Setting Directors’ Fees After Sarbanes-Oxley

Sarbanes-Oxley (SOX) has certainly made quite an impact on corporate governance since its enactment in 2002. Most of us remember the corporate debacles that brought about SOX. In fact, one of them, the Enron failure, is still very much in the news today.

Consider some of the ways that SOX has affected corporate governance: choosing auditing firms, assessing a company’s internal controls, strict prohibitions of conflicts of interest, etc. Not surprisingly, it has also affected compensation of board members. Additionally, many prospective board members think twice before they accept a board appointment.

A recent article that I wrote for the E-Commerce Times, Corporate Governance: Panic in the Boardroom, goes into detail about the many ramifications of SOX, as well as how one could still proudly serve on a board without being overly concerned with personal liability.

Rising Fees

There’s no doubt about it, SOX has had an unintended effect on publicly-held corporations — they have to pay higher fees to board members. Some recent studies that I’ve read show that board fees have indeed increased since the enactment of SOX and all of the publicity directed at board members.

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SOX has certainly directed attention to board service. The result of all of this unwanted attention is that fewer people want to serve on a corporate board. To make board service more attractive, directors’ fees have gone up accordingly.

The recent studies that I’ve looked at show quite a range for directors’ fees. Total compensation goes from about US$20,000 per year to $200,000 per year, depending on the size of the corporation and the extent of the board member’s responsibilities.

Components of a Board Fee

Surprisingly, there are more individual elements involved in comprising a board member’s annual fees than you can imagine.

There is, of course, the so-called basic annual retainer. This is the threshold of the total compensation package. Included in this figure are per-meeting fees, additional fees for telephonic meetings, as well as committee member fees.

Keep in mind, however, that officers and employees of a company who serve on a board usually get no compensation for their board services. Their compensation as an officer or employee should be sufficient for them. And, I do think that there is some sort of an inherent conflict of interest if an officer is given additional fees for serving on his/her own company’s board.

Some additional common board member perks consist of life insurance and health plans, stock option plans, and directors’ and officers’ insurance (D&O insurance) — a must for service on any corporate board. In fact, when I am invited to serve on a board, the first thing I ask is whether the company has D&O coverage and how much.

The Right Compensation

Executives are challenged with coming up with a fair fee for a director’s service. Obviously, supply and demand come into play here. If the would-be director is influential and can bring quite a bit of publicity or revenue to the company, he/she has to be paid accordingly.

That notwithstanding, there is an underlying principle that I instruct our clients to use when setting a director’s compensation package. That principle is: what value does the person bring to the board?

If the director is seasoned, effective, and can help the fortunes of a company, I would consider paying at least a part of the director’s annual fees in stock options. After all, if the director is doing a great job, the value of the company’s stock will commensurately increase over time after the director’s appointment.

Stock options should then be considered as an integral part of a director’s compensation package. From my perspective, stock options are extremely attractive in that they give the director a substantial upside to his/her fees if the company is successful. In many ways, I prefer stock options to a base fee.

One caveat: some corporate observers feel that stock option plans should be limited because they could somehow put board members in a conflicted position. My advice is to consult with your securities attorney to be sure that your company’s stock option plan complies with all applicable laws and regulations.

Here’s one final point. Some committee assignments really should carry a greater fee. For example, after the enactment of SOX, the audit committee became a central and crucial element for a company. The responsibilities of the committee are great, and their duties, if fulfilled faithfully, can be quite time consuming. To a lesser extent, I would say the same for the compensation committee.

So, when setting a compensation package for a board member keep in mind the duties required of this person and adjust the compensation accordingly. Additionally, it is not uncommon to pay the chairman of the audit committee something extra for his/her duties. This particular chairmanship does require a good deal of additional time, and I say this through personal experience.

Finally, the setting of board fees should not be an onerous task. Remember that the laws of supply and demand apply here, and that you pay for what you get. Also remember the concept of value added. If the person whom you intend to appoint to your board really has a good deal of self-confidence, then he or she shouldn’t be opposed to the concept of stock options as at least a partial payment for services.

Go after the best possible candidates for your board. The future of your company is worth it.

Good luck!

Theodore F. di Stefano is a founder and managing partner at Capital Source Partners, which provides a wide range of investment banking services to the small and medium-sized business. He is also a frequent speaker to business groups on financial and corporate governance matters. He can be contacted at [email protected].

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