Which Directors Will Get a Raise in 2004
from
September/October 2003
by Bonnie Azab Powell
Overall, 2002 was a blah year for director pay, according to a survey of 350 companies by Mercer Human Resource Consulting. Yes, average annual retainers and meeting fees rose by 5.1%, to $65,048—not bad, given the 2.4% increase in the year’s Consumer Price Index. But factor in long-term incentives and total compensation actually fell by 2.8%, to $151,881. That’s the bad news. The good news, which is beginning to show up in the next crop of proxy statements, is that some directors are doing a lot better this year—a trend that is likely to continue into 2004, when those with the nerve to assume high-profile chairs (of the audit or compensation committee, say) could see a 20% boost in their pay. And with stock options out of favor, more of that extra compensation is likely to come in cash or in restricted stock or other full-value shares.
The continued weakness of the stock market battered director pay in 2002, just as it had in 2001. But companies were nervous about using cash to make up the shortfall. One big reason: Sarbanes-Oxley. Companies didn’t yet know how the corporate-reform act would affect board structures and pay packages, and many were super-cautious. But now, says Peter Oppermann, a specialist in executive and board compensation at Mercer, “a lot more companies have started to make changes, especially when it comes to audit committee chair retainers. It’s the first time we’ve seen a differentiation between the chairs of committees, with a definite premium for the audit committee chair.” For example, Citigroup paid the chairman of its audit committee $25,000 in 2002, compared with the $15,000 it gave directors who headed other committees. Petroleum-products giant Ashland Inc. also pumped up what it paid for the job, handing its audit committee chair $5,000 last year. The heads of other board committees at Ashland received only the same $1,000-per-meeting fee as regular committee members.
The sorry stock market also pinched directors where it hurts. The Mercer study shows that a slightly greater percentage of companies—96%, vs. 95% in 2001—used stock in their 2002 director compensation packages, even though stock as a proportion of total pay fell slightly among the companies Mercer surveyed, to 55.8% from 56.6%. Mercer valued stock options using a binomial option-pricing model.
Stock is likely to remain the biggest slice of the pie, however. Says Claude E. Johnston, a managing director of Pearl Meyer & Partners, the compensation practice of Clark Consulting that studied director compensation at the 200 largest U.S. corporations: “You’re still going to see most well-designed director pay programs keep at least half or more of compensation in the form of equity.”
Directors don’t need studies to describe the damage to their compensation that the stock market can wreak. Those who sat on three of the boards Mercer ranked as best paid—Analog Devices Inc., AOL Time Warner Inc., and Capital One Financial Corp.—got, in fact, little or nothing. At Analog, a semiconductor maker, $817,423 of each director’s total comp came in the form of stock options—only $48,000 of it was in cash—and most of those options were largely underwater. At AOL Time Warner, directors were even worse off. All of their comp was in stock, and all of it languished in Davy Jones’s locker.
At Capital One, one of the biggest issuers of credit cards, the directors also ended up working for free—in their case, for the fourth year in a row. Their comp, like that of the company’s top executives, is linked to Capital One’s performance, thanks to a 1999 boardroom vote in which directors waived their annual $35,000 cash retainer and all meeting fees in exchange for one-time grants of performance-based options. “I think we’re different from a lot of directors in that our group tends to be more entrepreneurial,” Stanley Westreich, chairman of the compensation committee and president of Westfield Realty Co. in Arlington, Virginia, told Virginia Business at the time. “We’re willing to accept the risk.”
Or they were back then. In 2002 Capital One’s total return to shareholders was -44.8% — and the directors’ entire $1,042,845 stock-option compensation lay embedded in the ocean bed. The board’s tolerance for risk seems to have evaporated. The 2003 proxy states that “to reflect additional demands on the director for service,” the compensation committee, which Westreich still chairs, granted each outside director 60,000 options. The exercise price is $31.76, the stock’s market value at the time of the November grant, and the options vest over three years. Capital One shares were at $53.49 on June 16, 2003. If the price remains steady, board members will have made $434,600 apiece by November. AOL Time Warner’s board has also done some new thinking. Director comp for 2003 gives up on stock options entirely—how’s that for faith in a turnaround?—and will pay directors a $50,000 annual retainer instead, along with an annual award of common stock with a value of $72,000.
