Wishes vs. reality in pay practices.

• Author: Hill, Nancy
• Position: CEO and director compensation

How do outside directors feel about CEO compensation? How do they think their own pay should be determined?

We surveyed the outside directors of 100 New York Stock Exchange and American Stock Exchange firms to find out. We also examined the most recent proxy statements of these firms to determine whether the outside directors' opinions corresponded with actual practice. Some key results of the survey are discussed below.

Few topics related to corporate governance are more controversial than deciding the "proper" level of compensation for the chief executive officer. A related issue receiving more and more scrutiny is the compensation of the outside director. We asked an outside director from each of 100 firms listed on either the NYSE or ASE what his or her opinions were on structuring both CEO and director compensation and compared their opinions to actual practices.

In brief, outside directors do not want the CEO to serve on the compensation committee. They favor basing CEO compensation on attaining long-term goals, primarily increases in stock prices. However, directors are less willing to be their own pay to the long-term performance of the company. Companies that use independent compensation consultants are far more likely to reward CEOs for attaining long-term goals. Nevertheless, a sizable number of firms provide no long-term incentives for the CEO. Furthermore, a majority of the companies also fail to link directors' compensation to long-term goals.

Respondents to our survey came from firms with market values ranging from approximately $5 million to $14 billion, with an average of $2 billion. Median sales for the 100 firms in the sample were $401 million. Total number of directors on the boards surveyed ranged from 3 to 25, with a median of 8. The percentage of outside directors sitting on those boards ranged from 14% to 91%; on average, two-thirds of the board members were outside directors.

Over 80% of the outside directors believe that the CEO should not serve on the compensation committee. Company proxies reveal that in practice the CEO is not a member of the compensation committee for 95% of our sample. Compensation consultants are used by nearly 60% of the sample firms. The compensation consultant is independent of management for 85% of those 58 companies.

We asked the outside directors a series of questions concerning factors that could affect CEO compensation. The questions focused on whether favorable short- or long-term...