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8 HABITS OF HIGHLY EFFECTIVECOMPENSATION COMMITTEES
Copyright 2008 by The Segal Group, Inc., parent of The Segal Company and its Sibson Consulting Division. All Rights Reserved
Rick Smith
Senior Vice [email protected]
Jason Adwin
Senior [email protected]
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Todays Agenda
Governance Landscape: 1999 to Present Day
Sibsons Board Effectiveness Framework
The 8 Habits
Question and Answer
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Shareholder suits and rejection of management Increased regulation Greater prominence of third-party proxy advisors Rising sensitivity on executive pay levels and shareholder dilution
Effects
Crisis in Confidence Consumer Bliss
1999 2002
Market volatility Accounting scandals High profile bankruptcies Insider trading Security analyst collusion
Causes
Market BoomExponential
Executive PayGrowth
Market Bust
Discovery ofAccounting
Scandals / HighProfile
Bankruptcies
Spotlight onCorporate
governance
1999 2002: Consumer Bliss to Crisis in Confidence
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2002 To Present Responses: Action From All Fronts
Revised exchange listingrequirements (2003)
More prominentinstitutional investor voice
ISS and other third-partyproxy advisory services
opining on governanceand pay practices
Analyst conservatism
Media spotlight (allmediums)
Third Parties
More conservativefinancial forecasts
Greater transparency andcommunication with thestreet
New / revised governance
policies
More stringent Board ofDirector selection andtraining
Executive pay redesign
Greater CEO churn andfocus on successionplanning
Companies
Increased SEC authorityand staffing
Sarbanes-Oxley (2002)
FAS 123R (2004/2005)
Increased disclosurerequirements (CD&A andothers) (2006)
409A (2007 final)
Shareholder Vote onExecutive Compensation
Act (Say-on-Pay) (2007)
Inquiries on consultantindependence (presentand future)
Government /Regulatory
Boards and compensation committees have had to adjust
to the new environmentboth proactively and reactively.
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Compensation committees will continue to evolve
The role of the committee along with its members is continuouslychanging and evolving Increasingly larger time commitments
Growing legal exposure and liability
Increasing director and committee member compensation
More direct related experience for committee chairs and members
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Rewards
Learning/pursuit ofknowledge
Contacts
Business development
Sharing of expertise
Prestige/affiliation Cash compensation/
benefits/perquisites/stock
The Director Value Proposition is the mixof elements that attract and retain directors
Costs
Time
Experience/expertise
Effort
Risk
Reputation
LitigationFinancial
DIRECTOR VALUE PROPOSITION
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Board Effectiveness Framework
The Eight Habits
Appendix
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Board Effectiveness Framework
People, Practices, and Policies form the foundation for effectivegovernance
More than items to be checked-off, they have changed the nature of the
boardroom
How change is applied in real-time defines the behavioral dynamics of acorporate board
Composition Compliance andDisclosure
Rewards
Operating Discipl ine
Dynamics
Development
People
The Best Talent
Practices
Doing theRight Things
Policies
With Credibilityand Integrity
Greater detail on the framework can be
found in the Appendix of this presentation.
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Dynamics refers to how well therules of engagement are being applied
Simply establishing sound rules of engagement does not guaranteeBoard effectiveness
Indicators of strong dynamics include the ability to Leverage individual and collective capabilities
Build chemistry based on contributions and performance
Use the time commitments of each member efficiently
Drill into areas inside and outside of respective expertise
Raise issues that advance critical thinking
Balance stakeholder expectations while taking appropriate levels of risk
Challenge the status quo among board membersand with the executive team
Examine the strength, effectiveness, visibility and accountability of the Board andmake appropriate changes
* Jeffrey A. Sonnenfeld, Associate Dean for Executive Programs, Yale School of Management.
Its not rules and regulations. Its the way people work together. *
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Board Effectiveness Framework
The Eight Habits
Appendix
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The following reflect model habits of thehighest functioning compensation committees
1. Maintain Recent Advancements
2. Compensate Role and Activity
3. Work Beyond the Boardroom
4. Remain Internally Focused, Externally Sensitive
5. Build Rapport with Management6. Commit to Director Development
7. Build a Talent Portfolio
8. Broaden Scope of Responsibility
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Habit 1:Maintain Recent Advancements
Trends in Compensation Committee operations and accountabilitieshave raised expectations and are now expected baselines
Service limitations for activeexecutives
Greater scrutiny in directorselection
Formal evaluation (Board,Committee, and individuallevel)
Board and committeesuccession planning
Validation and compliance(charters, policies, anddecision rights)
Increased education on lawsand regulations
Greater directoraccountability and riskmanagement
Improved transparency(within the Board and toshareholders)
More thorough duediligence and approvalprocesses
Proactive agendas
Frequent ad-hoc meetings
Robust meeting materials,more timely distribution
Greater clarity in payphilosophy and design
Tally sheets and internalequity assessments
PeopleThe Best Talent
PracticesDoing theRight Things
PoliciesWith Credibilityand Integrity
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Habit 2:Compensate Role and Activity
Recognize the increasing role and time commitmentrequired of all directors
Increased complexity as directors balance diverse constituents: Shareholders and institutional investors
Customers, employees and executives
Regulators, media, third party advisors
An increasing shift to role-based compensation (i.e., retainer-based instead of meeting fees) The prevalence of retainer-based meeting fees has doubled from 2002 to 2007
Source: Equilar, Inc. Analysis of S&P 500 companies.
