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3.7 Board Committees and Director Compensation

A greater and more effective use of committees also stands out as one of the key changes in board functioning over the last 50 years. Committees permit the board to divide up its work among the directors; they also allow board members to develop specialized knowledge about specific issues. The value of having standing committees has been recognized by the NYSE, the NASDAQ, and the Securities and Exchange Commission (SEC), and today public company boards are required to have independent audit, nominating (and governance), and compensation committees. In addition, a growing number of companies are creating board committees to better communicate with and stay abreast of the concerns of external stakeholders, referred to as public responsibility, corporate social responsibility, stakeholder relations, or external affairs committees.

The Audit Committee

The audit committeeA committee charged with assisting a corporation’s board of directors in oversight of various aspects of a corporation’s functioning, including the company’s financial statements, internal controls, compliance with legal and regulatory requirements, and ethical standards and policies. is charged with assisting the board in its oversight of (a) the integrity of the company’s financial statements and internal controls; (b) compliance with legal and regulatory requirements, as well as the company’s ethical standards and policies; (c) the qualifications and independence of the company’s independent auditor and the performance of the company’s internal audit function and its independent auditors; and (d) preparing the audit committee report for inclusion in the company’s annual proxy statement. The committee typically consists of no fewer than three members, all of whom must meet the independence and experience requirements of the NYSE and rule 10A-3 under the Securities Exchange Act of 1934, which hold that each member of the Committee must be financially “literate” and at least one member of the committee must have accounting or related financial management expertise (the so-called audit committee financial expert). Its members, including the committee chair, usually are appointed by the board on the recommendation of the nominating and governance committee.

The Nominating (and Governance) Committee

The nominating (and governance) committeeA committee of three or more independent directors commonly charged with recommending new candidates for the board of directors, recommending director compensation, and implementing succession planning for the CEO. has multifacetted responsibilities and is typically charged with recommending new candidates for the board of directors and determining (a) the eligibility of proposed candidates, (b) reviewing the company’s governance principles and practices, (c) establishing and overseeing self-assessment by the board, (d) recommending director compensation, and (e) implementing succession planning for the CEO. The nominating (and governance) committee normally consists of three or more independent directors; its members and chair are usually appointed by the board on the recommendation of the chairman of the boardThe chief officer of a corporation, typically elected by the corporation’s board of directors..

The Compensation Committee

The compensation committeeA committee charged with overseeing human resources policies and procedures, employee benefit plans, and compensation. is charged with duties related to human resources policies and procedures, employee benefit plans, and compensation. It is also responsible for preparing a report on executive compensation for inclusion in the company’s annual proxy statement. It typically consists of three or more independent members; its members are normally appointed by the board on the recommendation of the chairman of the board with the concurrence of the nominating (and governance) committee.

Other Board Committees

In addition to these standing committees, a growing number of companies make use of ad hoc committees to address specific issues—a strategy committee to look at different growth options, for example, or a finance committee to develop recommendations to recapitalize the company. While ad hoc committees can be useful, they should have clear sunset clauses to prevent their institutionalization or a balkanization of the board on important issues.

Committees can also be used to send specific signals to employees or external stakeholders about what is important to the company. A growing number of boards are creating committees to better communicate with and stay abreast of the concerns of external stakeholders. Names for such committees include the corporate social responsibility, stakeholder relations, external affairs, or public responsibilities committees. For example, the board of General Electric has created a public responsibilities committee to review and oversee the company’s positions on corporate social responsibilities and public issues of significance that affect investors and other GE key stakeholders.

Finally, most bylaws make provision for an executive committeeA committee of key directors and other designated officers of a company that has the power to act for the full board in case of emergencies. With advances in technology, this committee is rarely used., usually consisting of the chair, the CEO and other designated officers of the company, and key directors, such as the chairs of the standing committees. In theory, the executive committee has the power to act for the full board in case of emergencies or when there is no time for the full board to meet and deliberate, although this is fraught with danger. Fortunately, advances in communication technology have made executive committees increasingly redundant, and their use has all but disappeared from the corporate governance landscape.

Director Compensation

Setting director pay typically is not done by the compensation committee of the board. Rather, director pay decisions normally are made by the nominating committee. The justification for this structure is twofold. First, it provides for a separation of the director and executive compensation decisions. Second, it allows the nominating committee to integrate compensation with board-building strategies.

The job of director has become significantly more challenging in recent years; it demands stronger qualifications, requires more time, and increasingly carries personal financial risk. In this new governance climate, the pool of available independent directors has shrunk and pushed up director pay. Directors are typically paid with a mix of cash and equity, with equity representing about half of the total direct compensation. Nonemployee chair and lead-director pay is generally structured like that of other directors on the board (retainer, meeting fees, and equity), while employee, non-CEO chairs are typically paid like an employee (salary, incentives, and benefits). A majority of companies pay a premium to committee chairs—especially audit and compensation committee chairs—reflecting the increased time commitment and additional responsibility. With respect to the equity component of director compensation, companies have reduced their reliance on stock options and increased the use of full-value awards.