Compensation Committees: Good Governance Process Leads to Effective Decision-Making

That is, Committee decision-making must pass muster under fiduciary standards to be defensible and withstand judicial scrutiny. To meet these fiduciary standards, Compensation Committees should have in place a robust governance process from which to develop sound compensation determinations and outcomes.

A clear understanding of the actual responsibilities of the Committee is a predicate to developing a sound governance process. Typically, these responsibilities are and should be outlined in the Compensation Committee’s written charter. At a minimum, a Committee’s responsibilities should address the following items:

■  Which executive positions fall under the purview of the Committee?

■  What compensation and benefit plans and arrangements fall under the purview of the Committee?

■ What are the Committee’s responsibilities with respect to compensation and benefit plans that fall under its purview?

■  What corporate governance policies fall under the purview of the Committee?

This list is not exhaustive, especially as Committees must evaluate and make decisions on a myriad of non-routine matters, such as approval of employment agreements, special awards and inducement grants. It would be an understatement to observe that a Committee’s responsibilities are extensive and demanding.

Once a Committee’s responsibilities are developed and understood, the Committee should be in a position to implement a robust governance process, designed to facilitate the Committee’s ability to make effective and prudent decisions on compensation matters and outcomes.

Outlined below are the key elements of a robust principles-based governance process.

■ Annual calendar. The Committee should develop a comprehensive annual calendar. It is critical to note that annual Committee calendars should be considered dynamic, reviewed continually and updated throughout the year to account for new and revised corporate priorities and ad hoc agenda items. A sample Committee calendar for a calendar year company follows the end of this article.

■ Preparation for Committee Meetings. Another practice we recommend is to establish a definitive schedule for preparing for each Committee meeting. The schedule should allow for ample time to confirm meeting priorities and prepare presentation materials, with multiple opportunities for feedback on agenda items and materials among management, outside advisors and the Committee Chair. Keeping to the schedule should help ensure that the Committee materials are fully vetted for consistency with corporate priorities, regulatory implications and potential investor and/or market reactions, etc. It is not unusual for this meeting schedule to commence 6 to 8 weeks in advance of each Committee meeting.

■ Committee Liaison. The Committee should designate a point person (or persons) on the management team to be the principal liaison (e.g., CHRO, head of executive compensation, corporate secretary) between management and the Committee Chair and the full Committee. The Committee liaison’s primary responsibilities should include sending all relevant parties notification of the time and date of each Committee meeting and the meeting agenda, ensuring Committee meeting books include all relevant documents, forwarding the electronic or paper meeting books to all appropriate parties, and preparing and distributing minutes of each Committee meeting.

■ Two Meeting Review Process. The Committee should discuss and evaluate particularly complex, sensitive or highly important matters over at least two Committee meetings. This suggested cadence will avoid a rushed decision-making process and help to ensure that Committee members have sufficient time to understand the details of the subject matter and reach a thoughtful and prudent decision. Where possible, the Committee’s annual calendar should reflect and reinforce this decision- making process.

■ Executive Session Requirement. The Committee should regularly hold executive sessions (generally, at each meeting) when the Committee members can discuss sensitive matters without members of the management team present in the meeting. As a general matter, the Committee’s deliberation on CEO performance and compensation should be handled in executive session. Similarly,
Committee deliberations on any other executive officer’s performance and compensation should exclude that executive officer and other executive officers whose presence is not required.

■ Confirmation of Action Items/Decisions. The Committee Chair should hold a “debrief” meeting with the Committee’s advisors and management (together or separately, depending on the situation) within 3 to 5 days following each Committee meeting to confirm approved decisions, open issues and any action or implementation items going forward.

Building an effective governance process is not a specific project-based effort – rather, it is borne of a principles-based approach which continually evolves over time, starting with the building blocks described above. Once a Committee has a good handle on using these building blocks to implement its governance process, the Committee’s fiduciary responsibilities are more easily fulfilled.