To Pay or Not to Pay
By: JOHN H. STOUT
April 2004
ABA presentation, Seattle, Washington
I. THE CURRENT CORPORATE GOVERNANCE ENVIRONMENT RESPECTING COMPENSATION ISSUES: A MATTER OF ORGANIZATIONAL INTEGRITY
Organizational integrity is the overriding responsibility of Boards of Directors and senior management.
What stakeholders need most from Boards of Directors and senior management is assurance of an organization’s integrity – including an assurance that the organization’s values and culture support that integrity.
- Critical to an organization’s integrity is the “tone at the top.” The Board and senior management must recognize their joint roles in assuring that the organization has, and practices, values that support a culture of integrity, fairness, trust, and high performance.
- Boards and senior executives must be extremely sensitive to the signals they send to the organizations they lead. Compensation may be the single most visible of those signals. How people are rewarded and what behavior is incented is an important element of an organization’s culture and values.
- Underlying many of the highly publicized examples of corporate (including nonprofit) misconduct are often cultures of excess and greed, an imperial CEO/executive management team and Boards which are overly deferential to management or passive.
- Nothing undermines a corporate culture more quickly than compensation practices which are perceived as unfair or rewarding behavior which is inconsistent with an organization’s values.
- Actual or perceived conflicts of interest detract from an organization’s integrity, and compensation decisions may involve actual or apparent conflicts of interest.
Boards of Directors should look to best governance practices in making compensation decisions.
- As the primary objective of a nonprofit corporation is to serve the mission for which the entity was organized, compensation decisions must be aligned to serve the best interests of the organization as well.
- Boards of Directors should consider adopting an overriding philosophy of compensation which provides a context for director, management and other employee compensation.
- Boards of Directors should consider creating compensation committees comprised solely of independent directors. Boards should define “independence,” and make their definitions available to stakeholders.
- Compensation committees should have charters which detail their responsibilities.
- Director compensation should be fair, take into account the demands of director service and the risks involved, and be paid in cash. Benefits and “perks” should be minimized or eliminated, as they may in actuality or appearance detract from the director’s independence, and promote longevity of service.
- Boards, or compensation committees, should utilize appropriate resources of the organization to procure advice in the establishment of director and executive compensation. Boards and compensation committees, rather than management, should hire any professional advisors used to assist in compensation determinations.
Boards should look to the five basic principles outlined in the recent National Association of Corporate Directors’ Blue Ribbon Commission Report on Executive Compensation and the Role of the Compensation Committee in making compensation decisions.
- Independence
- Fairness
- Linkage to performance
- Long-term value for the organization and its stakeholders
- Transparency
II. BOARD AND COMMITTEE EDUCATION
Board and committee members should periodically obtain education on compensation practices generally and with respect to like organizations.
III. EVALUATION
Boards and compensation committees should evaluate the performance of the compensation function, and assess both the performance of those making the decision and the effectiveness of compensation plans.