The Compensation Committee Handbook / Edition 3

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Now in a thoroughly updated Third Edition, Compensation Committee Handbook provides a comprehensive review of the complex issues facing compensation committees in the wake of Sarbanes-Oxley. This new and updated edition addresses a full range of functional issues facing compensation committees, including organizing, planning, and best practices tips.

As the responsibilities of the compensation committee continue to increase, the need for practical and comprehensive material has become even more imperative. Complete with compliance advice on the latest rules and regulations that have developed since the publication of the last edition, Compensation Committee Handbook, Third Edition provides the most up-to-date and reliable information on: The latest regulations impacting executive compensation, including new regulations issued by the SEC, recently revised GAAP accounting rules, and the just-finalized IRS regulations impacting the taxation of stock options, The roles and responsibilities of the compensation committee, including best practice tips and techniques, Selecting and training compensation committee members, How to make compensation committees a performance driver for a Company, Practical applications, including incentive compensation and equity-based compensation. Compensation Committee Handbook, Third Edition will help all compensation committee members and interested professionals succeed in melding highly complex technical information and concepts with both corporate governance principles and sound business judgment.

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Editorial Reviews

From the Publisher
"This Reviewer...finds nothing to quarrel with in Reda's presentation of several hotly contested matters and strongly recommends the book." (Financial Analysts Journal, April/May 2003)
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Product Details

  • ISBN-13: 9780470171318
  • Publisher: Wiley
  • Publication date: 12/21/2007
  • Edition description: Older Edition
  • Edition number: 3
  • Pages: 560
  • Product dimensions: 6.14 (w) x 9.21 (h) x 1.19 (d)

Meet the Author

JAMES F. REDA is Managing Director, Executive Compensation Consulting, Arthur J. Gallagher & Co., Human Resources Consulting Practice. Mr. Reda has served for more than 27 years as advisor to the top management and boards of major corporations in the United States and abroad in matters of executive compensation, performance, organization, and corporate governance.

STEWART REIFLER is the head of the executive compensation practice at the New York office of Vedder Price, P.C. Mr. Reifler has over 25 years of experience negotiating and structuring executive compensation arrangements on behalf of executives, board compensation committees, and companies.

MICHAEL L. STEVENS is a partner in the executive compensation practice at Alston & Bird, LLP. Mr. Stevens has over 20 years of experience advising clients with respect to securities, corporate governance, and tax issues relating to stock plans, incentive compensation arrangements, executive employment agreements, and deferred compensation.

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Table of Contents

Ch. 1 The compensation committee 3
Ch. 2 Selecting and training compensation committee members 32
Ch. 3 CEO succession and evaluation 54
Ch. 4 Director compensation 77
Ch. 5 Corporate governance 91
Ch. 6 Securities issues 118
Ch. 7 Tax, ERISA and labor laws, regulations, and rules 147
Ch. 8 Accounting rules 175
Ch. 9 Executive employment and severance arrangements 203
Ch. 10 Incentive compensation 219
Ch. 11 Equity-based incentives 234
Ch. 12 Executive pension-benefit, welfare-benefit, and perquisite programs 260
Epilog : a glimpse of the future 275
App. A Selected SEC rules, regulations, schedules, and forms 281
App. B List of organizations and periodicals 345
App. C List of directors' colleges and other training opportunities 358
App. D Annotated form of compensation committee charter 365
App. E Sample compensation committee reports 382
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First Chapter

Compensation Committee Handbook

By James F. Reda Stewart Reifler Laura G. Thatcher

John Wiley & Sons

ISBN: 0-471-64769-1

Chapter One

The Compensation Committee

One of the most important determinants of a successful corporate strategy is the quality of the compensation committee. The committee is charged with designing and implementing a compensation system that effectively rewards key players and encourages direct participation in the achievement of the organization's core business objectives.