People Practices Policies
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S&P 500 Director Compensation Analysis:2002 vs. 2007
1133416Committee Retainer (Audit)
1054522Full Value Shares
461913Committee Retainer (Comp)
47118,30080,400Total Annual Equity
Prevalence
Pay Level Medians
(25%)
(43%)
8249%
% Increase
5067Meeting Fees (Comp and Audit)
38%67%Stock Options
60,00033,000Cash Retainer$194,300
2007
$130,600
2002
Total Director Comp1
1 Total Compensation assumes a non-employee director serves as a member of the Audit Committee and the Governance Committee and attends five
Board meetings, seven Audit Committee meetings, and five Governance Committee meetings.2 Prevalence represents the percentage of companies that pay a given fee out of the 355 companies covered in the analysis.Source: Equilar, Inc.
On average, the number of meetings has increased 38% from 2002 to 2007(from 4.8 to 6.6), leading to increased retainer-based compensation.
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Habit 3:Work Beyond the Boardroom
Increasingly, work is done outside of committeemeetings
Responsibilities reach beyond reading board booklets and meetingattendance
Informal sensing and lobbying outside of meetingsmost often led
by Committee Chair
Requires fostering interpersonal relationships and communication Compensation committee members
Other committee members/chairs of other committees
Board Chairman
Nothing in a committee meeting should come as a surprise.
People Practices Policies
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Habit 4:Remain Internally Focused, Externally Sensitive
Successful pay programs are driven by internalrequirements, yet informed by external practice
Focus on instituting programs that align with individual companysmission, culture and operating dynamics
Remain open to alternativesexamine pay levels, vehicles and
design mechanics; reserve time to evaluate: How effective programs are todaystrategically and operationally
Programs at competing peer companies
Industry or broader market best practices and emerging trends
Potential application of alternative designs, pros and cons
Build the above into formal agendas annuallyled by managementor external experts
The best committees do not wait for programs to become ineffective
before looking at alternative approaches. Evaluation is continuous.
People Practices Policies
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Habit 5:Build Rapport with Management
Relationships with company leaders improvescommittee process and creates more of a collaborative
environment Relationships exist with diverse cross-section of leaders
Corporate Leaders: CEO, HR, Finance, Legal Line: Business unit heads
Fosters transparency leading to greater insights on: Company/function needs and challenges Leadership perceptions and potential decision implications
Are helpful during the following exercises: Performance metric selection, goal setting, and calibration Talent management (hire, fire, retention, succession, etc.) Regulatory compliance and reporting Executive pay oversight, decision making, and communication
Building rapport with management, does not mean managing the company.
People Practices Policies
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Habit 6:Commit to Director Development
Investments in education and development ensureoptimal contribution from directors
Formal on-boarding processes to ease integration For new directors and new compensation committee members
On-going director education/consultant briefings
Practices, future trends, and regulations
Director development stipends (e.g., attendance at networkingworkshops and conferences)
Committee rotation New members bring new perspectives and knowledge to the committee
Be mindful not to rotate members too frequently
People Practices Policies
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Habit 7:Build A Talent Portfolio
A diversity of skills and experiences leads to richdiscussion and better decision making
Overall board competencies driven through individual directoraptitude
Committee members bring diverse: Backgrounds Expertise
Experience (general or compensation)
Develop director profiles for attraction and selectionensure rightmix of skills
Plan for successionmaintain list of qualified candidates
People Practices Policies
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Habit 8:Broaden Scope of Responsibil ity
The Compensation Committee works with a variety ofissues beyond pay
Committees role and responsibilities expand to include additionaltalent management elements such as: Leadership and succession planning
Career planning
Strategic recruiting
Performance management
Committee members knowledgeable of external talent markets as
well as the available talent within the company
By expanding the committees focus, itbecomes the Human Capital Committee.
People Practices Policies
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A well-governed Board helps buildgoodwill, value, efficiency and effectiveness
Outcomes of Effective Governance
Correlates to better company performance and greater access toinvestment capital for public companies
Reduces potential for corporate liability litigation
Increases competitive position for attracting director talent
Enhances competitive advantage
Increases ability to adapt to unprecedented amount of change in thebusiness community
People
The Best Talent
Practices
Doing theRight Things
Policies
With Credibilityand Integrity
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Questions
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Board Effectiveness Framework
The Eight Habits
Appendix
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Sibsons Board Effectiveness Framework
For public companies, the components within People, Practices and Policies form thenecessary foundation for effective governance. They cannot be overlooked or treated simplyas items to be checked off. How these components are applied in real-time begins to definethe behavioral dynamics of a corporate board
Composition
Mix, Skills and Experience Selection Criteria and Process
Board Succession Planning
Compliance and Disclosure
Regulatory Compliance By-laws, Guidelines and Written Codes
Transparency Sarbanes-Oxley Compliance
Rewards
Compensation Continuous Learning
Sharing of Expertise Prestige / Affiliation
Operating Discipl ine
Structure Roles and Accountabilities Decision Rights Performance Measures and Standards Documentation Evaluations Meeting Effectiveness Internal / External Communications
Dynamics
Engagement and Interaction Objective Problem Solving Facilitation / Conflict Resolution Cross-Committee Collaboration Decision-Making Processes
Development
Board Capability Planning Assimilation of New Members
Skills and Knowledge Development
APPENDIX
People
The Best Talent
Practices
Doing theRight Things
Policies
With Credibilityand Integrity