Wednesday, March 29, 2006
Top Seven Things a Compensation Committee Member Should Do
Before I moved into academia, I was with Wal-Mart for ten years serving as Vice President and General Counsel of the Corporate Division. Below is a list of tips for compensation committee members based on my own observations:
1. Remain independent: Compensation committee members must be independent, and there are several different rules that govern independence. Your company may have defined independence. In addition, under the short-swing profit rule and the SEC's regulations implementing it, you are not independent if you engage in any transactions that are discloseable under Item 404 of Regulation S-K. If you are with a law firm or investment bank there is no minimum dollar threshhold for disclosure. Thus, your Hong Kong partner who performs two hours of service for the issuer could compromise your independence. You also need to pay attention to the IRS's rules implementing I.R.C. section 162(m). Under this section, an issuer may not deduct compensation in excess of $1 million per year unless the compensation committee members are independent (and several other hoops have been jumped through). Finally, pay attention to your stock exchange's listing standards as they relate to independence.
2. Avoid boilerplate: Under the current proxy disclosure rules, you have to sign off on a compensation committee report. Review every statement in the report every year for accuracy. Make sure the report accurately reflects the company's practices and policies. Ask for verification if you are unsure.
3. Ask questions: Your job as a director is to put your nose in, but keep your fingers out. In other words, let the CEO run the show on a day-to-day business, but make certain that you ask appropriate questions. The business judgement rule provides some protection and you are generally allowed to rely on management reports, but be alert to red flags. Ask a lot of questions and follow up if the answers are murky or if you have had prior experiences that lead you to question management's representations.
4. Review consultant reports: Most companies engage compensation consultants to review the company's compensation practices. Make certain that you review their reports carefully. Ask questions about the reports. If appropriate, ask that the consultants attend a meeting to answer your questions.
5. Keep perspective: In a bull market, it's easy to lose perspective. Remember the phrase, "the high tide floats all boats." The fact that a company appears to be doing well and its stock price is up doesn't necessarily mean that management is performing at a level that merits big raises. After all, if all of the other players in the industry have done even better, then your company is actually lagging behind.
6. Keep up to date: The SEC has issued extensive proposed executive compensation reforms. Stay abreast of the proposed changes; ask for regular updates on the changes from company management or the legal eagles at your own company.
7. Prepare for every meeting: Read the materials carefully ahead of time. There's nothing more troubling than for an outside director to ask a question that is clearly covered by the materials. You cannot adequately provide strategic guidance to the company if you aren't familiar with the materials provided.