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8.3 The Role of the Compensation Committee

The board of directors is responsible for setting CEO pay. Well-designed executive compensation packages are tied to an effective performance evaluation process, reward strong current performance, and provide incentives for creating long-term value. They must be structured to attract, retain, and motivate the right talent, and avoid paying premiums for mediocre or poor performance, or worse, for destroying long-term value. They should be designed to align the interests of management with those of shareholders and other stakeholders in both the short and the long term. While responsibility for CEO performance evaluation (and that of other key senior executives) often rests with the full board, determining appropriate compensation policies for the company’s CEO and most senior executives normally is the task of the board’s compensation committee.

The role of the compensation committee has changed significantly in recent years. In the wake of the Sarbanes-Oxley legislation, the new SEC rules, and other regulations, many boards are reevaluating the composition, charter, and responsibilities of the compensation committee. This also reflects the fact that the mission of the compensation committee has grown in recent years to include two distinct elements. Strategically, the committee has the responsibility to determine how the achievement of the overall goals and objectives of the company is best supported by specific performance-oriented compensation policies and plans. This includes designing and implementing executive compensation policies aimed at attracting, retaining, and motivating top-flight executives. Administratively, the committee has responsibility for ascertaining that the company’s executive compensation programs (covering base salary programs, short- and longer-term incentives, as well as supplemental benefits and perquisites) remain competitive within the market.

Within the context of this expanded mission, compensation committees must

  • provide the necessary transparency required by the regulations through proper disclosures within the company’s SEC filings;
  • recommend for board approval the specific performance criteria and annual and longer term performance targets for awards under the executive compensation program;
  • review the performance of the top five officers relative to the achievement of performance objectives for use in calculating award levels under the executive compensation program;
  • provide periodic oversight of all short- and long-term incentive plans, perquisites, and other benefits covering the company’s executives to ensure that such programs meet the stated performance goals of the organization;
  • ensure that all committee business is conducted in a moral and ethical fashion, maintaining the highest levels of personal conduct and professional standards, and taking action to notify the board of any issues—as well as the necessary corrective action—that may affect the committee’s ability to objectively fulfill its duties and responsibilities.