Board stock ownership: more, and more again.

• Author: Meyer, Pearl

The tremendous growth in the use of equity is changing the landscape of total pay for directors.

The performance expectations, responsibilities and risks associated with directorship are in the midst of exponential growth, and new strategies for compensating directors are keeping pace. While the approach and vehicles used to pay directors have changed dramatically in the last few years, the story can be told in just one word -- ownership.

Equity has skyrocketed to a position of undisputed and unchallenged prominence in compensating the outside director for board service, restoring an ownership stake to directors that is reminiscent of the earliest days of Corporate America, and, at the same time, irrevocably linking the interests of board members to those of the shareholders whom they represent. Results of Pearl Meyer & Partners' 1997 annual survey of board compensation in the 200 largest U.S. industrial and service corporations confirm the dramatic cash to equity shift in how directors are paid.

The cash to equity shift originated more than a decade ago at the senior executive level with corporations moving an increasing portion of management and employee remuneration into company stock to motivate and reward the creation of shareholder value. When corporate governance activists turned their attention to director independence from management several years ago, a similar movement began and is now firmly entrenched at the board level. For evidence, we look to equity compensation, which accounted for an estimated 2% of total board remuneration in 1985 and now constitutes 45% of total direct pay. Corporate governance activists would prefer to see equity increase even further, to no less than 50%. With heavy use of outright stock and stock options, as well as widespread replacement of board pensions and all or a portion of cash retainers paid in equity, it appears that this 50% goal will be reached and indeed exceeded in the very near future.

The movement to stock ownership is basically unchallenged. There is a consensus within the business and investor communities that all stakeholders benefit when board members are on an equal "at risk" footing with the stockholders. Despite recent heckling aimed at directors pay, it has always been one of the best "buys" in American business -- and it has been the "how" of board compensation, not the "how much," that has been in question. The value of the "buy" has grown dramatically for shareholders since directors, through their pay, have come into ownership of meaningful stakes in the companies they serve.

Board ownership has ushered in a new era of management accountability. Bringing directors into an ownership position has stymied the inertia suffered by many boards, whose responsibility it is to hold management focused on the well-being of shareholders and the corporation's other stakeholders. Boards that once allowed entrenchment of ineffective management now monitor, evaluate and, where necessary, replace top management. Directors, with their own investment on the line, are found to be more vigilant -- more pro-active in meeting potential problems head-on before trouble arises and snowballs.

Unparalleled dominance of equity

As shown in Exhibit 1, 91% of the 200 largest U.S. companies now include stock in the compensation of their outside directors, as compared to a mere handful 10 years ago and 88% last year. The types of equity vehicles vary widely from outright full value current grants to deferred shares, restricted stock, and stock options -- and are often used in combination. When companies offering elective deferral programs, which permit tax-sheltered investment of current cash retainers and/or meeting fees in company stock, are added to the 91%, an unprecedented 95% of the top 200 corporations now include some form of equity in board remuneration. All but one of the survey companies pay annual retainers and 83% also pay board and/or committee meeting fees, which represents a 4% decline in the last year. Three-quarters of the companies recognize the greater responsibility undertaken by committee chairs by providing chairs with special retainers or higher meeting fees.

[Exhibit 1 ILLUSTRATION OMITTED]

As reported in 1997 proxies, total direct compensation for board service is at an all-time average high of $93,578 among the top 200 corporations. Annual retainers remain the largest...