8 HABITS OF HIGHLY EFFECTIVE

COMPENSATION 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 President
rsmith@sibson.com
212-251-5444
Jason Adwin
Senior Consultant
jadwin@sibson.com
212-251-5196
1
Todays Agenda
Governance Landscape: 1999 to Present Day
Sibsons Board Effectiveness Framework
The 8 Habits
Question and Answer
2
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 Boom
Exponential
Executive Pay
Growth
Market Bust
Discovery of
Accounting
Scandals / High
Profile
Bankruptcies
Spotlight on
Corporate
governance
1999 2002: Consumer Bliss to Crisis in Confidence
3
2002 To Present Responses: Action From All Fronts
Revised exchange listing
requirements (2003)
More prominent
institutional investor voice
ISS and other third-party
proxy advisory services
opining on governance
and pay practices
Analyst conservatism
Media spotlight (all
mediums)
Third Parties
More conservative
financial forecasts
Greater transparency and
communication with the
street
New / revised governance
policies
More stringent Board of
Director selection and
training
Executive pay redesign
Greater CEO churn and
focus on succession
planning
Companies
Increased SEC authority
and staffing
Sarbanes-Oxley (2002)
FAS 123R (2004/2005)
Increased disclosure
requirements (CD&A and
others) (2006)
409A (2007 final)
Shareholder Vote on
Executive Compensation
Act (Say-on-Pay) (2007)
Inquiries on consultant
independence (present
and future)
Government /
Regulatory
Boards and compensation committees have had to adjust
to the new environmentboth proactively and reactively.
4
Compensation committees will continue to evolve
The role of the committee along with its members is continuously
changing 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
5
Rewards
Learning/pursuit of
knowledge
Contacts
Business development
Sharing of expertise
Prestige/affiliation
Cash compensation/
benefits/perquisites/stock
The Director Value Proposition is the mix
of elements that attract and retain directors
Costs
Time
Experience/expertise
Effort
Risk
Reputation
Litigation
Financial
DIRECTOR VALUE PROPOSITION
Boar d Ef f ec t i veness Fr amew or k
The Eight Habits
Appendix
7
Board Effectiveness Framework
People, Practices, and Policies form the foundation for effective
governance
More than items to be checked-off,they have changed the nature of the
boardroom
How change is applied in real-timedefines the behavioral dynamics of a
corporate board
Composition Compliance and
Disclosure
Rewards
Operating Discipline
Dynamics
Development
People
The Best Talent
Practices
Doing the
Right Things
Policies
With Credibility
and Integrity
Greater detail on the framework can be
found in the Appendix of this presentation.
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Dynamics refers to how well the
rules of engagement are being applied
Simply establishing sound rules of engagement does not guarantee
Board 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 and
make appropriate changes
* J effrey A. Sonnenfeld, Associate Dean for Executive Programs, Yale School of Management.
Its not rules and regulations. Its the way people work together. *
Board Effectiveness Framework
The Ei ght Habi t s
Appendix
10
The following reflect model habits of the
highest 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 Management
6. 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 accountabilities
have raised expectations and are now expected baselines
Service limitations for active
executives
Greater scrutiny in director
selection
Formal evaluation (Board,
Committee, and individual
level)
Board and committee
succession planning
Validation and compliance
(charters, policies, and
decision rights)
Increased education on laws
and regulations
Greater director
accountability and risk
management
Improved transparency
(within the Board and to
shareholders)
More thorough due
diligence and approval
processes
Proactive agendas
Frequent ad-hoc meetings
Robust meeting materials,
more timely distribution
Greater clarity in pay
philosophy and design
Tally sheets and internal
equity assessments
People
The Best Talent
Practices
Doing the
Right Things
Policies
With Credibility
and Integrity
12
Habit 2:
Compensate Role and Activity
Rec ogni ze t he i nc r easi ng r ol e and t i me c ommi t ment
r equi r ed of al l di r ec t or s
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-basedcompensation (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
13
S&P 500 Director Compensation Analysis:
2002 vs. 2007
113 34 16 Committee Retainer (Audit)
105 45 22 Full Value Shares
46 19 13 Committee Retainer (Comp)
47 118,300 80,400 Total Annual Equity
Prevalence
Pay Level Medians
(25%)
(43%)
82
49%
% Increase
50 67 Meeting Fees (Comp and Audit)
38% 67% Stock Options
60,000 33,000 Cash Retainer
$194,300
2007
$130,600
2002
Total Director Comp
1
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
I nc r easi ngl y, w or k i s done out si de of c ommi t t ee
meet i ngs
Responsibilities reach beyond reading board booklets and meeting
attendance
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
15
Habit 4:
Remain Internally Focused, Externally Sensitive
Suc c essf ul pay pr ogr ams ar e dr i ven by i nt er nal
r equi r ement s, yet i nf or med by ex t er nal pr ac t i c e
Focus on instituting programs that align with individual companys
mission, 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 practicesand emerging trends
Potential application of alternative designs, pros and cons
Build the above into formal agendas annuallyled by management
or 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
Rel at i onshi ps w i t h c ompany l eader s i mpr oves
c ommi t t ee pr oc ess and c r eat es mor e of a c ol l abor at i ve
envi r onment
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
I nvest ment s i n educ at i on and devel opment ensur e
opt i mal c ont r i but i on f r om di r ec t or s
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 networking
workshops 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
18
Habit 7:
Build A Talent Portfolio
A di ver si t y of sk i l l s and ex per i enc es l eads t o r i c h
di sc ussi on and bet t er dec i si on mak i ng
Overall board competencies driven through individual director
aptitude
Committee members bring diverse:
Backgrounds
Expertise
Experience (general or compensation)
Develop director profiles for attraction and selectionensure right
mix of skills
Plan for successionmaintain list of qualified candidates
People Practices Policies
19
Habit 8:
Broaden Scope of Responsibility
The Compensat i on Commi t t ee w or k s w i t h a var i et y of
i ssues beyond pay
Committees role and responsibilities expand to include additional
talent 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, it
becomes the Human Capital Committee.
People Practices Policies
20
A well-governed Board helps build
goodwill, value, efficiency and effectiveness
Out c omes of Ef f ec t i ve Gover nanc e
Correlates to better company performance and greater access to
investment 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 the
business community
People
The Best Talent
Practices
Doing the
Right Things
Policies
With Credibility
and Integrity
21
Questions
Board Effectiveness Framework
The Eight Habits
Appendi x
23
Sibsons Board Effectiveness Framework
For public companies, the components within People, Practices and Policies form the
necessary foundation for effective governance. They cannot be overlooked or treated simply
as items to be checked off. How these components are applied in real-timebegins to define
the 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 Discipline
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 the
Right Things
Policies
With Credibility
and Integrity