The first rule of director compensation should be that you have to show up to get paid,” says Rees of the AFL-CIO. “Directors who miss more than 25% of the board meetings, frankly, shouldn’t be renominated.” Part of the problem, says Rees, is that many directors are “over-boarded” — meaning they serve on so many boards they don’t have time to do the job.
There has been considerable debate over the last decade on the responsibilities of the Board, Board performance and compensation linkages. Various boards have come under scrutiny for having received compensation which showed no linkage to the company’s poor performance under their guidance.
Cedar clarifies the role of the Board and provides guidance on the appropriate compensation package to ensure that the Boards discharge their responsibilities effectively.
Responsibilities of the Board of Directors
The Board is collectively responsible for promoting the success of the company by directing and supervising the company’s affairs. Key Responsibilities of the Board of Directors are:
- Strategic supervision of the company, being free from day to day tasks: This is important because the directors focus on the long term interests of the company. Their objective is to ensure that the strategic viewpoint is given importance and not compromised.
- Trusteeship to protect & enhance shareholder value: One of the most important responsibilities of a director is to ensure that shareholders interest is protected and the value of their holdings is maximized.
- Set strategic goals & seek accountability for fulfillment from the senior executives: The directors are in a position to discuss strategic objectives and to ensure their compliance so that the company is able to follow the strategic intent.
- Collectively responsible for the success of the company: Through effective program planning, implementation and evaluation the directors have to ensure that the company achieves desired levels of performance and moves towards achieving the future goals of the company.
- Prudent & effective controls to manage risk: The directors have the primary responsibility to ensure that proper control mechanisms are in place (both financial and others) for the effective implementation of the objectives laid out for the company while managing associated risks.
- Set company values and standards: Directors are the ambassadors for and representatives of the organization. Their interaction with individuals and groups both within and outside the organization’s membership affects the image the organization has in the community. Also they play a crucial role in defining the values and standards for the company.
Key Responsibilities for the Chairman of the Board are:
Provide leadership: As a chief mentor, the chairman of the Board should act as a guiding force for the other members. He should ensure that the Board is able to discharge all its responsibilities and duties in an effective manner.
- Ensuring provision of accurate, timely information to directors: It is imperative to have access to accurate and reliable data on time to take impactful decisions. To ensure the effectiveness of the Board, the chairman has to play an important role ensuring that timely, adequate and correct information is available to the directors.
- Effective communication with shareholders: The Board of directors act as trustees for the shareholders and as the leader of the Board, the chairman has to take the responsibility for effective communication with the shareholders to keep them adequately informed about the affairs of the company
- Evaluate performance of the Board & its committees: As the head of the Board of directors, the chairman has to supervise the functioning of the Board and the committees to ensure that they are discharging their responsibilities in an adequate manner.
- Facilitate effective contribution of non-executive directors: For the overall interest of the company, the chairman should encourage increased participation and involvement of the non-executive directors. There should be adequate deliberations across crucial aspects to ensure that best possible decisions are taken. In doing this the chairman shall encourage constructive relations between executive and non executive directors.
Key Issues Concerning the Board
Strategic planning: It is important that the Board of directors is clear about the organization’s objectives and aware of the organization’s resources, to incorporate both into being consciously responsive to a dynamic environment. The Board has to ensure that fundamental decisions impacting the long term objectives of the company are judiciously taken.
- Meeting key managers: For effective implementation of strategic objectives the Board needs to meet key managers and discuss and review the progress in relation to the goals set. They need to discuss on crucial matters pertaining to the success of the company and to ensure adequate deployment of strategy.
- Succession Planning: This is increasingly gaining importance keeping in mind the long term existence of the company. It is important for the company to regularly recognize and develop people within the company to take up bigger roles in the future. The Board should work towards having an adequate bench strength for critical roles.
- Discussing the competition: No organization, howsoever successful, can afford to ignore competition both existing and prospective. The Board must discuss key issues on competition and recommend future course of action as and when required.
- Discussing the industry: Just as competition is important, the industry as a whole should also be studied on an ongoing basis. New trends and developments should be discussed and possibilities of diversification and growth should be explored. Mergers and Acquisitions are of particular importance in this regard. The Board should be vigilant and should always be on the lookout for opportunities for growth.
- Risk Management: The Board of directors are the trustees of the shareholders and should ensure that through adequate control mechanisms both financial and others the risk is managed effectively. A system of adequate checks and balances at appropriate levels should be in place to ensure risk, particularly financial, is adequately addressed.
- Monitoring performance: As the trustees for the shareholders, the Board should monitor the performance of the company on a regular basis. This is important to ensure that the company is on track as far as its strategic objectives are concerned. “GE’s new pay for director performance is sure to be revised yet again. But for the moment it is pointing in the right direction: some cash, some stock, and some time before stock can be cashed”, say Dennis Carey and Michael Useem of “Directors & Boards”
Good Board Practices
The division of responsibility between the Chairman and the Chief Executive Officer (MD/GM) should clearly be laid out in writing and agreed to by the Board. As per central bank regulations in UAE, these roles should be clearly demarcated and segregation of functions of the Board and general management to prevent any overlap.
In India, due to high family ownership, the non-executive Chairman usually is a family member, safe guarding the interests of the majority share holders. Some Boards have the position of Chairman- cum-Managing Director which should be discouraged.
