Report of the NACD Blue Ribbon Commission on Director Compensation

Introduction to the 2006 Edition Director Compensation: Investing in Good Governance

What is a corporate director worth? The first NACD Blue Ribbon Commission on Director Compensation posed this question more than a decade ago, in 1995. The basic factors of a director pay formula remain the same in this first decade of the new century. As in the past, each board must set director pay for itself, weighing the time and expertise the particular job requires as well as the opportunity cost and reputational and/or liability risk board service may impose.

New Environment

Today, however, there is a new environment for director pay. Although these basic factors remain unchanged, their absolute value has risen. Total compensation awarded directors in 2005 compared to 2004 rose by about 20 percent on average for most public companies—with a smaller rise in very large companies (14 percent) and a much larger jump in smaller firms (36 percent), according to the annual NACD Pearl Meyer & Partners report. And the increase from 10 years ago was more than 200 percent. In large ($1 billion plus companies) for example, pay rose from an average retainer in the $30,000 range, with additional stock paid in only 2 percent of companies, to an average retainer in the $60,000 range, plus additional stock worth that same amount or more.

It is not at all surprising that the level of director pay has risen so dramatically. 

Obviously the presence of an equity component has helped to increase totals. Our 1995 report recommended that 50 percent or more of director pay be in stock, and this has in fact become a common practice. In a strong stock market, this can lead to large increases in particular instances. When directors defer their pay and receive it all at once, it can lead to windfalls in individual cases. 

A Bigger Job

More significantly, the director’s job has kept pace with most changes. In the past decade directors have been spending more time on the job, need greater expertise than ever, bear a greater opportunity cost for their time, and finally, run a higher reputational and liability risk.

Time. In the past decade, the average number of hours directors spend on board and committee duties has doubled from 100 per year in 1995 to 200 per year in 2005.

Expertise. The passage of Sarbanes-Oxley in 2002 and related stock exchange guidelines in 2003 have increased the amount of governance knowledge directors must have today. Meanwhile, the increasing complexity of industries, their regulatory framework, and their technologies demands more homework on the part of directors new to a particular industry.

Opportunity Cost. CEOs and other fully employed persons today are generally expected to limit their board seats to two or three, and they are choosing those with a keen sense of the competing opportunities they are declining.

Risk. The WorldCom settlement in 2005 raised the specter of out-of-pocket payments and social shame to directors for violations of technical aspects of securities laws—even if they did not participate in any fraud or act of bad faith.

The foreword to this book, provided by Pearl Meyer & Partners, details a recent Securities and Exchange rule requiring greater disclosures on director pay. The factors above can be an important part in justifying the increasing amounts of pay awarded to deserving directors.

Robert Stobaugh
Chairman, Blue Ribbon Commission on Director Compensation