Outstanding, well-integrated compensation strategy does not just happen. Rather, it is the product of the hard work of independent, experienced compensation committee members. The most effective pay strategies are simple in design, straightforward in application, and easy to communicate to management and investors. The pay program for the chief executive officer (CEO) should be in line with pay programs for the company's other executives and with its broad-based incentive programs. In other words, there should be no conflict in the achievement of objectives, and the potential rewards should be as meaningful to all participants as to the CEO.

The United States is unique in its vast number of high-earning entrepreneurs, entertainers, athletes, lawyers, consultants, Wall Street traders, bankers, analysts, investment managers, and other professionals. Yet, it is the pay levels of corporate executives, in particular CEOs, that stir the most heated debate and controversy. It is estimatedthat the bull market of the 1990s created over 10 million new millionaires whose wealth was derived almost solely from stock options. During this period, many CEOs made hundreds of millions in option gains and other compensation-often making as much as 400 times the earnings of the average workers in their companies. Beginning in late 2001, the business world changed dramatically. Now, with the public's and investors' direct focus on corporate governance and compensation philosophy, and anticipated changes in accounting rules affecting equity-based compensation, CEOs and other executives should not expect to sustain historic rates of wealth accumulation, absent substantial performance that is no longer linked solely to the price of the company's stock.

While the proxy statement compensation tables provide historical information and raw data about the company's remuneration of its top executive officers, the compensation committee's report in the proxy statement provides a window into the company's compensation philosophy and a means for investors to assess whether and how closely pay is related to performance. A thoughtfully prepared compensation committee report is good evidence of a well-functioning compensation committee that takes its work seriously.

Among the topics covered in this chapter are:

Board and board committee structure

Independence measures

Compensation committee size

Compensation committee charter

Role of the compensation committee and its chair

Duties and responsibilities

Precepts for responsible performance

Compensation benchmarking

The importance of meeting minutes


Much of the recent public scrutiny of corporate governance issues has focused on structural issues as they relate to corporate boards-questions related to independence from management; separation of the chair and CEO positions; issues related to the composition and function of board committees; and renewed efforts to create a framework in which outside directors can obtain impartial advice and analysis, free of undue influence from corporate management.

While it has always been desirable to have a healthy complement of outside directors on the board, new corporate governance rules adopted by the New York Stock Exchange (NYSE) and Nasdaq in 2003 require that a majority of a listed company's board consist of independent directors and, with limited exceptions, that such board appoint fully independent compensation, audit, and nominating/ corporate governance committees. The new NYSE and Nasdaq rules also prescribe standards for determining the independence of individual directors, which, when layered over the director independence standards under Section 162(m) of the Internal Revenue Code (Code) and Rule 16b-3 of the Securities Exchange Act of 1934 (Exchange Act), make the nomination and selection of compensation committee members a challenging exercise.


When selecting directors to serve on the compensation committee of a public company, the nominating committee should choose only those persons who meet all the relevant independence requirements that will permit the committee to fulfill its intended function. For example, a compensation committee member must be an "independent director," as defined under NYSE or Nasdaq rules, where applicable. In addition, a public company is well served to have a compensation committee consisting solely of two or more directors who meet (i) the definitional requirements of "outside director" under Code Section 162(m), and (ii) the definitional requirements of "non-employee director" under Rule 16b-3 of the Exchange Act. This often leads to a lowest common denominator approach of identifying director candidates who satisfy the requirements of all three definitions. Unfortunately, the three tests are not identical, and it is indeed possible to have a director who meets one or more independence tests but not another.

NYSE/Nasdaq Independence Tests

Under the 2003 NYSE listing rules, an independent director is defined as a director who has no material relationship with the company. Nasdaq defines independence as the absence of any relationship that would interfere with the exercise of independent judgment in carrying out the director's responsibilities. In both cases, the board has a responsibility to make an affirmative determination that no such relationships exist. The rules list specific conditions or relationships that will render a director nonindependent. These are summarized in Exhibit 5.1 in Chapter 5.

