Why Some Board Members Are Paid More Than Others
from
September/October 2005
by Julie Connelly
The governance world has always maintained the polite fiction that all directors on a board are equal and therefore all are paid the same. Yet the biggest trend to emerge from a new survey of board-member compensation at the 200 largest U.S. corporations is that some directors make a lot more than others. The disparity shows up at the committee level. Says Gregory Loehmann of Pearl Meyer & Partners, which conducted the 2005 survey exclusively for Corporate Board Member: “Over the last three years, the incidence of boards paying an increased amount to one committee member or chair versus what the counterpart might get on a different committee has increased from 23% of the top 200, to 51%, to 67%.” Similar disparities showed up in a survey by Aon Consulting of some 1,500 companies of various sizes.
As regulatory requirements and governance best practices have boards restructuring themselves and creating new positions like lead director or non-executive chairman, the pay differential becomes even more marked. For example, the compensation collected by Walt Disney Co. directors makes that board look like Snow White and the dwarfs, at least in terms of relative scale. Non-executive chairman George Mitchell gets $500,000 a year plus options on 6,000 shares. The other board members receive the same annual option grant, but the rest of their compensation totals only $160,000 apiece. That assumes, as most compensation studies do, that Grumpy or Sneezy is a member of two committees and chairs one of them.
Pay differentiation is but one of three trends spotlighted by the Pearl Meyer study. The others: Pay is going up, and options are losing favor as a part of director compensation because they are viewed as an inappropriate form of pay for performance. While it’s hardly news that what directors are paid is rising, the increase at the top 200 companies is relatively modest. Total remuneration grew 8.7% in 2004, to $191,971, on top of a 13% hike in 2003. The cash retainer rose by 14.2%, to $51,702, after a 17% increase the year before; the equity portion was up 6.1% from an 8% expansion the previous year. Overall, cash accounted for 44% of the package, slightly more than in 2003, and equity was 56%. However, if you enlarge the sample size to 585 of the largest U.S. companies, which Aon Consulting calls the “jumbos” in its pay survey, total compensation is up 20%.
In their own worklives, many shareholders have never seen a 20% annual raise, but they don’t seem to be complaining about directors who do. Listen to Darren Robbins, a partner at Lerach Coughlin Stoia Geller Rudman & Robbins, a firm of plaintiffs’ attorneys not exactly celebrated for their empathy with the corporate establishment. “My clients are concerned that directors not be underpaid. They want them engaged,” Robbins says. “It’s a balance, like many things, but they want to avoid the head-in-the-sand Enron situations.” Adds another plaintiffs’ attorney, Edward Labaton, a senior partner at Goodkind Labaton Rudoff & Sucharow, the lead firm in the current class action against AIG: “Director compensation is a drop in the bucket in most large corporations. People are offended by $5 million or $20 million or even $100 million in executive comp, but to pay a director $100,000—that doesn’t attract any attention.”
Indeed, director pay is relatively picayune. The Pearl Meyer research shows that over eight years total board-member remuneration has averaged just 1.4% of the total collected by CEOs at those same top 200 companies.
Perhaps because director pay started out more or less as an honorarium for people who made their living doing other things, it often continues to have an ad hoc feel to it. Says Jill Kanin-Lovers, formerly senior vice president for human resources at Avon Products and currently a director of Heidrick & Struggles International and Alpharma Inc.: “Board compensation is not a discipline like executive compensation. It’s more fluid.”
Although members of the board set their own pay, with the compensation committee usually in charge of coming up with a package for the whole board to vote on, no one seems to have any firm sense of what is too much or even what is enough. The main thing is that directors want to be compensated for the increasing amounts of time they have to spend on board business and travel. “As they get to feel overburdened, they start to inquire whether they are being paid competitively,” says Pearl Meyer, chairman of the firm that bears her name.
