Principles-based governance of executive compensation: a group of independent directors, concerned about the state of executive compensation, is encouraging boards to adopt guiding principles.

• Author: Delves, Donald P.

Over the past year, over two hundred independent directors concerned about improving the governance of executive compensation have held discussions on how to develop and implement compensation principles and best practices. The Independent Directors' Executive Compensation project (IDEC) was created to encourage boards to consider voluntary changes in order to make their compensation programs more responsive to corporate governance principles and better understood by shareholders.

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IDEC's core recommendation is that boards use the best practice known as principles-based compensation--adopting a set of key principles as a lodestone to guide the board through pay decisions. IDEC has developed a tentative set of principles for boards to consider. These resulted from a consensus reached by about 200 independent directors, expressed in small conferences, individual meetings, conversations and correspondence. (As members of IDEC, we have been involved in this process.)

The purpose of the project is to be a resource to board members and others for highly effective oversight of executive compensation. The principles are seen as an initial framework for collecting, organizing and disseminating best practices, research, articles and dialogue on the governance of executive compensation.

IDEC Principles

The IDEC principles include: alignment with shareholders and company strategy; accountability--meaning that boards effectively use compensation to hold management accountable; engagement--the capacity for compensation programs to attract, retain and motivate high levels of performance; fairness--to executives, employees and, above all, to shareholders; objectivity--requiring that board and compensation committee decisions be based on unbiased information and advice; and transparency--clearly showing shareholders and the public the entire process.

This initiative is already bearing fruit. Two boards have committed to principles-based compensation, and many others are considering doing so. These boards have adopted a customized set of principles and will use them to evaluate management's compensation programs and practices, and as the basis for communicating those programs to shareholders in the companies' annual proxy filings.

IDEC offers its set of principles not as a prescription but as an exampleto consider. The project is seeking to avoid a one-size-fits-all approach because, members believe, boards should...