Rule 16b-3 Independence Test

Awards of stock options and other equity awards to directors and officers of a public company, generally referred to as "Section 16 insiders," are exempt from the short-swing profit provisions of Section 16 of the Exchange Act if such awards are made by a compensation committee consisting solely of two or more "non-employee directors" (as defined in Rule 16b-3 under the Exchange Act). In addition to such compensation committee approval, there are three alternative exemptions under Rule 16b-3: (i) such awards to Section 16 insiders can be preapproved by the full board of directors, (ii) the awards can be made subject to a six-month holding period (measured from the date of grant), or (iii) specific awards can be ratified by the shareholders (which alternative is, for obvious reasons, rarely taken).

Disadvantages of relying on full board approval for the Rule 16b-3 exemption are that (i) it is administratively awkward to single out awards to Section 16 insiders for special full board approval, and (ii) if the full board takes on that role, the proxy statement report on executive compensation must be made over the names of all the directors. Therefore, prevalent practice is for the compensation committee to be staffed exclusively with directors who meet the Rule 16b-3 definition of "non-employee director," and to have the compensation committee approve all equity awards to Section 16 insiders.

To qualify as a "non-employee director" under Rule 16b-3, a director cannot (i) be a current officer or employee of the company or a parent or subsidiary of the company; (ii) receive more than $60,000 in compensation, directly or indirectly, from the company or a parent or subsidiary of the company for services rendered as a consultant or in any capacity other than as a director; or (iii) have a reportable transaction under Regulation S-K 404(a) or a reportable business relationship under Regulation S-K 404(b) of the Securities and Exchange Commission (SEC), as outlined in Exhibit 1.1.

IRC Section 162(m) Independence Test

For any performance-based compensation granted to a public company's CEO or its next four most highly compensated executive officers ("covered employees") to be excluded from the $1 million deduction limit of Code Section 162(m), such compensation must have been approved in advance by a compensation committee consisting solely of two or more "outside directors" (as defined under the Code Section 162(m) regulations). Full board approval of such compensation will not suffice for this purpose, unless all directors who do not qualify as outside directors abstain from voting. Therefore, prevalent practice is for the compensation committee to be staffed exclusively with directors who meet the Code Section 162(m) definition of "outside director," and to have such compensation committee approve all performance-based awards to executive officers and others who might reasonably be expected to become covered employees during the life of the award.

To qualify as an "outside director" under Code Section 162(m), a director (i) cannot be a current employee of the company, (ii) cannot be a former employee of the company who receives compensation for services in the current fiscal year (other than tax-qualified retirement plan benefits), (iii) cannot be a current or former officer of the company, and (iv) cannot receive remuneration from the company, directly or indirectly, in any capacity other than as a director. Exhibit 1.2 outlines the Code Section 162(m) independence test, including a summary of what constitutes "indirect" remuneration.

State Law Interested Director Test

To further complicate the analysis, the concept of independence is also applied in determining whether a director is "interested" in a particular transaction under consideration by the board or the committee. A director who meets all of the regulatory definitions of independence under the NYSE/Nasdaq rules, Code Section 162(m), and Rule 16b-3 can still have a personal interest in a particular transaction that can interfere with his or her ability to render impartial judgment with respect to that transaction. This type of nonindependence will not render the director unsuitable to serve on the compensation committee, but he or she may need to be excused from voting on the particular matter. An example of this might be a situation in which the compensation committee is determining whether to hire a particular consulting firm to advise the committee with respect to a particular matter and one of the committee members has a relative at such consulting firm. This relationship would not necessarily bar the committee member from satisfying any of the regulatory definitions of independence (particularly if the amount of the consultant's fee is less than $60,000), but the director might have a personal interest in having the committee hire that consulting firm over another. In that case, the interested director should disclose the nature of his or her interest in the matter and abstain from voting on the hiring question. Once that consulting firm has been hired to represent the committee, the matter is over, and the originally interested director may resume active participation in the business of the committee.