Were directors paid at an hourly rate commensurate with what they command in their professional lives, board pay would be up in the stratosphere. But that’s not the way it happens. Directors are careful, especially these days, not to appear greedy. They look at what peer outfits are paying and consider such qualitative aspects as the complexity of their company and the work demands that are likely to be placed on the board. They also call in compensation consultants for advice. And then they go their own subjective way, typically pegging their bucks to the median figure turned up by their research and to the peculiarities of their company. Says venture capitalist Betsy Atkins, a director of Chico’s, Polycom Inc., and Reynolds American Inc.: “In the end, you look at your compensation as how it will be seen by outside institutional investors and the advisory firms like ISS [Institutional Shareholder Services] or Glass Lewis.” Even so, there is a ratcheting effect. “If you want to be at the median and pay keeps increasing to reflect the time constraints of the job, then the median keeps rising,” says Watson Wyatt consultant Diane Lerner.
The decline of options as part of the pay package also reflects a concern for appearances. Gregory Loehmann of Pearl Meyer observes that the disenchantment with options parallels the shrinkage in director pensions, which none of the biggest 200 corporations award anymore. “Once things start rolling and somebody calls something a best practice, directors almost have to do it,” he says. “The practices at these large companies are good proxies for public opinion.” As recently as 2002, 75% of the top 200 corporations granted options to their directors. Today only 50% do, while 80% are handing out full-value shares. Just about everyone applauds this move. Says Cynthia Richson, corporate governance officer at Ohio’s Public Employees Retirement System: “It’s better that the board not be subject to any potential incentive to manipulate the stock price short term.”
Of course, some directors are paid more than others at the same company because their workload is weightier. More and more of the board’s business is transacted at the committee level, where the issues are thrashed out and a consensus for action is developed and presented to the whole board. As a result, committees are meeting more often. For example, the average number of audit meetings at all companies rose 17% in 2004 over the previous year, according to Aon Consulting. “The highly differentiated pay is a direct reflection of the time involvement,” says Patrick McGurn, executive vice president of ISS. “Many audit committees are meeting once a month, and when you include telephone meetings, sometimes they’re meeting twice as often.”
It’s logical, therefore, that the members of the audit committee are the chief beneficiaries of higher pay—especially since arms frequently have to be twisted to get people to serve. Pearl Meyer tells of sitting in a CEO’s office and hearing only his side of a telephone conversation, which consisted of a repeated “No way!” When he hung up, he laughed and told her, “They just asked me to be chairman of the audit committee. No way am I going to do that!”
Among the top 200, total 2004 pay for the audit chair included an average of $24,080 for committee service (retainer and meeting fees), a 14.8% increase from 2003. The members of the audit committee got a 4.9% raise, which took them to an average of $11,802. Meanwhile, the poor stiffs over in compensation, who’ll be spending the rest of 2005 figuring out how to pay CEOs their customary extortionate sums when options have to be expensed starting in 2006, averaged $15,416 for the chair, up 11.1%, and $6,651 for the members,up 2.6%. Pay for the members of the governance and nominating committee actually declined 2.7%, to $5,042—let’s not dwell on the symbolism of that—but the chair’s pay rose 7%, to $12,491.
For a real-world illustration of this pay differential, take a look at Monster Worldwide, an online job mart. The retainer that Ronald J. Kramer, president of the casino company Wynn Resorts, receives as chairman of Monster’s audit committee is suitably gargantuan at $96,000, whereas the chairman of the compensation committee, Michael Kaufman, former president of SBC/Prodigy Transition, pockets a comparatively paltry $25,000. The Spencer Stuart Board Index comments that Kramer’s is the highest audit retainer among the S&P 500. Of course, the Monster audit committee did meet 16 times in 2004, while the comp committee got together nine times and the whole board met eight times.
Differentiated pay might also mean differentiated liability for directors if class-action plaintiffs try to contend that the better-paid board members have a greater responsibility for the affairs of the corporation. The Delaware Court of Chancery recently found that Salvatore Muoio, an outside director of Emerging Communications, a U.S. Virgin Islands telecom that went private, had an obligation to vote against accepting a merger price from the controlling shareholder that Muoio, a former securities analyst with expertise in the telecom industry, knew was inadequate.
