Role of the Compensation Committee

The Business Roundtable long has been a leader in Corporate Governance thought leadership.  They have written Principles of Corporate Governance going back to 2002.  This is the seventh in a series of articles that summarizes their principles.

Every publicly owned corporation should have a committee composed solely of independent directors that addresses compensation issues. The compensation committee should have at least three members and should be composed solely of independent directors. All committee members should have and maintain sufficient knowledge of executive compensation and related issues to perform their duties effectively.

The compensation committee’s responsibilities include overseeing the corporation’s overall compensation structure, policies and programs, establishing or recommending to the board performance goals and objectives for the CEO and other members of senior management (or, in some companies, in conjunction with the corporate governance committee), and establishing or recommending to the independent directors compensation for the CEO and senior management.

The compensation committee should see that the corporation’s compensation policies reflect the core principle of pay for performance and should establish meaningful goals for performance-based compensation paid to senior management. The committee should see that the corporation’s compensation policies and performance goals are closely linked to its strategic plan and that they create incentives to produce long-term value for shareholders without encouraging excessive risk-taking.

The compensation committee should have the authority to retain compensation consultants, counsel and other advisers to provide the committee with independent advice. The compensation committee should understand all aspects of an executive’s compensation package, and should review and understand the maximum payout due under multiple scenarios (such as retirement, termination with or without cause, and severance in connection with business combinations or the sale of a business).

The compensation committee should require senior management to build and maintain significant continuing equity investment in the corporation. To align senior management interests with the interests of shareholders, the committee should establish requirements that senior management acquire and hold a meaningful amount of the corporation’s stock for at least the duration of their tenure with the corporation.

In addition to reviewing and setting compensation for senior management, the compensation committee should look more broadly at the overall compensation structure of the enterprise to determine that it establishes appropriate incentives for management and employees at all levels and that these incentives do not encourage inappropriate risk-taking. The committee should consider carefully and understand the incentives created by different forms of compensation. Incentives should further the corporation’s long-term strategic plans by looking beyond short-term market value changes to the overall goal of creating and enhancing enduring shareholder value, and they should be consistent with the corporation’s culture.

The committee should see that the corporation has in place appropriate practices to mitigate risks created by compensation programs. Executive compensation should directly link the interests of senior management, both individually and as a team, to the long-term interests of shareholders. It should include significant performance-based criteria related to long-term shareholder value and should reflect upside potential and downside risk.

The compensation committee should carefully examine the benefits and perquisites provided to senior management and determine whether they appropriately balance the interests of long-term shareholders and the ability of the corporation to recruit and retain top talent. The corporation should generally bear the cost of these items only if they are directly related to management’s job performance; the corporation should not bear the cost of personal expenses.

The compensation committee should oversee the corporation’s disclosures with respect to executive compensation. Disclosure about executive compensation should be transparent and written in plain English so that it is understandable to shareholders. In particular, the committee should use the compensation discussion & analysis (CD&A) disclosure to provide shareholders with meaningful and understandable information about the corporation’s executive compensation philosophy, policies and practices, the factors that the committee and the board consider in making compensation decisions, and the relationship between executive compensation and corporate performance.

— Steve Odland

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