New and updated information on the laws and regulationsaffecting executive compensation
Now in a thoroughly updated Fourth Edition, The CompensationCommittee Handbook provides a comprehensive review of thecomplex issues challenging compensation committees that facerevised executive compensation disclosure regulations issued by theSEC, as well as GAAP and IFRS rulings and trends. This new andupdated edition addresses a full range of functional issues facingcompensation committees, including organizing, planning, and bestpractices tips.
- Looks at the latest regulations impacting executivecompensation, including new regulations issued by the SEC, as wellas GAAP and IFRS rulings and trends
- Covers the selection and training of compensation committeemembers
- Explores how to make compensation committees a performancedriver for a company
- Guides documentation requirements and timing issues
The Compensation Committee Handbook, Fourth Edition willhelp all compensation committee members and interestedprofessionals succeed in melding highly complex technicalinformation and concepts with both corporate governance principlesand sound business judgment.
|Edition description:||New Edition|
|Product dimensions:||8.80(w) x 5.90(h) x 1.80(d)|
About the Author
JAMES F. REDA is Managing Director, ExecutiveCompensation Consulting, Arthur J. Gallagher & Co., HumanResources Consulting Practice. Mr. Reda has served for more than 27years as advisor to the top management and boards of majorcorporations in the United States and abroad in matters ofexecutive compensation, performance, organization, and corporategovernance.
STEWART REIFLER is the head of the executive compensationpractice at the New York office of Vedder Price, P.C. Mr. Reiflerhas over 25 years of experience negotiating and structuringexecutive compensation arrangements on behalf of executives, boardcompensation committees, and companies.
MICHAEL L. STEVENS is a partner in the executivecompensation practice at Alston & Bird, LLP. Mr. Stevens hasover 20 years of experience advising clients with respect tosecurities, corporate governance, and tax issues relating to stockplans, incentive compensation arrangements, executive employmentagreements, and deferred compensation.
Read an Excerpt
Compensation Committee Handbook
By James F. Reda Stewart Reifler Laura G. Thatcher
John Wiley & SonsISBN: 0-471-64769-1
Chapter OneThe 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
Compensation committee size
Compensation committee charter
Role of the compensation committee and its chair
Duties and responsibilities
Precepts for responsible performance
The importance of meeting minutes
BOARD STRUCTURE; THE FOCUS ON INDEPENDENCE
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.
COMPENSATION COMMITTEE COMPOSITION AND MULTIPLE INDEPENDENCE REQUIREMENTS
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.
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.
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Table of Contents
About the Authors xix
PART One THE MODERN COMPENSATION COMMITTEE 1
CHAPTER 1 The Compensation Committee 3
Board Structure: The Focus on Independence 4
Compensation Committee Composition and
Multiple Independence Requirements 5
Compensation Committee Size 10
Compensation Committee Charter 11
Role of the Compensation Committee 13
Role of the Compensation Committee Chair 14
Duties and Responsibilities of the Compensation Committee 14
Compensation Benchmarking 26
The Importance of Compensation Committee Meeting Minutes 29
Call to Action 31
CHAPTER 2 Selecting and Training Compensation CommitteeMembers 33
The Role of the Nominating Committee 33
Nomination and Selection of New Compensation Committee Members34
Time Commitment 39
Attracting Candidates 41
Conducting the Search 41
How to Approach Candidates 43
CEO Involvement in the Selection Process 43
Making the Final Selection 44
How to Say No 47
What if the New Director Does Not Work Out? 47
Benefits of an Educated Board 48
Orientation of New Members 49
Ongoing Training 51
Outside Experts and Advisors 53
CHAPTER 3 CEO Succession and Evaluation 59
The Relationship Between Pay and Succession Planning 61
The Advantages of Effective Succession Planning 65
The Succession Planning Process 67
CEO Evaluation 73
CHAPTER 4 Director Compensation 97
Elements of Director Compensation 99
Trends in Director Compensation 106
Conducting a Director Compensation Study 109
PART Two LEGAL AND REGULATORY FRAMEWORK 115
CHAPTER 5 Corporate Governance 117
Fiduciary Duties of Directors 117
Practical Applications of Fiduciary Duty Rules 126
Stock Exchange Corporate Governance Rules 131
External Compensation Policies and Guidelines 131
CHAPTER 6 Disclosure of Executive and Director Compensation143
Compensation Discussion and Analysis 144
The Tabular Disclosures 146
Option Grant Practices 154
Director Compensation 155
Disclosure of Material Compensation Risk 155
Compensation Disclosure Requirements for Smaller ReportingCompanies 157
Golden Parachute Compensation 158
Pending Dodd-Frank Disclosure Requirements 160
Beneficial Ownership Reporting 162
Disclosure of Related Person Transactions 162
Director Independence and Governance Disclosure 163
Disclosure of Equity Compensation Plans 165
Plan Filing Requirements 167
Form 8-K 168
Selected Provisions of Regulation S-K 168
CHAPTER 7 Other Securities Issues 171
Selected Dodd-Frank Provisions Relating to
Executive Compensation 171
Special Rules Regarding Stock Transactions 175
NYSE/NASDAQ Rules: Approval of Equity
Compensation Plans 189
Selected Sarbanes-Oxley Provisions Relating to ExecutiveCompensation 193
CHAPTER 8 Tax Rules and Issues 199
Organizations Responsible for Federal Tax 200
Major U.S. Tax Law and Issues 201
CHAPTER 9 Accounting Rules and Issues 255
Organizations Responsible for Accounting Standards (Past andPresent) 256
New Equity-Based Compensation Accounting Rules 261
Previous Equity-Based Compensation Accounting Rules Under U.S.GAAP 280
Other Current and Past Accounting Standards 283
CHAPTER 10 ERISA and Labor Law, Rules, and Issues 305
ERISA Law and Regulations 305
Labor Laws and Regulations 309
ADEA Law 310
PART Three PRACTICAL APPLICATIONS 315
CHAPTER 11 Executive Employment, Severance, andChange-in-Control Arrangements 317
At-Will Employment Arrangements 318
Contractual Employment Arrangements 319
Fundamental Elements of a Written Employment Arrangement 320
Types of Employment Arrangements 323
Terms and Conditions Contained in Employment Arrangements325
CHAPTER 12 Incentive Compensation 349
Useful Definitions and Abbreviations 349
Cash versus Equity 352
Typical Plan Features and Designs 353
Shareholder Approval Requirements 364
Retention-Only Plans 364
CHAPTER 13 Equity-Based Compensation 367
Equity-Based Incentive Awards 367
Stock Ownership and Retention Guidelines 384
CHAPTER 14 Executive Pension-Benefit, Welfare-Benefit, andPerquisite Programs 387
List of Programs 388
Pension-Benefit Arrangements 388
Welfare-Benefit Arrangements 397
APPENDIX A Selected SEC Rules, Regulations, Schedules, and Forms405
APPENDIX B List of Organizations and Periodicals 511
APPENDIX C List of Director’s Colleges and Other TrainingOpportunities 519
APPENDIX D Sample Compensation Committee Charters 527
APPENDIX E Sample Compensation Discussion and Analysis(CD&A) 547