Executive Compensation and the Role of the Compensation Committee

Plan Evaluation

Compensation Committees will retain discretion to adjust plans to protect the interests of the shareholders and ensure corporate performance. This discretion is applied during the performance measurement periods as members evaluate and monitor the plan's effectiveness. Plans may need to be changed due to two forces:

1. Environmental change: The environment does not match the assumptions made about it in the plan. The biggest challenge in these kinds of situations is distinguishing between events caused by external events vs. those inside the company. For instance, when a decline in stock value is caused by mismanagement, the action to be taken is very different than when it's due to a downturn in the stock market.
2. OR
2. Internal change: An individual's, and thereby corporate performance, does not match the plan. The committee will utilize performance standards that apply to a particular executive. For instance, suppose that the profits of the company are down due to the poor performance of one of the divisions. Should all division heads suffer low bonuses if the standard used is corporate profits? While monitoring the performance standards at the corporate and individual levels, the compensation committee has an opportunity to correct the course of the plan. The committee needs to review, on a regular basis, the operation of the compensation plan during the year.

Executive Performance Evaluation

Monitoring performance during the year gets the compensation committee into the arena of individual performance appraisal. It is important that the committee and the executive are clear and in agreement on operational definitions of the measures. Setting performance goals that are appropriately challenging while not being impossible, as well as balancing plan design with individual performance, is essential. A natural extension of this process is succession planning, and many Compensation Committees are taking on these expanded responsibilities. Since compensation committee members are required to be independent board members, the committee may be the best place for such responsibilities to reside.

The Board of Directors may sometimes delegate the CEO performance evaluation to the compensation committee. An effective evaluation process has these attributes:

• Leadership - a Board member who has credibility with the CEO such as the Board Chairman, Lead Independent Director or Compensation Committee Chair is assigned to be the "Process Owner".
• Qualified Participants - use a 360-degree approach and obtain performance feedback from all Board members, direct reports to the CEO, and customers.
• Evaluation Criteria - a holistic evaluation of leadership, culture, communication, job performance, board relations, shareholder relations and specific performance criteria such as key strengths and development opportunities should be conducted.
• Evaluation Focus - the purpose is to provide constructive feedback and professional development advice that will improve the CEO's performance and effectiveness.
• Administration - the Board Chair or Lead Director administers the evaluation in a simple process. Where 360-degree feedback is included, a third-party administrator may be needed for confidentiality.
• Feedback - the "Process Owner" Board Chair or Lead Director should meet with the CEO to provide summary feedback.