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Show Them The Money

As board members take on more responsibilities in light of compliance concerns, HR's leadership can help keep them sufficiently compensated and, therefore, actively involved.

Tuesday, February 1, 2005
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Last November, A. Hamish Petrie spent several hours immersed in a debate over director compensation. As the vice president for people and communications at Alcoa, the big Pittsburgh-based aluminum producer, he is also the company's chief internal resource for the board's compensation and benefits committee.

And the committee was trying to decide what to pay its directors.

"This is a very pertinent topic right now," says Petrie, who began his career with Alcoa in 1978 at an Australian plant. "The board is expected to do more these days. There are added accountabilities. And obviously, you want to attract, retain and motivate the best people. But we need to find the best way to do that. We spent several hours today going over this. And so we're heading in the direction of adjusting compensation for all directors. We've got to stay in touch with the market."

Indeed, the tone and substance of the work handled by boards is changing. Many board members are attending more meetings, participating in more committees and, in general, devoting longer hours and shouldering larger workloads. Some directors, however, are tackling more responsibilities than others.

Gone are the days when boards met a few times each year, demands were relatively few and compensation was fairly uniform. As Alan Johnson, a New York-based compensation specialist, notes, a director's responsibilities have ratcheted up twofold to threefold. And, as a result, not every director is created equal.

Today, the passage of the Sarbanes-Oxley Act and the subsequent emphasis on corporate governance means that nearly all directors are committing more of themselves than ever before. This is translating into more regulations to follow and more vigilance in handling legal and financial responsibilities. No one wants to sit on the board of the next Enron, after all.

But as a result, the nature of director compensation is undergoing some fundamental changes. As one experts notes, board members are people, too.

And while it may not be a good thing to overemphasize compensation, it does help to remember that some directors are going to compare what they are getting paid by different companies.

"Even comfortable directors don't like to work for free," says Ira Kay, an executive compensation consultant at Bethesda, Md.-based Watson Wyatt Worldwide.

That's made clear from reading the results of a recent survey by Sibson Consulting, the New York-based executive compensation firm, which found that companies are starting to respond in a big way. Since 2002, 81 percent of companies have made or are planning to make changes to compensation for regular board and committee service, according to Sibson.

Another survey -- conducted by Pearl Meyer & Partners, an executive compensation consulting firm based in New York -- found that board compensation grew 13 percent to nearly $176,000 in 2003, following two consecutive years in which board pay was nearly flat.

What's more, compensation for committee service rose, on average, by about 35 percent, to more than $23,000. Fees paid to directors chairing audit committees, for instance, jumped 47 percent, while the average increase given to directors who chair compensation committees rose 24 percent, according to the report.

"A great deal has changed," says Ed Archer, Pearl Meyer's managing partner. "Directors are looking at increased responsibility and increased risk. And not only is there more of a time commitment, but there are also unscheduled meetings. A director may have, typically, worked 150 hours a year, but now is putting in 250 hours."

And what does all of this mean for the leaders of HR? "The human resource executive remains involved in board compensation," says Archer, "but that role is evolving, too."

This evolution is significant, according to experts. As Charles Peck, a compensation specialist at The Conference Board, says: "The care and feeding of the board of directors is, typically, the domain of the corporate secretary. But it's actually handled by human resources."

By most accounts, HR executives will continue to be intimately involved in setting board compensation. But with the demands placed on directors to display transparency and accountability, the nature of that involvement is changing. Today, human resource executives should expect to spend more time acting as facilitators -- researching comparable board pay, interacting with outside consultants and meeting with the compensation committee to review strategies and goals.

In other words, a human resource executive must do a great deal of research that provides ammunition on trends and data, and then be prepared to discuss the findings. But experts add that it's important to offer a point of view, not just a recitation of facts or a presentation of options. Talk about mission statements or guiding principles, but build comfort levels and make a point.

HR as Leader

To succeed, a human resource executive should be willing to lead board members in a particular direction.

"The good news is that the human resource person was already the liaison with the board, or at least the compensation committee," says Blair Jones, senior vice president and practice leader for leadership performance and rewards at Sibson Consulting. "But the demands are greater and the role now requires emphasizing education, connecting dots between your company and others, having opinions, knowing best practices.

