Compensation for Business Leaders

DETERMINING AND APPROVING BUSINESS LEADERS' PAY

The administration of business leaders' compensation differs from other pay programs when it comes to one major question: Who sets their pay?

In privately held companies with a single owner-manager, an executive may well set their own pay. In U.S. publicly traded companies, SEC regulations and tax codes (such as IRC 4958) call for executive pay oversight by a Board of Directors, which may form a "Compensation Committee” composed of some of the Board members.

Even so, the rise of CEO compensation levels is a concern for board members, especially when it can affect a corporation's earnings.

The Role of the Board of Directors

In publicly traded companies and many privately held corporations, a special committee of the Board of Directors known as the "Compensation Committee" sets executive pay. This committee typically consists of 3-5 members who need to pass an independence test; typically, they are "outside directors," as opposed to "inside directors." That is, they are not members of the management team affected by the compensation decisions. These outside members may include:

• CEOs and COOs from other companies
• former government officials
• retired executives
• academicians
• investors
• bankers
• thought leaders in their area of expertise

"Outside director" Compensation Committee Board members are defined as:

• Not a current employee;
• Not a former employee who received compensation for prior services in the current year, and who has not been an officer of the corporation;
• Not directly or indirectly receiving remuneration from the corporation during the current year, other than director fees, or
• Not receiving more than de minimis remuneration from the corporation during the prior year, other than director fees.

The legal "independence" guidance that exists regarding Compensation Committees include: Parts of IRC 4958 Regulation S-K Item 407 on Corporate Governance, outside Director, as previously mentioned. The Committee assures that the shareholders, creditors, and other stakeholder groups are not unfairly taken advantage of by the management group in terms of their potential to strip funds from the organization or become unnecessarily rewarded. They meet independently of the management group, often with consultants, to ascertain the level and effectiveness of the organization's compensation plans. The independence requirements are further governed by the stock exchange(s) where the company’s stock is listed. Tap the link for more information on Compensation Committee independence regulations www.law.cornell.edu.