Full Disclosure of Pertinent Information

The SEC's proxy rules require disclosure of relevant background information about each director that is intended to give shareholders an indication of the director's unique qualifications and any relationships or affiliations that might affect his or her judgment or independence. For example, disclosure is required regarding:

All positions and offices the director holds with the company.

Any arrangement or understanding between the director and any other person pursuant to which he or she is to be selected as a director or nominee.

The nature of any family relationship (by blood, marriage, or adoption, not more remote than first cousin) between the director and any executive officer or other director.

The director's business experience during the past five years.

Any other public company directorships held by the director.

The director's involvement in certain legal proceedings.

Any standard arrangements pursuant to which directors are compensated, and any other arrangements pursuant to which a director was compensated during the company's last fiscal year for any service provided as a director.

Any transaction, or series of similar transactions, occurring in the last year or currently proposed, to which the company or any of its affiliates is a party, in which the amount involved exceeds $60,000 and in which the director had, or will have, a direct or indirect material interest.

Certain business relationships that currently exist, or existed during the last fiscal year, between the company and an entity affiliated with the director or nominee, and the nature of such director's or nominee's affiliation, the relationship between such entity and the company and the amount of the business done between the company and the entity during the company's last full fiscal year or proposed to be done during the company's current fiscal year.

Any indebtedness of the director in excess of $60,000 to the company or its subsidiaries at any time in the last fiscal year.

Any failure by the director to make a timely filing of any Section 16 report during the last fiscal year.

Any director interlocking relationships.

Director Interlocks

As a reflection of the current insistence on unbiased, independent analysis in setting executive pay, there is a special sensitivity to so-called "director interlocks." A director interlock exists where any of the following relationships is in evidence:

An executive officer of the company serves as a member of the compensation committee of another entity, one of whose executive officers serves on the compensation committee of the company.

An executive officer of the company serves as a director of another entity, one of whose executive officers serves on the compensation committee of the company.

An executive officer of the company serves as a member of the compensation committee of another entity, one of whose executive officers serves as a director of the company.

NYSE/Nasdaq description-A director of the listed company is, or has a family member who is, employed as an executive officer of another entity where at any time during the last three years any executive officers of the listed company served on the compensation committee of such other entity.

While not prohibited as a legal matter, director interlocks are suspect due to the possibility that they could engender a "you-scratch-my-back, I'll-scratch-yours" influence or other quid pro quo situation affecting executive compensation decisions.


Excerpted from Compensation Committee Handbook by James F. Reda Stewart Reifler Laura G. Thatcher Excerpted by permission.
All rights reserved. No part of this excerpt may be reproduced or reprinted without permission in writing from the publisher.
Excerpts are provided by Dial-A-Book Inc. solely for the personal use of visitors to this web site.

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  • Posted January 14, 2010

    more from this reviewer

    A solid field guide to compensation programs

    Anyone involved in compensation issues will want to keep this handbook nearby. The author wrote it mainly for directors who serve on the compensation committees of publicly traded firms. But the book raises issues and advocates practices that many company managers should consider. Though much of the book is quite technical, this basic survey of compensation issues is appropriate for a broad professional audience. getAbstract recommends it as a good first step toward more equitable and effective pay practices.

    To learn more about this book, check out the following Web page:

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  • Anonymous

    Posted November 17, 2001

    Compensation Committee Handbook

    Every board member is interested in how to be more efficient and effective in compensation decisionmaking. James Reda has impressive consulting and research credentials for enlightening directors on this matter. His new book presents both the fundamental concepts and practical strategies of 'best practices' compensation in a way that will boost the performance of any compensation committee.

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  • Anonymous

    Posted November 17, 2001

    Compensation Committee Handbook

    Jim Reda has written an excellent and a remarkably thorough handbook for compensation committees of boards of directors. It is certain to become a well-worn volume on the bookshelves not only of compensation committee members, but also of CEO¿s, board chairmen, CFO¿s and corporate secretaries. I highly recommend this book to the 4000 members of the American Society of Corporate Secretaries. It is an indispensable guide and resource for good corporate governance.

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