The Advisors' Blog

– Broc Romanek, CompensationStandards.com

In this article, Farient’s Robin Ferracone has some practical observations about comp committee members:

In the second year of Dodd-Frank, executive compensation continues to be top of mind as proxies roll off the presses and say-on-pay votes are cast. As part of the season, there is no shortage of director conferences to attend to hone our director skills, particularly in the area of executive compensation. This is a good thing.

Recently, a prominent individual at an investment company was going to speak on a panel at one such conference. In preparation for the panel, he asked my opinion on two governance policy questions:

1) Should compensation committees include at least one compensation expert as a member of the committee?

2) Should compensation committee members be rotated on and off of the committee?

As a business person who currently serves on boards and chairs a compensation committee, and as an executive compensation consultant who has served a myriad of compensation committees over the years, I have not surprisingly formed some opinions on these two topics.

I am always amazed when boards treat compensation, like human resources (HR) in general, as an area that should be intuitively obvious. However, just like audit committee members are most effective when they are financially literate, compensation committee members are most effective when they have a certain amount of compensation literacy and expertise. It helps when people on the compensation committee have a generally familiarity with both the strategic and technical aspects of compensation. It helps when compensation committee members have a feel for the issues based on real experience with the subject matter, not just as a line executive or onlooker.

The good news is that board directors can either come to the table with compensation experience or obtain such experience “on the job.” Take Laurie Siegel, for example, who chairs the compensation committee at CenturyLink, a $15B telephone company. Laurie is a seasoned HR executive and early in her career worked with me as an executive compensation consultant.

Obviously, she comes to the table with ready-made skills and can be immediately effective as a compensation committee member. But board directors without this deep knowledge also can gain expertise by engaging in educational programs, and insisting on getting a tutorial from the company’s internal staff and/or consultant that includes both Compensation 101 (i.e., executive compensation in general), and the compensation philosophy, programs, and processes for the specific company at hand.

These learning opportunities, coupled with about a year of service on the compensation committee, can give directors who are new to the compensation committee the experience and skills they need to become highly effective compensation committee members. I’d also suggest that those on the nominating and governance committee put compensation expertise on the list of qualifications for new board members.

As for the second issue, whether or not board members should be rotated on and off of the compensation committee, my view is that rotation is a good thing, but in measured doses. I would roll members on or off the compensation committee one at a time. My experience is that new blood can bring fresh thinking, which is healthy, but institutional knowledge on the committee also provides needed stability and a deeper understanding of the company’s culture.

Further, compensation committee members should serve on that committee for a minimum of three years before rotating off. Similarly, compensation committee chairs should stay in their role for at least three years. Too much turnover in either compensation committee membership or the chair role can create too much disruption, which can be bad for the organization. Clearly, these are board governance decisions, and board qualifications and rotational policies should not be dictated by investors or the government.

Finally, expertise and a certain amount of stability in the compensation committee membership help avoid one of the biggest mistakes that new compensation committee members make, which is to import their experience from a very different environment, such as academics or private equity, to the company at hand. Not that experience in a different environment isn’t useful, it is. But compensation is a delicate cultural issue and must be tailored to the unique circumstances of the organization at hand. This means that what works in one environment often won’t in another, particularly when crossing industries or ownership structures (e.g., private to public).

To sum up, my experience is that compensation committees function best when the people sitting on these committees, and certainly the chair of these committees, have some expertise that is directly relevant, either through background or experience, and that rotating people on and off the committee in measured doses can bring new thinking to the table without the downside effect of wholesale disruption. Aligning executives with investor interests can best be achieved when the right directors, with the right experience, training, and resources, and are in the right seats at the right time.