Tag Archives: corporate governance

Compensation Plans for Directors on Public Corporate Boards are Outmoded, Out Of Touch and Ought To Be Reformed

In the public corporate world, nothing is more conflicting and confusing than the purpose and worth of a board of directors

State and federal laws require that every corporation must have a board of directors with its legal responsibilities delineated in bylaws, but there is little agreement anywhere about the proper role and appropriate compensation for the board of directors.

Corporate-BoardsIn simplest of terms, the corporate board of directors is elected by the owners (shareholders) of a company to represent their interests. In turn, the board is legally responsible for hiring the executives who manage the company, reviewing and approving the strategy and plans of management and then supervising adherence to the strategy and the implementation of the approved plans. All of this activity is dedicated to the proposition that the interests of shareholders are paramount.

This is all straightforward and seems simple and easy, except in the real world – especially with publicly traded companies – it falls apart. There is constant deliberation, confusion and frustration as to how a board of directors should function and perform its duties. And there is an even more rancor and never-ending debate on how much and in what form directors should be compensated.

It’s Time for a Change 

All of this confusion and conflict arises because the traditional concept of a board of directors has become outmoded. It is no longer sufficient or appropriate for the board of directors of a public company to exclusively represent the interests of shareholders, which is universally translated into focus and preoccupation on the current stock price.

But this singular objective raises questions: Which shareholder’s interest should come first? Should it be long-term shareholders or those shareholders seeking short-term gain? Should the interests of banks and other institutional investors who often own millions of a corporation’s shares take preference over an individual who owns a few hundred shares in an IRA? Even more to the point, is the value of a corporation only to be measured by the stock price at the end of each quarter?

The point is, or should be, that there is more to the ultimate value of a company than can be measured simply by the current stock price; and to do so may be detrimental to the long-term vitality and value of the company. And because this is true,  the “charter” of a modern public corporate board of directors should be changed from singularly representing the “shareholders,” to a duty to represent all “stake-holders” of the company.

This refashioned board would not only be responsive to the best interests of shareholders, but also the best interests of management, employees, vendors, customers and even the communities in which the company does business. This revitalized board of directors should function to assure that the interests of all stakeholders are in parallel. The reason for this is simple: It is in the ultimate best interests of all shareholders when the interests of all stakeholders are aligned in parallel, because the potential for long-term success and survival of a company is significantly enhanced.

The idea that the board of a public company should represent broader interests than those of just the shareholder is not as farfetched as one might believe. The Wall Street Journal reported (May 23, 2013) that as a condition to approving Japan’s SoftBank Corp’s acquisition of Sprint Nextel Corp. the Justice Department and Homeland Security will have the right to approve a director of the Sprint board who will be responsible for “overseeing national security issues.” With that in mind, why shouldn’t the board also be charged with looking out for the best interests of employees, customers and the communities in which the company operates?

The (Pay) Envelope, Please . . .

The often heard cry is that director compensation should be tied directly to benefits received by the shareholder; and the way to do this is for directors to have “skin in the game.” This past week (May 21, 2013) another WSJ article reported that “Funds Get Active Over Director Pay.” The article pointed to an increasing number of large mutual fund groups calling for director compensation to be tied directly – if not exclusively – to the performance of a company’s stock.

There is no surprise here. When CEO of LifeUSA, I vividly remember meeting with a mutual fund manager at Fidelity, the multinational financial services company. He already held a big position in LifeUSA shares, so I asked him why he had purchased the stock. His response was likened to that of a stock day trader: “I don’t even know what your company does, but the numbers looked good, so I purchased the stock.” I later noted that when the stock reached a certain level, he dumped his position. So the question is: Why should compensation of corporate directors be based on the singular focus of guys like him, institutional investors whose interest in owning the corporation’s stock is measured by quarters of profit rather than decades of broad corporate performance?

The answer is, it shouldn’t. Interests that are tied to only one segment of many stakeholders can and will be detrimental to  Compensationthe interests of others. The most important responsibility for a director should be attentivenes to the overall long-term value and performance of the entire company, for all stakeholders. There is no argument that stock price is an important indicator of corporate value, but it is rarely the only indicator. There may be times when stock price needs to take a back seat to long-term growth and value. A director of a company should not be in a position to anti-select against the best long-term interests of a company in order to enhance his personal compensation.

There is also the inherent problem and fallacy of attempting to tie compensation to a benchmark that can’t be controlled by the individual being compensated, i.e. current stock price.  The truth is that actions taken to directly influence a current stock price are either very short-term in nature or illegal.