Directors are invited to join certain committees because they have specific expertise, and it is easy to conflate higher pay with more expertise and greater responsibility. While the presence of an expert on a committee does not relieve the other directors of their due-diligence responsibilities, in reality most people tend to yield to the specialists in the field. And aren’t those financial experts on audit committees putting in more time so that the board as a whole can be confident that the company’s financials accurately reflect the state of its business?
Fortunately, the Securities and Exchange Commission has been clear that the financial expert on the audit committee is not more liable than other directors just because he or she has specialized knowledge. “And that is, or ought to be, the Delaware law as well, in my opinion,” says E. Norman Veasey, former chief justice of the Delaware Supreme Court and now a partner at Weil Gotshal & Manges. “It would be a perversity of corporate governance goals, in my view, for Delaware courts to announce a general rule that a director with special expertise is more exposed to liability than other directors solely because of her status as an expert.”
Beyond the increasing pay differentials among directors that result from their committee work, another question is how much extra a lead director or non-executive chairman should be paid. Figuring out compensation for a lead director is particularly difficult, because the parameters of the job vary from company to company. Sometimes an officially designated lead or presiding director has clearly defined responsibilities for setting agendas, meeting with the CEO, and chairing executive sessions. Other times the title rotates among the audit, compensation, and governance committee chairs, depending on what issues are facing the company. There isn’t much market data on lead-director compensation to look at, “so you have to apply judgment about the additional time the job will take,” says Peter Lupo, national compensation practice leader at Aon Consulting. “If it will take 20% more time, you pay them 20% more. Or sometimes you look at how much the person’s time would be worth in a professional capacity—say, $500 an hour or $600 an hour—and pay them that way.”
At the top 200 corporations, lead directors receive an average of 17.5% more than the other directors, according to the Pearl Meyer study. “But only 33% of these companies have official lead directors, and just under half of them are paid for their additional time,” Meyer says. “The job rotates at 46% of the companies, and those directors are not paid for it.” There are even fewer non-executive chairmen than lead directors; only 11% of the top 200 companies have them. Most CEOs maintain a death grip on the chairman’s title and greet any attempt to split the two jobs much as Saint Augustine viewed chastity: Yes, but not yet. But deciding what constitutes adequate pay for the chairman is easier than for a lead director, because the chairman is benchmarked against the CEO. “Say the CEO’s base is $1 million and the chairman puts in a quarter of the CEO’s time,” says compensation consultant J. Richard of the Half Moon Bay, California, firm of the same name. “That’s a $250,000 retainer.” The non-executive chairman doesn’t receive a bonus as the CEO does, but Richard believes that in addition to the retainer he or she should get a premium, at least 25%, over what the other directors are paid in meeting fees and equity grants.
George Mitchell’s $500,000 is high but not unique. Nicholas deB. Katzenbach, MCI’s outside chairman, pulled down $425,000 last year—a $150,000 board retainer, an additional $125,000 retainer for being chairman, and $150,000 for what the MCI proxy called “service on the Board of Directors of WorldCom, the Company’s predecessor corporation.” Says Paul Hodgson, senior research analyst at the Corporate Library, a governance watchdog: “If you look at the pay levels in the U.K., where there is a split between the CEO and a non-executive chairman, you’ll find that many of the chairmen are paid at a level similar to Mitchell’s.”
Money has rarely been the prime lure for a director, although anyone choosing between two board positions that were otherwise equal would certainly take the job that paid more. Compensation experts expect pay to start leveling off in three to five years, once the procedures are in place for the audit committee to deal in a routine manner with Rule 404, the part of the Sarbanes-Oxley Act that sets internal reporting standards. “And if it doesn’t level off,” warns Cynthia Richson of the Ohio Public Employees Retirement System, “I’m going to be asking questions.” That’s when board members and shareholders alike will learn the answer to the question, How much is enough?
