “Given that the number of newregulations seems to be increasing, if not daily, certainly withconsiderable frequency, one just spends a lot of time reading about theregulatory climate,” she says.
Alfred C. DeCrane Jr., former chairman and chief executive of Texacoand now a director of Harris Corp. and Corn Products International,says that members of the compensation committee frequently have heavyworkloads of their own and that they, as well as those on the auditcommittee, should qualify for extra pay. Hills concurs, as does Batts,even though Batts concedes such an arrangement might “perturb somedirectors on other committees.”
Ultimately, the overwhelming majority of governance experts anddirectors interviewed for this article agree that the most importantreason to raise board members’ pay is to compensate them fairly fortheir time—rather than for the risk of liabilities they may incur, oras an incentive to work harder. And that, says Millstein, is theAmerican way. “In this country,” he says, “you’re paid for what youdo.”
Boardroom Perks: Shrinking But Still Slick
Serving on corporate boards may be more demanding today than it was afew years ago, and companies may or may not adequately compensatedirectors for their time and the risks they assume. But at somecorporations, serving on the board still carries handsome perks.
Among the most common are the so-called product-evaluation privilegesoffered by airlines and car companies. At most major U.S. airlines, forexample—Southwest is a notable exception—board members and theirspouses get to fly free on their companies’ planes. UAL Corp. and AMRCorp. also offer free flights to dependent children and cover anyfederal tax liabilities directors might incur by exercising theirflight privileges. UAL takes the deal one notch further; it providesdirectors with free air-cargo services and offers free flights for lifeto those who retire with at least five years of board service. AtGeneral Motors, board members are eligible to receive a new GM car ortruck every six months, with the proviso that they return their currentvehicle when picking up a new one. Ford directors have the use of twofree cars a year. Their choices expand into Ford acquisitions,including Jaguar and Volvo—but not Aston Martin.
Directors get to “evaluate” products in other sectors as well. CallawayGolf Co. gives free golf clubs and other golf equipment to itsdirectors and any family members living with them. Whirlpool provideshome appliances, H&R Block income-tax preparation services. OrvisCo., a maker of fishing rods and other outdoor gear, doesn’t coddledirectors with exorbitant pay but does schedule its quarterly boardmeetings at some of the best and most exclusive hunting and fishinglocales in the world. (See “Angling for Profits.”) And directors of companies registered in Bermuda, such as Tyco International, get to go there.
That said, cars, airline tickets, dishwashers, trips, and Big Bertha drivers aren’t the perks prized most by directors.
“The most desired perk, which not all companies provide, is beingtransported to board meetings on company planes—particularly if themeeting is going to be held in a boondocks location,” says Warren
Batts, an adjunct professor of strategic management at the Universityof Chicago Graduate School of Business and a director of CooperIndustries and Methode Electronics. “Some boards almost have to do thatto get good directors. You could call it a perk; I could call it a nicecondition of service, if it means you don’t have to kill a lot of timegetting to board meetings.”
Batts says that when he served on the boards of Sears and Sprint,corporate planes were available to him. “If I was traveling and havingdifficulty getting back on commercial service, Sears would provide aplane for me,” he says. “Sprint, to a lesser degree, would do the same.It was not like they were running a taxi service, though—it was on aspecial-purpose basis. Cooper Industries does it too.”
Companies have become stingier with boardroom perks over the past fiveyears. Charitable donations made in the names of directors, pensionplans for directors, and health-care plans for directors are allbecoming less commonplace, according to governance experts. “Companieshave really scaled back,” says Charles King, managing director and headof global board services at Korn/Ferry International. “I think they arevery sensitive to this issue, perhaps because of all the scrutiny ofexecutive compensation, perhaps because they just want to do the rightthing, perhaps because the economy’s been in the tank. In any event,there are a lot fewer people flying around in corporate jets and a lotfewer frivolous expenditures.” On that score, General Electric is nolonger offering directors the chance to buy its Bellataire diamonds atcost.
Few directors complain publicly about the cutback in boardroom perks,and some applaud the trend. “The bulk of perks ought to be eliminated,”says Raymond Troubh, a director of nine public companies and theinterim chairman of Enron Corp. “Current compensation should be allthat directors are looking for.” Still, no one expects board members tosuffer too terribly. While some critics might complain about somethingas simple as holding a board meeting at a resort, King says, “you don’treally expect these folks to stay at the local Holiday Inn.”