When a director’s compensation is heavily weighted only in the direction of stock performance, thinking can be narrowed to only those actions – good or bad – that impact short-term stock performance. That could – and has – resulted in directors taking actions that may increase their own compensation, but be damaging to customers, employees and ultimately, the long-term well-being of the company.

Changes That Should be a Comin’

It may be as irrepressibly optimistic as a Pollyanna to believe it will ever happen, but the best long-term interests of all stakeholders in a company will result only when director’s compensation is tied to multiple factors. Director compensationStakeholders should follow the pattern set by many compensation plans for senior executives. For example, it is not unusual for the total compensation of senior executives to be calculated based on a number of corporate performance benchmarks; with stock price playing a minor, if any role at all.

For example, a senior executive is compensated with a base salary and a bonus based on benchmarks such as increase in revenue, control of expenses, growth in profits, increase in shareholder equity and return on investment. Underpinning these benchmarks, of course, are related corporate functions, including labor relations, corporate responsibility, product development and customer satisfaction, and so on.  It is assumed that if management is successful moving these benchmarks in a favorable direction, then the stock price will naturally follow.

For the long-term benefit of all stakeholders and the company, director compensation should be determined by the same type of formula approach. However, in order to implement such a compensation philosophy for directors, the corporate world must disabuse itself of a number of myths and outdated rules. These include: all directors should receive the same base compensation, director pay should be tied to “peer-group” comparisons and directors will make better decisions if their compensation is based on stock performance.

Director Selection Revisited

Instead, directors should receive base compensation predicated on the experience and value they bring to the board. Other than the ego of existing directors, there is no reason why a company should have to raise the compensation of all directors to attract a new director who can add unique value, experience and perspective. Then, additional director compensation should be based on a set of benchmarks that are critical to the overall value, development and long-term growth of the company.

For example, a pool of compensation could be developed for the board members based on results such as increase in profits, growth in revenues, reduced expense ratios, employee turnover, increased market share and stock performance. These critical measurements may not be the same for all companies – nor should they be – but the idea would be to establish a compensation plan for board members that focuses their interest, attention and actions on the key performance measures that benefit all stakeholders in the company and not just those who may happen to be stockholders at the time.

This may be nothing but a pipe-dream, but should a company take this approach with its board of directors it will benefit from having directors who care about to overall growth and value of a company, not just one group. And in the long run, that will be better.

And the Moral of the Story …

For the most part, boards of directors for public corporations are mired in an outmoded paradigm of the past. There may have been a time when the sole purpose for the existence of these companies was to enrich powerful shareholders, at the expense of all else. In this environment it was reasonable to base director compensation exclusively in relation to the performance of the stock price. Unfortunately, while this approach did enrich some, it also lead to abuse – both to other stakeholders in the company and the long-term growth of the company. There is a litany of inappropriate and often illegal actions taken by boards that were focused only on one element of a company’s value.

There should be a more enlightened and broader approach to the function and responsibility of a board of directors and how the directors should be compensated. Directors should be rewarded for their ability to represent the interests of all stakeholders, not just shareholders. Directors should be rewarded for their ability to monitor and encourage actions that will lead to the long-term development, success and viability of the organization. The good news is that ultimately this approach will be in the best interests of all shareholders.


A Corporate Board of Directors is Most Effective When it Practices Good Parenting

There is more to being a successful corporate director than meeting strict fiduciary duties, enjoying the prestige of position, hobknobbing, ego-stroking and raking in big bucks.

At the moment an individual is invited to become a corporate director – especially of a public company – there is a natural rush of well-earned ego gratification. At its most superficial level, being a director of a public company gives the individual status and bragging rights at the country club or cocktail parties. On a more fundamental level, the invitation to join a board is recognition and validation of past efforts, accomplishment and sound experience; all things that can’t help but to stroke the ego. There is nothing wrong with that, but to be an effective director, that ego must be checked at the door.

Efforts targeted to achieve individual success and recognition must be relegated to the past and sublimated to the development and accomplishments of a larger organization and its management team. (You may be able to name the CEO of a successful company, but can you name even one of its directors?) The effective director will recognize they are entering a new phase of their business life; that, while it will draw on their past experiences, it is not about the past or their individual recognition.

