The Inexact Science of Board Compensation
Throughout my experience working with various company Boards of Directors, I have yet to encounter a director who believes they are overpaid. If director compensation is too low, qualified candidates may decline the opportunity to serve on a specific board. This is particularly true for potential directors who are highly sought after or have a limited capacity to serve on multiple boards. In such cases, compensation becomes a higher priority. However, it’s important to note that compensation typically ranks third or fourth in terms of factors that attract potential candidates. The top reasons for an executive to join a board include:
- The company itself – factors such as size, business model, maturity, challenges, and opportunities.
- Cultural fit with the executive team and existing board members.
- The unique experience the candidate can bring to the board, such as functional expertise, industry knowledge, and familiarity with various business challenges and opportunities.
When it comes to Board Compensation, we cannot apply basic logic. The largest public companies in the United States offer between $250,000 and $500,000 to serve on their Boards of Directors. The average time commitment for a public company board member ranges from 200 to 250 hours per year, including board meetings, committee meetings, travel, and preparation. This amounts to an hourly rate of approximately $1,250 to $2,000. While this may seem substantial on an hourly basis, many individuals serving on these boards earn upwards of $10 to $20 million per year, which translates to $5,000 to $10,000 per hour.
Private company Board Compensation is generally significantly lower than that of public companies. There are several reasons for this disparity. Firstly, the time commitment for private company board members is typically less than 100 hours per year. Secondly, the committee requirements are often lighter or even non-existent in private companies. Finally, private companies tend to have lower revenue and less complexity compared to their public counterparts.
Board of Directors compensation is an essential topic for organizations, as it involves rewarding the people who provide strategic oversight and guidance. These individuals are responsible for protecting the interests of shareholders and stakeholders, making key decisions, and ensuring long-term growth and stability. The compensation provided to directors should be fair, competitive, and reflective of their contributions to the organization. In this blog post, we will discuss the factors to consider when compensating board members and offer guidelines for establishing a fair compensation structure.
1. Understanding the Role of the Board of Directors
Before determining the appropriate compensation for board members, it’s essential to understand their roles and responsibilities. Directors are responsible for:
- Setting the strategic direction of the company
- Ensuring proper governance and compliance with applicable laws and regulations
- Overseeing executive management
- Representing and protecting shareholders’ interests
- Mitigating and managing risks
Given these responsibilities, board members should be compensated fairly for their time, expertise, and commitment.
2. Factors Influencing Board Compensation
Several factors influence the compensation provided to board members, including:
- Company size: Larger companies typically offer higher compensation to attract and retain experienced directors.
- Industry: Board compensation may vary depending on the industry, as some sectors require more specialized knowledge or have higher levels of risk and regulation.
- Company performance: The financial performance of the company may also influence board compensation. Companies that are performing well may choose to offer higher compensation to retain and reward directors for their contributions to the company’s success.
- Time commitment: The workload and time commitment required of board members should be considered when determining compensation. Boards with a higher meeting frequency or more complex matters to address may require higher compensation to attract and retain qualified directors.
- Regulatory environment: The compensation structure should comply with applicable regulations and governance guidelines.
3. Components of Board Compensation
Board compensation typically comprises a mix of cash and equity-based incentives. The primary components include:
- Annual retainer: A fixed cash amount paid to board members for their services, regardless of the number of meetings attended.
- Meeting fees: Additional cash payments made to directors for attending board and committee meetings. These fees are intended to compensate directors for the time and preparation required for each meeting.
- Equity grants: Stock options or restricted stock units (RSUs) that align the interests of directors with those of shareholders. Equity grants are generally subject to vesting schedules and holding periods to encourage long-term commitment and discourage short-term decision-making.
- Committee fees: Additional compensation for serving on specific board committees, such as the Audit, Compensation, or Nominating and Governance committees. These fees may vary depending on the complexity and workload of each committee.
- Expense reimbursements: Directors are typically reimbursed for travel and other expenses incurred in attending board meetings and performing their duties.
4. Establishing Fair Compensation Guidelines
To ensure fair compensation for board members, organizations should follow these guidelines:
- Benchmark against peer companies: Regularly review and benchmark board compensation against comparable companies within the industry and of similar size. This will help to ensure that compensation remains competitive and in line with market standards.
- Balance cash and equity components: Strive for a balance between cash and equity-based compensation. This approach provides directors with a predictable income while also aligning their interests with the long-term success of the company.
- Review compensation annually: Regularly review and update the compensation structure to account for changes in the company’s size, performance, and market conditions.
- Consider the time commitment: Evaluate the workload and time required of board members when determining compensation. Ensure that directors are fairly compensated for their time and expertise.
- Engage independent advisors: Engage compensation consultants or other independent advisors to provide an objective perspective on board compensation and to ensure that your directors are being paid fairly for the expectations the company has on them.
This blog post highlights the importance of fair Board of Directors compensation, as directors play a crucial role in providing strategic oversight and guidance for organizations. Compensation typically ranks third or fourth in attracting potential candidates, with factors like company size, cultural fit, and unique experience being more important. Public company board compensation is higher than private companies due to factors like time commitment, committee requirements, and company complexity. A balanced mix of cash and equity-based incentives is recommended, and organizations should follow guidelines such as benchmarking against peers, reviewing compensation annually, and engaging independent advisors to establish fair compensation structures.