A better approach to director pay.

• Author: Fitzsimmons, James J.
• Position: Chairman's Agenda: Governing for Shareholder Prosperity

Shareholder alignment is the goal, and that means eliminating certain fixed-cost elements and extending the use of stock options.

Given all the controversy surrounding CEO pay, it is only a matter of time before significant attention is focused on the pay of the CEO's boss - the board of directors. To prepare for this discussion and, more importantly, to do what's best for the company, it makes sense to take a cool-headed, analytical look at how board members are compensated today and consider how current pay arrangement might be improved upon.

In this article we do just that, starting first with a solid, fact-based review of how and how much board members are actually paid - with some findings that may surprise many readers - followed by a proposed approach that we feel represents a better way to pay directors. What we suggest is a more extensive use of stock grants and stock options that will help transition today's fixed approach to director's pay to one that is more performance-based and strongly aligned with shareholders.

A popular and frequently referenced survey, the Spencer Stuart Board Index (SSBI), tells us that the "average total compensation" of directors is around $45,000. If you are one of the many critics who think this is too much (given that directors "only" attend six to eight meetings per year) then you are in for a shock because the SSBI tells only slightly more than half the story. In reality, the use of stock-based pay and pension plans means that a director is receiving a lot more compensation. As Exhibit 1 shows, directors at the companies listed make a close to 40% more than the "total compensation" data reported in the SSBI survey.

The past 10 years have seen not only a significant increase in the amount of directors' pay but also greater variety in the way this pay is delivered. This is due principally to the increased use of pension plans and stock-based programs, including stock grants, restricted stock, and stock options. Yet, while the method of payment might appear dramatically different on the surface. Exhibit 2 illustrates that not all that much is different in terms of impact.

Back in 1980, directors tended to have an all-cash compensation package, consisting of an annual retainer and payments derived from meeting attendance fees. Meeting fees typically have involved a fixed amount - e.g., $1,000 that a director receives for showing up for meetings and, usually, separate fees for both board and committee...