Establishing Effective Governance

The pace of change in regulatory and legislative developments in executive compensation has never been greater. New regulations now say that publicly traded companies need compensation committees that are independent of management. Boards must now review incentive pay plans, even for several pay grades below senior officers. Clawbacks will soon be required for publicly traded companies. So how can a board keep track of it all? Meridian Compensation Partners’ Michael Brittian and Daniel Rodda write about how a board can get a handle on its ever changing agenda.

What kind of a bank needs a compensation committee and who should be on it?

U.S. security exchanges have established listing standards requiring that, among other things, each member of a company’s compensation committee be a member of the board of directors and “independent,” with a specific definition of what independence means. Many nonpublic companies view it as good governance to adopt similar standards, and create compensation committees comprised solely of independent directors to review and approve management compensation.

What should the compensation committee charter say?

Beyond reflecting all applicable securities exchange listing standards, the charter should clearly and concisely articulate the committee’s purpose and duties. This should primarily include the committee’s responsibility to oversee and approve the compensation of the company’s CEO and senior officers, including the pay philosophy, structure and programs. The charter also should reflect the committee’s oversight of a compensation risk review for all employee incentive plans, per regulations that went into effect for all banks in 2010.

The charter should reflect the company’s specific situation and circumstances, rather than a “boilerplate” template. A good charter will be comprehensive regarding the committee’s duties and responsibilities without being overly specific as to how they will be carried out.

With all the new regulations surrounding pay structures, how should a board keep pace with it all?

Boards should receive regular presentations and updates from management and/or outside advisors on new regulatory developments and how the company is responding. Board members should also seek opportunities for education outside board meetings, through peer networking, publications, conferences and webcasts.

What are some of the ways compensation committees can improve on process in order to enhance their effectiveness?

A high-functioning compensation committee defines a robust process for making pay decisions. This includes having an established annual calendar of discussion topics; ensuring the committee has input into agendas; scheduling pre-meetings with the committee chairman and management; receiving materials well in advance of meetings and reviewing those materials thoroughly in advance. Committees also should ensure ample discussion time for proposals and hold executive sessions at each meeting. A well-developed process can help with planning and communication.

How should you decide on an agenda for each meeting?

A well-crafted annual calendar of meeting dates and discussion topics is a critical practice for an effective compensation committee and will shape each meeting’s agenda. Often, we see the compensation committee’s management liaison (e.g., executive vice president for human resources), with input from the committee’s independent compensation consultant, develop an initial draft of the annual calendar for the review by the chairman. The calendar and discussion agendas should include all of the responsibilities and duties of the committee reflected in the charter. The calendar should seek to spread activities throughout the year; since many pay decisions are made in the first quarter, other less time-specific activities can be allocated to other meetings. Each meeting agenda should clearly articulate the discussion topics, allotted timing, individual(s) responsible for leading the discussion, and the nature of the discussion (e.g., review, approval and/or recommendation to the full board).

How much input should management have in the pay structure?

Management is often the primary architect of the compensation programs, subject to rigorous review and evaluation by the compensation committee. Management’s role should be to provide strategic perspective for the business, develop and implement the human resources strategy, and prepare proposals for the committee’s consideration and approval. The committee’s responsibility is to oversee sound governance and pay practices, critically evaluate management’s proposals and ask questions, and approve officers’ compensation strategies, programs and rewards. In developing proposals for the committee, management should not make recommendations for the CEO’s awards. Pay actions should be considered independently by the compensation committee and/or full board in executive session without management present.

Michael Brittian is a partner in Meridian Compensation Partners’ Dallas office.

Daniel Rodda is a senior consultant in Meridian’s Atlanta office.