For listed companies, a senior independent director should be appointed, to lead the non-executive directors and chair meetings with non-executive directors in the absence of the Chairman.
To ensure effective commitment, the number of Board memberships for a person should be restricted to 4-5.
The size of the Board for large organizations should be around 10-14 to be effective. There may be local regulations which need to be adhered to.
Guiding Principles for deciding compensation to Directors
The Board compensation package should be competitive to attract and retain experienced talent.
- Compensation should be in line with the experience/expertise that the member brings to the table.
- The compensation policy may provide for variable compensation that is directly linked to the performance of the company along various parameters such as company performance (revenue growth, market share, profitability, productivity, share performance etc). There should be multiple parameters to prevent manipulation. The Board gets compensation only for creating the framework for delivery and monitoring, not the actual delivery.
- A meaningful way of aligning the shareholder’s and director’s interests is to look at compensation partly by way of stock. Non-management directors should own stock in value terms to the extent of 3-5 times their annual retainer fee over time. Some companies provide loans to facilitate this. This is discussed in more detail below.
- Only non-management directors are to receive compensation for serving on the Board.
- Board compensation varies depends on a variety of factors including company size, maturity and industry. Typically the compensation for a Board of a small unlisted company will be lower than a big listed company.
- The chairman receives 25-50% more than other directors.
- In case the Board member performs some other special function other than discharge of regular board duties, he should be compensated accordingly
Components of Board Compensation
The main components of Board compensation are:
Annual retainer for Board Meetings
These are fees that are paid to the Chairman and the nonexecutive Board members and may be paid monthly, half yearly or annually. This is the main component of Board compensation.
In various countries it is paid as a commission (including India) and may vary from year to year depending on the performance of the company. However, there is no evidence of direct linkage as payment being a percent of profits.
Typically retainers vary from USD 10,000 for small/medium to USD 50,000 (large) depending on the size of the company. In developing countries like India they would tend to the lower range. In the Fortune 500 companies the sums are much larger.
It is recommended that certain portion of the retainer should be paid as restricted stock, discussed below.
Board Meeting fees (per meeting)
Board meeting fees are paid to the Chairman and the Board members for discharging their duties towards the company by regularly attending the Board meetings. It is envisaged that 4-6 meetings are held annually, once every quarter. Fees are in the range of USD1000-2000 per meeting. In India it is lower between USD 100-300 per meeting.
Annual retainer for Committee Meetings
Board members may serve on various committees such as audit committee, compensation committee etc. An annual retainer is paid to the non-executive Committee Chairman and the non-executive committee members for discharging their duties towards the company by serving on the committees. Some of the committees such as the audit committee warrant higher retainers with increasingly complex compliance issues. Typically committee retainers are in the range of USD 7500-15000.
Committee Meeting fees (per meeting)
Non-executive Board members who are part of the committees are compensated separately for the Committee meetings that they participate in towards discharging their responsibilities towards the company. The no. of committee meetings for each type of committee are expected to be 4 per year in the normal course. The range would be between USD 500-1500 per meeting.
A meaningful portion of the Board’s retainer should be way of restricted stock to be available after the person leaves/retires from the Board. It is recommended that 50% of total board compensation should be paid as restricted stock and balance 50% should be paid in cash. If there is a variable portion depending on company performance, minimum 50% should be paid as stock. In India and the Middle East, the practice of compensation by way of restricted stock is still to pick up.
The non-executive directors should hold stock to the extent of 3-5 times their annual retainer. These measures align interests of the directors with those of the stock holders and the long term interests of the company.
There has been practice of rewarding the Board by way of stock options in the west and India. However, stock options have become undesirable as a form of compensation because of the undesirable focus on share price (which is subject to manipulation) instead of company’s underlying performance. There have been various instances in the USA/ UK to discourage stock options. Even for CEO’s in major US companies (Pepsico, Merrill Lynch) stock options have been jettisoned in favour of restricted shares that are worthless unless earnings targets are met. Where directors leave, the options/restricted stock should vest one year after they leave.
Some of the other benefits that may be given are (a) reimbursement of travel fees, (b) providing insurance – Director’s liability, Life, Medical and (c) Matching donations, charitable giving plan (d) retirement pension plans, payments to honorary emeritus directors etc.
It is generally recommended that part of the director’s compensation should be by way of restricted stock. The Board members are also not to sell the stock till they retire thus avoiding room for short term manipulations. Board member’s stock value thus becomes directly proportional to the long term growth of the firm.
The Board is responsible for giving direction and monitoring the performance of the company and protecting share holders interests. The Board members bring valuable experience to the company and they need to be suitably rewarded. Their contribution/ performance is reflected in the company’s performance, measured not only by stock performance but other performance parameters of market share, revenue, profitability etc.
While the Board has significant responsibilities to protect and enhance Shareholder value, setting strategic direction and goals and providing leadership guidance to the entity, it is imperative that it also gets compensated adequately and proportionately. The balance therefore lies in determining the right mix of setting it to be competitive, yet ensuring that it is not disproportionate.
The best Board compensation structures are not just set by industry benchmarks, but by defining the context and strategic vision, and aligning with what is good for the company in the long run.
For a further conversation on this subject of Cedar View or how we may be able to help please email V. Ramkumar, Senior Partner, Cedar at V.Ramkumar@cedar-consulting.com