Compensation is always on peoples’ minds, especially when you want to keep attracting good executive talent. Independent director compensation is now on the minds of many board members. Below you will learn four key compensation trends that may signal compensation changes in 2024.
As reported by Grant Thornton on August 16th, 2023.
Board compensation: 4 key trends from 2023 proxy filings
With the onset of “The Great Resignation,” the focus of many compensation committees has been attracting, retaining, and motivating key executive talent to guide companies through economic uncertainty. Independent director compensation, however, is now on the minds of many board members as companies begin to adapt to a cooling labor market and consider their go-forward pay strategies.
To understand how boards are responding to these changing conditions, Grant Thornton studied director compensation levels and practices at over 1,500 companies in the Russell 2000 Index that have filed proxy statements in 2023 and identified four key compensation trends that may signal a change in direction.
1. Customize the pay mix to reflect expected contributions
One of the most notable trends in board compensation is that companies are customizing director pay mix. It has historically been common for board members to be compensated through an annual cash retainer, annual equity retainer (whether in stock options or full value grants), and a variety of committee and meeting fees. Many of these practices continue — however, companies have gradually refined approaches to board compensation to reflect the varying levels of time, effort, and focus (often unpredictable in any given year) of their independent directors by customizing the program to reflect expected contributions.
The primary elements used include cash and equity retainers, an additional retainer for the board chair or lead independent director, committee chair and membership retainers and, now only occasionally, meeting fees. Many public companies also provide an initial equity grant for newly elected directors to create immediate alignment with shareholders and assist directors in complying with company stock ownership requirements where applicable.
The chart below illustrates median total compensation levels from 2023 proxy statement filings, broken out between cash and equity, for independent directors across the 11 General Industry Classification Standard (GICS) sectors represented in the Russell 2000 Index. For reference, the weighted average market capitalization of a company in the Russell 2000 is approximately $2.76 billion and the median market cap is $950 million (as of Dec. 31, 2022).
While the median total compensation amounts shown above may be instructive reference points for boards as they benchmark competitive pay levels, companies have considerable latitude in how the total dollar amount will be delivered. For example, higher-growth companies in the Healthcare and Information Technology sectors may emphasize equity compensation (between 60% and 70% of the total) for directors, while more stable sectors such as Utilities and Financials tend to pay a majority of the total compensation amount in cash.
2. Offer premiums for board leadership positions
Most companies provide independent directors with a cash retainer for serving on their boards, though it is becoming increasingly popular to offer additional cash retainers for board leadership roles. Over 53% of companies in the Russell 2000 provide a cash premium to their independent board chair. For instances in which the board chair is not an independent member of the board, companies may have a “Lead Independent Director” (LID) who serves to support the chair while also ensuring there is a sufficient independent voice to counterbalance the board chair.
About 32% of companies in the Russell 2000 Index specify a leadership premium for LIDs. Many middle-market companies in the Russell 2000 have board chairs who are also the company’s CEO, which necessitates the role of the LID. This creep in pay for LIDs has been increasing substantially over time as the role of LIDs has expanded.
3. Replace meeting fees with committee retainers
Meeting fees, paid in cash to directors for attending a board or committee meeting, were once a common supplemental element in the director pay package. Now, only about 11% of companies in the Russell 2000 Index use meeting fees, whether for in-person or virtual attendance. The median amount among Russell 2000 constituents that still offer meeting fees is $1,500 per meeting. Interestingly, the Financials sector (and banks in particular) represent 40% of the organizations that pay meeting fees.
As part of this shift in director pay mix, companies are opting to forgo meeting fees in favor of committee retainers. This may encourage board members to focus on defined duties and responsibilities, while avoiding the perception that meetings are continuously encouraged to enhance director compensation.
