Best practices in director pay.

• Author: Davis, Michael L.
• Position: Directors of corporations

Early in 1995, the National Association of Corporate Directors (NACD) commissioned a study on director compensation. The special Blue Ribbon Commission consisted of 19 members, including corporate chairmen, chief executives, outside directors, board advisors, educators, and shareholder advocates (see box, page 18). The objective was to examine existing U.S. director compensation practices and determine how, if at all, these practices could be improved to meet better the overall goals of the corporation. The commission released its report in mid-june, recommending five principles for use by all companies. Based on these principles, the report also outlines six best practices that boards should consider in the design and administration of director compensation programs.

The principles and best practices outlined in the report are viewed by some as revolutionary, by others as necessary and long overdue, and by others with skepticism. Whatever your view, it is a new direction for those involved in designing and administering director compensation programs.

There is no widely accepted philosophical framework for director compensation in the United States. This is surprising given the important role corporate directors play in the companies they serve and in society as a whole. Interestingly, executive compensation plans frequently speak of the need to attract, retain and motivate top management; on the other hand, director compensation plans frequently discuss the need to attract and retain, but rarely address the need to motivate. This omission apparently reflects the view that incentives work for executives, but not for directors. True, the director job is quite different from that of the executive. The commission, however, makes a case for rejecting this difference and recommends that companies address this missing goal of motivation.

The commission defines two purposes for a director compensation program:

* Align the interests of shareholders and directors.

* Provide value to directors for value received.

There is no single formula for achieving these two purposes; each company's circumstances are unique. Each company must independently assess its own situation and shareholders must recognize the need for these programs to differ from company-to-company. As the NACD report indicates, although these programs are likely to be different across companies, "the world is watching, ready to praise or criticize, based on what it considers to be best practices."

Five Principles

Despite the varying...