Guidance on compensation committee membership.

• Position: BOARD COMMITTEES

Ed. Note: The Complete Guide to Executive Compensation (Third Edition) by Bruce Ellig was published in January 2014 by McGraw-Hill (www.mhprofessional.com). Long recognized as the guide to executive pay, the new edition is an impressive, 1,000-page magnum opus, fully updated to address important changes regarding boards of directors' responsibilities, shifts in stakeholder power, venture capitalism, and laws such as Dodd-Frank and health care reform. Ellig is a renowned compensation expert. He directed worldwide HR for Pfizer Inc. and was secretary to the board's compensation committee. He has written several articles for Directors & Boards. The following is a passage from the book's examination of the compensation committee of the board.

All pay and benefit decisions of the board and other elected corporate officers are to be decided by the board with compensation committee input. The exception to this rule is when action is otherwise prescribed by law, regulation, or security listing requirements.

A rather common definition of membership is: the committee "shall not consist of less than three members meeting appropriate statutory and regulatory requirements as independent and disinterested persons." Typically, all committee members are members of the board.

Depending on the makeup of the particular board, the compensation committee made up solely of outside directors could consist of former governmental officials, bankers, lawyers, academicians, or executives of other firms. Some people are critical of companies whose board membership consists of retired members of management and those considered to be suppliers of contractual services (e.g., bankers, outside counsel, and management consultants). The retired executive may have fraternal ties to existing management, having hired and trained therm The presence of suppliers on the board may give a false signal to others that this company is "tied up" with a supplier.

Such individuals cannot be considered true outside directors, that is, individuals independent of management. To qualify, the individual must meet the SEC 16b-3 requirements. The SEC has also ruled that securities exchanges must adopt listing standards requiring that compensation committee members be independent.

Because many of the performance measures used in the executive incentive pay plans are financial in nature, it could be argued that the compensation committee should have at least one person who is a member of the audit...