The compensation committee recharged: what's being asked of the committee in the coming year challenges the traditional distinction between oversight and management. How should the members fulfill their expanded role?

• Author: Nussbaum, Martin
• Position: COMPENSATION COMMITTEE

COMPENSATION COMMITTEE members, like their colleagues on the audit committee, are facing higher levels of responsibility and increased scrutiny. The focus on the audit committee intensified with the scandals leading to the passage of the Sarbanes-Oxley Act in 2002. While that law did not impose the same sorts of requirements on compensation committees, it did address certain of the compensation practices associated with those scandals, such as loans, trading blackouts, and bonuses paid on the basis of incorrectly reported earnings. More generally, tonality and approach of SOX has been extended to other areas of governance.

An obvious parallel is the relationship between the compensation committee and the consultants who assist it in making its decisions. Auditors were required to be independent before the adoption of SOX, but the precise delineation was principally a matter determined by occasional SEC pronouncements and self-regulatory mandates. SOX specifically prohibited firms functioning as independent auditors from performing services that had traditionally been deemed acceptable. While there is no list of prohibited relationships that would debar a compensation consultant from performing any particular services, disclosures concerning the compensation committee and the compensation process call for disclosure of the roles played by management and consultants in compensation decisions. To the extent that a consultant is engaged by management to perform services for the company, that too must be disclosed. Such retention of the consultant by management can become a basis for challenging the consultant's independence.

The traditional role of the compensation consultant in working with management to design programs and administer benefit plans may well be bifurcated, with one consultant working with management to create and administer plans and another, working solely for the compensation committee, charged with reviewing compensation and providing advice with respect to market standards. To the extent that such a division becomes the norm, and the number of consultants involved in the compensation process increases, there will be a greater burden placed on small and midcap companies and their boards.

Disclosure ... and more disclosure

Disclosure is also the route that is driving increased involvement by the compensation committee in the determination of compensation. The extent of compensation disclosure has been increasing over the past...