Rarely is it expressed in this fashion, but becoming a corporate director is, in a way, like the young person who has had a great time playing, partying, enjoying the freedom to care only about “me,” and then becomes a parent. Suddenly life is not all about them, but about parenting and providing the child with every possible opportunity for healthy growth and a good life. The surest path to failure as a parent is to impose your plan on the life of the child; or even worse, to interfere with and attempt to live their life for them.

Good parenting means setting a good example, exposing the child to ideas and opportunities, supporting the efforts of the child to find their way, being a resource for them to depend upon and then stepping back to allow them to be what they will be. It is the same type of role the corporate director should fill. Some critics may view this “corporate-director-as-parent” analogy as fanciful. It is not, after all, the traditional way to describe the duties of a director. But it is the way that effective directors see their role and add value to the company they serve.

Could You Be a Good Director?

At its most fundamental, the board of directors is a group of individuals elected by the shareholders to represent their interests. Shareholders charge the board with seeing that the company is well managed and the value of their investment is protected and potentially enhanced. These accountabilities call for the director to perform two clearly defined duties:

  • Monitor the activities of management
  • Make certain that strategies are developed and implemented that offers the best opportunity for increased shareholder value.

Critical to the effective functioning of a board of directors is the understanding that fulfilling the fiduciary obligations and encouraging increased value are interdependent, but separate and distinct. A company has never become great because it functioned under a clear set of processes and procedures. Likewise, many a successful company has been rent asunder by the failure to have strong organizational and financial controls. This is a delicate balance that many directors fail to understand or strive to achieve.

In order to fulfill its fiduciary duties, the board of directors will appoint and compensate the officers and managers of the organization, review, approve and endorse a long-term vision that has been identified and delineated by management; and finally to approve and monitor – with specific and determinable checkpoints – the development and implementation of strategies calculated to achieve the vision.

It is important that most directors bring to the board business experience rich in operational and strategic success. But there’s a caveat here. Such experience can lead to the most egregious error a director or board can make, and that is to become involved in the actual management of the company.

The board of directors is – and should always be – distinct from management. In its role as parent, it should to act that way: encouraging, guiding, supporting, and challenging, but not being one of the kids. It is not the province – nor should it be the prerogative – of the board to manage a company, but it does have the responsibility to monitor the managers it has hired. When the board inserts itself into the management of the company, these lines become blurred, and it risks losing focus on its primary purpose. The authority of the CEO is then undermined. Messages to management and employees can become mixed as well as confusing. The ability of the board to hold management accountable is weakened.

The most effective separation of powers is for the executive team to conceptualize a vision and develop strategies to achieve it. The board can properly question and challenge management’s thinking, but once it has given approval to the vision and strategies, involvement should be limited to overseeing the execution of the strategies and measuring the performance of the management group against the agreed-upon objectives. The board of directors can rightly offer an experienced, independent sounding-board for management to present their ideas and plans, but once approved, the board should step back from management and serve as a council of accountability for the actions of management.

This approach to the relationship between the board and management does not preclude individual directors from using their unique experience and knowledge to offer perspective and mentoring for management; much like a parent can use their life experience to guide and mentor the child. After all, it is this distinctive individual knowledge and successful experience that qualifies one to be a director and is the license to judge and monitor the plans and performance of management. But, at the same time, this past experience should never be used as an excuse to interlope on the actual management of the company; just as a parent should not use their life experiences and desires to interlope on how a child lives their life.

And the Moral of the Story …

A board of directors plays a unique and valuable role in the corporate universe. The board straddles the worlds of ownership and management. It has a fiduciary responsibility to represent the interests of shareholders, but is closest to the management group it has hired. To be efficient and effective the board must position itself as a fulcrum that balances the obligation of corporate governance without inhibiting management from developing and implementing their plans for growth.

This is the ultimate challenge for most corporate boards because they are comprised of individuals who have a history of success and leadership in management. Most directors are used to being hands-on, involved and in charge. Thus, the very attributes that qualify an individual to be a director are the very attributes that make it difficult for them to remain above the fray and function in the objective role to approve, monitor and assign accountability.

It is possible for a board of directors to function effectively, but only when the individual directors recognize that – unlike their past experiences – this is not about them. There is no need for them to prove how good they are or how much they know. Instead, the board and its directors should take on the role of parenting. The experience and success of the individual directors provides the knowledge to protect the interests of shareholders and is a resource that can advise and consent with management as they develop and implement plans for corporate growth.

As long as a board and its individual directors keeps this balance in perspective, it can be very effective; but when this is violated – either by not meeting their fiduciary obligations or by interfering with management’s ability to manage the company – they become little more than bad parents.