Director pay: overhaul in progress: a 'premium' for board leadership: changes in board governance--in terms of time, effort, role, and responsibility--are beginning to be matched by changes in board compensation.

• Author: Canavan, Judy
• Position: Director Compensation

UNTIL THIS YEAR, director compensation practices tended to be generic. Differentiation in pay levels was historically driven by company size and industry rather than individual director contribution. A new factor is now influencing board pay--the role a director is required to play.

As described in the accompanying sidebar (see page 50), there is a growing imbalance between the new demands and traditional rewards of directorship. There is now heightened scrutiny, more stringent governance requirements, and greater intellectual and time requirements placed on directors; and, for certain roles, these demands are even magnified. In response, companies are considering very explicit changes to board pay--changes that reflect the contributions and role of the individual director.

There are two key categories of directors whose pay will be most affected:

* Leadership roles such as board chair, committee chair, and lead independent directors.

* Those in roles in which directors bear the greatest "burden of effort," generally translating into the greatest expertise and time. The primary focus is on the members of the audit committee, but we expect that this will broaden as other committees (e.g., compensation, governance) increase demands on directors.

A premium for board leadership

The CEO currently chairs most companies' boards. According to the Conference Board, in 66% of the companies surveyed, the CEO is also the chair of the board, while only 22% reported having an independent outside chair. Only 6% acknowledged having a lead director.

However, this will likely change. Institutional Shareholder Services (ISS) recommends voting for shareholder proposals requiring that the position of chairman be filled by an independent director, unless there are "compelling reasons" to recommend against the proposal. The Conference Board also asserts that if a company chooses to have its CEO serve as the chair, then a "lead independent director" should be an appointed position. The National Association of Corporate Directors and others also have similar recommendations.

To respond to these demands, more companies are considering the creation of roles such as lead independent director and independent board chairs. Additionally, boards are seeking directors who bring new expertise. This could have a dramatic impact on compensation for these positions as the demand for these roles outpaces the potential supply.

Even now, companies that have non-CEO chairs or lead independent directors are taking steps to acknowledge the additional time, effort, and responsibility through additional pay for these roles.

To shed light on the degree to which companies are paying a premium for these roles, we reviewed the compensation levels for three leadership roles:

1. The chair of the board, who is the company's former CEO.

2. The chair of the board, who is fully independent (i.e., was never an employee, is not the founder, and has no other material associations with the company).

3. The lead independent director.

In the accompanying table, the pay levels for these positions are compared with the overall director pay levels for the company. For instance, the chair retainer is calculated as a percent of the regular board member retainer. These data reveal some interesting findings:

* Companies pay their former executive chairs handsomely relative to other board members. Median total compensation levels are:

--Three times more than regular board members, and

Almost twice that of their fully independent chair counterparts.

Often these pay levels are designed as part of a transition package and are meant to recognize the level of knowledge and insight that these former executives bring to the table.

* Independent chairs earn, on average, 36% more than regular board members.

* Most companies pay lead independent directors a premium, but a few do not:

--Companies that pay a premium are providing 16% more than regular directors. Interestingly, this premium is about half as large as that for independent chairs.

--However, 20% of companies with lead...