Compensation Committee 101: What Does It Do?Written by Paul R. Dorf, Ph. D., APD
Upper Saddle River, N.J. – June 8, 2005 - The increased focus on size of Executive Compensation Packages and their apparent disconnect with realities of company performance have placed tremendous concern on a company’s decision making process. Add to that issues of corporate governance, and you now have placed Compensation Committee very much in limelight. But what is role of Compensation Committee?
The Compensation Committee is appointed by and serves in an advisory role to a company’s Board of Directors. It makes important final decisions on many executive compensation matters, including types and particulars of pay plans themselves, amount of compensation, and even performance measures and specific targets upon which executives will be judged for purposes of calculating incentive awards. In its capacity, Committee is responsible for functioning both in a strategic role, as well as serving in an administrative capacity. Strategically, Committee must consider how achievement of overall corporate goals and objectives can best be supported through use of specific compensation programs that will support a pay-for-performance environment. From an administrative standpoint, Compensation Committee must undertake necessary studies, evaluate alternatives plans, recommend elements of Executive Compensation Package including, salary programs, short-term and long-term incentives, and supplemental benefits and perquisites for Corporate Officers. Ultimately, Committee ensures that these programs are installed and administered in such a way as to achieve desired results.
The following are primary duties and responsibilities typically assigned to Compensation Committee by Board:
·Develop Compensation Philosophy for Company and ensure that it is consistent with company’s business strategy, mission, and culture.
·Approve any compensation plans in which Officers and Directors are eligible to participate, subject to review of full Board and shareholders, as appropriate.
·Responsible for recommending, providing oversight, and approving awards of stock options and other equity, perquisites and other benefits, and employment and change of control contracts, subject to Board and shareholder approval, as required.
A Primer In Executive Compensation In Not-For-ProfitsWritten by Paul R. Dorf, Ph. D., APD
Upper Saddle River, N.J. – July 19, 2005 - A tremendous amount has been written about Executive Compensation, and lately, most of this information has been extremely unflattering. Much of criticism has resulted from gross excesses, misinterpretations of regulations, and rash of criminal cases brought against top management of a number of large firms, such as WorldCom, Tyco, Enron, and a host of others. Virtually every day another egregious example of corporate greed has come to light. The effect has been a huge increase in media attention, which in turn has acted as stimulus for new government regulations aimed at curbing these abuses. While most of regulations are aimed at publicly traded companies, there has been some spill-over into Not-For-Profit (NFP) sector. NFPs have their own set of federal and state regulations limiting executive compensation; most draconian of these regulations being IRC §4958, or what many refer to as “Intermediate Sanctions”.
It is interesting to note that, for most part, regulations covering for-profit, publicly traded companies provide few, if any penalties, and certainly none are spelled out for board members involved in approval of compensation deemed to be excessive. Since in many situations, only penalty is that companies cannot deduct amount of an excessive compensation payment, brunt of penalty falls onto shareholders. Conversely, NFP regulation calls for a 25% excess tax plus a disgorgement of excess amount. If this does not occur, fine jumps to 200%. In addition, board members of NFP, most of who are not paid for their board service, but are merely acting in an altruistic manner, are subject to individual fines of lesser of 10% of excess, or $10,000.
What are components of NFP compensation package? There are traditionally six (6) elements that to one degree or another comprise Total Compensation Package of executives, whether or not they are part of a For Profit or NFP. These are base salary, annual bonuses or incentives, long-term incentives which could include stock options, restricted stock, phantom stock, and a large group of equity and cash based programs, typical fringe benefits, supplemental benefits and perquisites, and lastly various written documents or agreements that spell out employment and severance provisions. In case of NFPs, most of these elements are included but often with scaled-down arrangements. One area that is definitely changing is increased acceptance and use of annual bonuses and incentives. Rather than paying cash compensation in form of salary only, many NFPs are beginning to introduce variable pay. This not only better aligns cash compensation with achievement of predefined results; it also allows Board to in effect “reduce” pay when NFP’s situation changes, performance objectives are not met, or when there are cash flow issues. It also allows NFP to provide a more competitive compensation package that better reflects realities of market place. The one compensation element, which heretofore has been virtually missing from Total Compensation Package, is use of long-term incentives, which typically exists in For Profits in form of equity. This is one of major disparities between For Profits and NFPs, and it is one of areas which needs to be addressed in order to begin to “level playing field” between two business groups.
Although it is generally understood that individuals in comparable positions within For Profit and NFP industries will not necessarily be paid at exactly same level, there is still a misguided concept held by some individuals, that working at an NFP is rewarding enough, so that their overall compensation should be markedly lower. While altruism is clearly evident, it doesn’t pay rent. Recognizing ability of an NFP to pay reasonable levels of compensation, without harming organization’s ability to carry out its mission, should be a main consideration in determining what compensation elements comprise package, and in what amounts.
Is it appropriate to provide short-term and long-term incentives? Short-term incentives are generally associated with achievement of annual financial and/or operational goals. These goals are typically set at beginning of a fiscal year, and their achievement is part of a tactical plan to advance NFP’s mission. To ensure that these awards do not become an “entitlement”, Board must set realistic but stretch objectives, and determine actual level of accomplishment against those performance measures when granting awards. Paying out bonuses when performance is not achieved, or measures are a “slam dunk”, sends wrong message and defeats intent of entire incentive system.