Directors of Starbucks Corp., No. 3 on the best-paid list, are also remunerated entirely in stock. But those shares did better than many, rising 38.3% for the year. Board members at Tenet Healthcare Corp., No. 4, did well from both sides of their compensation mix. The company’s stock rose 63.8% in its fiscal year that ended in May 2002, and they collected $92,600 in cash.
Given the feeble markets, cash was obviously a director’s best friend in 2002, and the bigger the proportion of cash in the package, the truer that friendship. Directors of truck manufacturer Paccar won on two fronts, however. They collect almost 93% of their comp in cash—$130,000 for the year, more than any other company in the Mercer study. As a bonus, the stock that made up some 7% of their pay rose in value by 9.1%.
With Sarbanes-Oxley reforms now on the table, companies are likely to reward directors for the harder work that the act demands they do. “The meeting fee is a way to compensate people who are spending more time and effort,” says Claude Johnston. “If the audit committee is going to meet 12 times and another committee only four, it’s a more fair allocation to include a meeting fee.” That’s already happening. Even though slightly fewer companies handed out meeting fees in 2002, those that did increased the amounts they paid. Overall, committee meeting fees and retainers for all chairs were up 9.7% and 6.1%, respectively, according to the Mercer survey. The study by Pearl Meyer found that chair retainers averaged $10,000 for audit committees and $7,500 for compensation committees. The average retainer paid to those who chaired any committee, including audit and comp, was $6,996. Johnston thinks that directors serving in high-profile committee roles could see raises of 20% by next year.
Many reformers are pushing companies to divide the top jobs of chairman and CEO or, failing that, to name a lead director. Neither idea has picked up much steam. The Investor Responsibility Research Center (IRRC) studied board structure, independence, and compensation at 1,245 small- to large-cap companies in 2002 and found that only 84 of them have separated the two top jobs and named a non-executive chairman who met its definition of “independent.” Even fewer companies, 37, have identified a lead independent director. Many observers expect, however, that a lead director, not an independent chairman, is the way most companies will go. “It’s just never been baked into our corporate governance practices that you need two equal people at the top,” says Mercer’s Peter Oppermann. Either way, an independent chairman or a lead director can expect to be well paid, perhaps collecting a retainer that’s as much as 50% more than other outside directors’.
As the cash portion of compensation edges up, and with no fast recovery in sight for the depressed markets, both Mercer and Pearl Meyer predict that full-value stock grants will continue to gain popularity. General Electric, among others, decided in December 2002 to do away with options this year in favor of full-value grants. In July Microsoft made a similar announcement, and more companies may follow. That shift seems to go over well with the watchdogs. “Investors have grown suspicious of options, as they encourage a short-term focus with no downside risk for executives,” says Carol Bowie, the IRRC’s director of governance research services. “Many believe that used prudently, direct stock awards that are either tied to performance or require long holding periods, or both, will provide better alignment with long-term shareholder interests.” Paul Hodgson, a senior research associate at the Corporate Library, a shareholder watchdog, says he’d like directors “to spend some of their own money on stock, rather than have it awarded as part of their fees.” But any ownership is better than none, he adds: “We want directors to hold stock because it helps focus their minds on what they’re supposed to be there for.”
One thing remains sure about director compensation. As Bowie puts it, “Generally, investors will be tolerant of increased compensation for board members in exchange for their increased vigilance in protecting shareholders’ interests.” In other words, a raise is fine—but you’ll have to earn it. And many directors undoubtedly will.
Correction: Missing Minus
In the article “Which Directors Will Get a Raise in 2004” (September/October 2003), we reported that Capital One Financial Corp.’s total return to shareholders in 2002 was 44.8%. The credit-card issuer actually had a negative return (–44.8%), as the table accompanying the article accurately stated—which is why the board’s options ended so deep underwater.