While committee names vary, public company boards are generally organized into at least three committees: the Audit Committee, the Compensation Committee and the Nominating and Governance Committee. Directors are typically paid a cash retainer in addition to their annual board retainer for their service on a committee. Leadership retainers may be provided to committee chairs and tend to be twice the size of the committee membership retainer. Median annual membership retainers for the 2022 fiscal year in the Russell 2000 were $7,500 for the Audit Committee, $5,000 for Compensation Committee and $4,000 for the Nominating and Governance Committee.
4. Respond to changing tastes in equity retainer vehicles
Restricted stock units (RSUs) continue to be the preferred equity vehicle in independent director compensation across nearly all sectors, being used by over 70% of Russell 2000 companies. RSUs are considered to be less dilutive than stock options since they generally require fewer shares to deliver the same accounting value. It is also thought to be a more appropriate equity vehicle for directors because it offers both upside and downside risk, creating closer alignment between board members and other shareholders.
Stock options are used by only 17% of Russell 2000 companies, with the Healthcare sector being the largest user. Within Healthcare, about 67% of companies use stock options. This preference, however, appears to be changing. Many sectors, and Healthcare in particular, have begun to place increased emphasis on full-value equity awards such as RSUs given the volatility of the markets, though this may be a temporary trend. This is a notable development, as Life Sciences companies in the Healthcare sector have long favored appreciation-only awards such as stock options because they serve to encourage growth. Shrinking share prices, however, have made many these companies think twice about using options as they consider their dilutive impact and retention.
Under the right circumstances, stock options are still alive and well and an appropriate equity vehicle for many companies. Early stage and/or high-growth organizations may find that it makes sense to encourage both employees and board members alike to expand their appetite for risk. For these companies, stock options can offer greater leverage and may incentivize the right risk-taking, potentially complementing the options with full value grants.
Private company board compensation
The focus of this discussion has been on independent director compensation in the Russell 2000, but what about similarly sized private companies? Due to the lack of required public disclosure, private company board compensation is more of a “black box.” Private ownership could be comprised of a single individual, a small group of investors, a family, a private equity firm or a combination thereof. Based on published studies, the limited survey data available, and Grant Thornton’s own experience with private company clients, private company board compensation is best described as a spectrum.
On one end, there are private companies, usually larger and more sophisticated, that operate much like public companies from a governance perspective. These organizations often choose to align their board compensation levels and practices with their public company peers, including providing directors with actual equity awards. On the other end of the spectrum, there are closely held organizations that may only pay a modest cash retainer and/or meeting fees to independent directors. These boards may serve family ownership, for example, and operate more like an advisory committee than a true board. In these cases, the board may lack the fiduciary and broader governance responsibilities of a public company board. Moreover, company ownership may be less inclined to give up actual equity, and instead choose to use only cash-based compensation.
Between these two ends of the spectrum, private company board compensation can take on many forms, which may include using phantom equity retainers or other cash-based long-term incentive programs in lieu of actual equity. One common thread that most private company board compensation programs have is that pay is often tied to time commitment or expected work effort. This is contrasted by public company board pay which may be driven more by a company’s financial size, complexity, and industry. Given that many independent directors on private company boards may serve purely in an advisory capacity, their compensation may simply be a function of their time and energy spent on board service.
What can boards do?
Finding and retaining board members is an ever-evolving challenge for both public and private companies. People who possess the right blend of relevant experience and expertise, leadership skills, and commitment to be a corporate director are in demand. Companies can follow these approaches help determine the right compensation package:
- Emphasis on attracting, retaining, and motivating key talent for executive roles should extend to independent directors on the board as well. Give the process the same level of care and attention that goes into executive, including attractive compensation.
- Thoroughly review independent director pay. Mounting economic headwinds present an important opportunity for boards to ensure their pay programs are both market competitive and aligned with changing organizational strategies. A thorough review of independent director pay, including an external market analysis, should provide comfort to companies that their board compensation strategy is well-calibrated to attract top leaders to serve them on the board of directors.
- Evaluate the appropriateness and effectiveness of implementing any of the market trends outlined above. Would changes to equity vehicles, a more customized approach to pay mix, replacing meeting fees with committee retainers, or offering leadership premiums work for your company?
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