"At the end of the day, the human resource executive should be able to have almost a philosophical discussion. He or she can be the one who helps the board take a step back and view compensation. The trick is to be informed ahead of the curve, which means being aware of the marketplace, what other boards are doing--especially other boards where your own directors serve--and being able to play a leadership role."

Another human resource executive who agrees with this philosophy is Greg Lau, the executive director of global compensation and corporate governance at General Motors Corp. in Detroit. As secretary to both the compensation and governance committees on the board, he takes a very active part in helping shape director pay. And he says he can do so because he's in a unique position to understand what the General Motors directors are doing.

"Human resources should be leading today's changes," says Lau. "We know their workload. Director compensation stands by itself and is detached from executive compensation. So you want to be able to discuss meeting fees, the use of stock options and stock ownership. You should be able to review your own director compensation against a good list of similar companies as a benchmark. But it's not rocket science. You don't need a slew of consultants to do this."

Not surprisingly, some consultants disagree.

Watson Wyatt's Kay says boards are increasingly worried about transparency and the process of establishing proper lines of communication. To achieve this, he says, directors want legal and strategic advice from as many knowledgeable parties as possible, including outside consultants.

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"Human resources still has a role, but in terms of influencing the decisions on director pay, I think the role is lessened," says Kay. "With that said, human resources must still play a crucial role in helping directors stay abreast of trends, especially within their industries. They need to be on top of everything and ensure the company isn't embarrassed."

One important trend to keep in mind, say experts, is that the composition of board pay is changing, not just the total amount or the varying amounts that may be given to individual directors. The emphasis on corporate governance and the Sarbanes-Oxley Act has also meant a change in the form of compensation.

No longer are stock options a widely used form of payment. Instead, directors are increasingly being given fully valued stock, reflecting the overall trend away from doling out options. In 2002, 70 percent of companies surveyed granted stock options to directors, but that dropped to 59 percent in 2003, according to Pearl Meyer & Partners.

In 2003, the typical director would have received total pay in which cash comprised 49 percent and equity was worth 51 percent of the package, according to a survey by New York-based Mercer Human Resource Consulting. Two years earlier, however, cash was just 41 percent and equity accounted for 59 percent.

Of course, this varies among industries. Computer makers, for instance, continued to offer 71.4 percent of director compensation in stock, while directors of foresters and paper-products manufacturers received just 44 percent of the compensation in stock. Overall, though, a shift is under way and experts say human resource executives will need to adjust.

"I don't think the influence of the human resource executive has changed," says Peter Oppermann, a senior executive compensation consultant at Mercer. "But they need to work closely with the appropriate committee [focusing on] the process of establishing the compensation."

Taking Charge

Granted, the level of interaction and responsibility may fluctuate, depending upon which committee is setting board compensation. As Fred Cook, a New York-based executive compensation consultant, points out, the human resource executive may likely take a back seat to attorneys if a board's governance committee is chartered with establishing board pay.

"I favor seeing compensation determined by the governance committee," says Cook. "I want companies to avoid the perception of back scratching. In this way, a potential conflict of interest can be avoided."

With that said, he advises HR executives to be ready, willing and able to tackle several key tasks in order to provide sound advice to the board. These include providing sobering assessments of a board's value, annual salary reviews and comparisons with similar companies. And he stresses a thorough search for reliable sources. Cook also suggests downplaying the use of options. In addition, he advises human resource executives to look into board pensions. In the past, many boards would determine a pension based on the amount of a director's last annual retainer.

"It's a hell of a deal for the director," he says, "but it's a bad idea, because it makes the director beholden to the company. For the well-to-do director, it may not seem like a lot, but it could very well represent a large amount to a director who is from academia."

As Alcoa's Petrie makes it clear, staying abreast of such trends cannot be understated. "What's happening before our eyes is that the directors are more accountable, and so we've got to stay in touch with the market," he says. "In our own case, we recently had our compensation and benefits committee meeting, and so we did market research, reviewed internal matters, compared business objectives and made some recommendations. The HR team is comprised of process functional experts--we need to be involved in the process. So you must stay connected."

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