What to ask about compensation.

AuthorMeuter, Fred, Jr.
PositionCorporate compensation committee members - Advice to the Rookie Director

For compensation committee members, here are the key questions for determining what is expected of them and what the roles of the committee should be.

Today shareholders, employees, and the general public know more about the mission and workings of companies' compensation committees than they did four or five years ago.

To a great extent, this has resulted from the greater public exposure that committees are getting from the improvement of company proxies. Now, you can read and understand a proxy without first being a graduate of Harvard Law School! Some companies such as McDonald's have tried to make the proxy readable - a development that can only have positive results now and in the years to come.

More shareholders now realize that there is an identified group of company directors who are responsible for the overall structuring of a company's executive compensation program. It can be expected that this greater external visibility of the compensation committee will continue to grow and certainly its impact on executive compensation affairs will become more significant.

The committee's roles are now becoming better defined than during the latter part of 1989 when I wrote an article for DIRECTORS & BOARDS titled: "Questions the New Compensation Committee Member Should Ask." The present article updates some of the thinking expressed in 1989, focuses on the current roles of the committee, and touches on what committees may be doing in the future.

Again, as I did five years ago, several key or core questions should be raised and answered in order for all committee members, not just new ones, to determine better what is expected of them and what the roles of the committee should be. Let's start with what could be considered the key question:

Is the committee and its members expected to play a proactive or reactive role in executive compensation matters?

My thinking on this point has changed since five years ago when some compensation committees purposely were not playing a significant part in the design and evaluation of executive compensation programs. Previously, many committees operated from a lofty vantage point and resisted involvement in the design or evaluation aspects of a program unless they were conceptual in nature. Of course, there was always the ongoing involvement in the annual approval process of salary increases for the top tier of the company's executives. However, even here, company compensation practitioners were frequently asked by committee members this nagging question: Can't you decrease the number of executives whose compensation levels we are being asked to review?

Today, the situation has changed. I believe that committees are becoming more proactive. Members are questioning not only the many facets of executive compensation plans that are in place but also are asking why particular executive compensation approaches are not being used by the company. The proactive approach is certainly rapidly becoming the norm.

If the committee takes a strong proactive approach in executive compensation, is the CEO's leadership role in this activity being diminished? A few years ago, I would have answered yes to this question. Today my view has changed.

A proactive compensation committee will keep the CEO alert as to what is happening to executive compensation within the enterprise and also in the external corporate world. There is no reason why the CEO should relinquish his or her leadership role because of the proactive focus of the committee. However, the committee's proactive behavior will certainly force CEOs to go beyond the strong dependence that some have had on the company's executive compensation staff and, in some cases, outside consultants. The CEO will now have to know more about the whys and wherefores of executive compensation. Simply put, the CEO will be required to do more in-depth thinking about executive compensation. Certainly, this will be positive for everyone who is involved in the process, and, most important, it can only be beneficial for the company's shareholders.

In the prior article, I posed the following second question: What is the CEO's compensation philosophy? Now, the question would be better stated this way:

2 What is the CEO's and committee's compensation philosophy?

Previously, the compensation philosophy was usually developed and sponsored by the CEO. Today, I believe the development of a company's compensation philosophy has become more of a joint responsibility of the CEO and the committee. The SEC has forced the committee in the company's proxy to state its thinking supporting the organization's executive compensation plans. In addition, I believe that many compensation committee members feel that they must be committed to participate in the development of the company's compensation philosophy.

Here are several core questions that committee members should ask the CEO...

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