For nonprofit organizations, the role of the compensation committee largely depends on the bylaws and the compensation committee's charter. Both sets of rules determine if the committee has the authority to determine components for executive compensation packages and amounts, or if they merely make recommendations to the board.
Corporate boards are more highly regulated and have more pressure by investors regarding say on pay, so their compensation committees require clearer definitions along with clearly defined duties and responsibilities than their nonprofit counterparts. Publicly traded corporations must appoint all independent directors to the compensation committee because they are ultimately responsible to the shareholders, who are looking for assurance that executive pay correlates to performance.
The definition of the role of the compensation committee requires having a good understanding of the composition of the compensation committee, the authority of the committee, and the committee's duties and responsibilities.
How Can We Define the Compensation Committee?
In general terms, the compensation committee functions in advisory, strategic and administrative roles.
Compensation committees should be an authority on best practices, trends and regulations regarding executive compensation.
In this capacity, they serve as advisors to the board. In the capacity of their strategic role, compensation committees must be able to demonstrate to the board and shareholders how achieving corporate goals correlates with and supports executive compensation packages.
In an administrative capacity, compensation committees must perform much research, including identifying studies, evaluating alternatives and designing the most appropriate components for executive compensation plans. Their plans must meet the specifics of industry rules and regulations. The committee also takes on the primary responsibility for making sure that compensation plans produce intended results.
Who Serves on the Compensation Committee?
The current environment around executive compensation requires boards to appoint compensation committees comprised solely of independent directors. The appointees should collectively encompass general business skills and industry expertise.
Independence and skills are important and it's also important that the committee understands exactly what the board needs from them. It's imperative that boards develop a written description of the committee's role, duties and responsibilities, leaving nothing to chance.
What Authority Does the Compensation Committee Have?In general terms, compensation committees select the components for executive compensation packages, along with the corresponding amounts. They also specify the value of the total compensation packages for executives. The components of compensation plans, as well as how those components are structured and implemented, vary substantially between corporations. Most compensation plans consist of one or more of the following components:
- Base salary
- Bonuses: typically short-term goals with cash-based incentives
- Long-term incentives: often come with corporate equity
- Benefits: components such as health, dental or life insurance; vacation time; or company-sponsored savings and investment plans
- Perquisites: grants or privileges such as company cars, business cell phones and use of corporate properties
What Are the Duties and Responsibilities of the Compensation Committee?
The first responsibility of the compensation committee is to develop a philosophy around compensation that is in keeping with the corporation's mission and values. This incorporates things like ratio of salary to benefits, competitiveness, correlation to business strategy, drivers for increases or incentives, and how the philosophy affects employee morale and job satisfaction.
As a body of independents, it's appropriate for compensation committees to approve any compensation in which board directors or officers may be able to participate. This duty may be challenging for some committees because the full board generally votes on it and the board may allow shareholders to have input on it rather than take a chance on causing unrest with shareholders because of compensation amounts.
Acting as board advisors, compensation committees recommend, oversee and approve compensation in the form of corporate equity, stocks, perquisites and other benefits. They also oversee employment contracts in conjunction with board oversight and, under some circumstances, with shareholder approval.
Serving in an administrative role, the compensation committee recommends or approves the CEO's compensation package to the board along with compensation for submitting direct reports. The compensation committee also serves as a liaison between the CEO and the board on all compensation and human resources issues for senior executives.
Acting in the role of industry experts in executive compensation, the committee also reviews the board members' compensation components and amounts and makes recommendations to the board for changes. The board takes their recommendations into consideration and votes on them according to their duty of care, which means placing the interests of the organization above their own.
Executive compensation plans clearly outline performance metrics and how they correlate to the targets defined in the executives' compensation packages. The compensation committee compares performance to targets in deciding which benefits and awards the executive is entitled to under the agreement.
As advisors to the board, compensation committees may seek professional experts to help them in their role, including legal, accounting or compensation professionals.
In addition to working closely with the board, compensation committees usually work together with finance or audit committees to approve the overall compensation budget so that individual compensation plans are fully funded.
Concluding Thoughts on the Role of Compensation Committees
Compensation committees don't typically set compensation packages or amounts for non-officer positions, which is a function of human resources and senior management.
The committee should set compensation at levels that are competitive with other corporations and are commensurate with the position and level of performance. Between the board and the compensation committee, there should be an appropriate set of checks and balances.
The approach of the compensation committee should be to fulfill their duties and responsibilities while helping the board provide meaningful oversight. Committees need to perform these duties while being careful not to micromanage implementation of executive compensation plans.
Compensation committees in today's marketplace are being heavily scrutinized by boards, regulatory bodies and shareholders. For this reason, as well as for the purpose of fulfilling their fiduciary duties, members of compensation committees need to be cognizant of acting in ways that are routinely ethical, professional, accountable and transparent.