1. Director Compensation Philosophy

Oversight of director compensation can fall under the purview of either the governance and nominating committee or the compensation committee, depending on the individual company’s approach to committee responsibilities. However, whichever committee oversees director compensation, the issues will be the same. Establishing director compensation is inherently a little awkward, as the directors are responsible for establishing their own pay levels.

Director Compensation Philosophy

To date, director compensation has not been subject to the same level of external scrutiny as executive compensation. There are likely two main reasons for this. First, director compensation levels are relatively modest when compared with executive compensation levels. Secondly, director compensation programs are not highly leveraged. Much of the controversy surrounding executive compensation stems from concerns about the pay-for-performance relationship or excessive levels of non-performance-based pay. Director compensation is generally not explicitly designed to link director pay levels with performance, aside from paying directors in the form of company equity. While in the past, directors often had non-performance-based pay in the form of perquisites, insurance benefits, or retirement plans, today’s director compensation programs do not generally include significant amounts of special benefits. Unlike executives, directors are generally not participants in retirement plans or covered by severance arrangements. Due to concerns about potential litigation based on excessive director compensation, some companies have established limits on director compensation particularly in their shareholder-approved plans.

To manage director compensation programs effectively, the key objectives that committees focus on are 1) aligning the interests of directors with those of long-term shareholders, and 2) attracting and retaining qualified directors to serve on the board. In practice, the first objective is addressed by ensuring that a meaningful portion of director compensation (50% or more) is delivered in the form of company equity and often deferred until the director retires from the board. With this kind of compensation structure, directors can accumulate a meaningful ownership level over time, which will give them a financial incentive to act in the long-term interests of shareholders, consistent with their responsibilities as directors or stewards of the company.

To address the second objective of attracting and retaining qualified directors to the board, most companies ensure that they establish a competitive target pay positioning for directors. The majority of companies use the same peer group for establishing both director compensation and executive pay levels. This may seem somewhat counterintuitive, as directors are typically drawn from a broader array of backgrounds than executive talent. However, most companies opt to use the same peer group because it sends a message that directors are being treated comparably to executives. Similarly, if executive pay is targeted at the median of the peer group, most companies will target director pay at the median as well to ensure that management does not feel that directors are less rigorous in assessing their own pay.