Effective Compensation for Board of Directors

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"Effective Compensation for Board of Directors" is a dynamical approach for finding out the appropriate ways to compensate the key performers of any organization. This group project consists of four major parts. The first part (PART 1) is the introduction of Board of Directors and its future direction, second part (PART 2) is the Compensation for the Board of Directors in context of roles of managing compensation and the affectivity of the competitive of the organization, PART 3 is related to the Decision making of compensating the Board of Directors, and the last part (PART 4) is the new dimensional perspective to compensate the executive based on the Organic Organization as the newest organization structure compared to any existing contemporary organization structures. In this group project, the project approaches the Board of Directors as the key performers, which inclusive of the Board of Directors, CEO, and the Executive. The main point of view is the CEO is normally elected by the Board of Directors, and the Executives as the performers for the organization. Hence, the application that being discussed within this group project is being seen through the aspect of the Board of Directors. After all, the compensation strategies that have been found are applicable to all three major performers which are the Board of Directors, CEO, and the Executives. This group project is a relevant project for our group as have learned the effective ways of compensating the key performers and players within the organization. Furthermore, effective compensation in this group project has also being enhanced by the organic organizational structure which is in the last part (PART 4). Effective approach to compensate Board of Directors is crucial in driving the organization toward success achievement with further competitive advantage and commitment of key players of the organization.

PART 1 Board of Directors

1.1 Introduction

It seems that we are exposed daily in the financial media to examples of CEO compensation on a scale that many feel is out of control, too large and in some cases questionable. The recent positive business environment and the associated escalation of stock prices as it had the effect of creating enormous individual fortunes for many more executives. Corporations as a whole are making more money than most have ever made, and much of this increased money supply inevitably goes towards compensation for the people that work for them. The boards of directors of these companies are being placed in the position of wanting to maintain the growth of the company's profits and at times are being forced to make a successful CEO's compensation package increasingly appealing, as an incentive to remain with the company.

1.2 Board of Directors

In relation to a company, a director is an officer of the company charged with the conduct and management of its affairs. The directors collectively are referred to as a board of directors. Sometimes the board will appoint one of its members to be the chairman of the board.

Theoretically, the control of a company is divided between two bodies: the board of directors, and the shareholders in general meeting. In practice, the amount of power exercised by the board varies with the type of company. In small private companies, the directors and the shareholders will normally be the same people, and thus there is no real division of power. In large public companies, the board tends to exercise more of a supervisory role, and individual responsibility and management tends to be delegated downward to individual professional executive directors (such as a finance director or a marketing director) who deal with particular areas of the company's affairs.

Another feature of boards of directors in large public companies is that the board tends to have more de facto power. Between the practice of institutional shareholders (such as pension funds and banks) granting proxies to the board to vote their shares at general meetings and the large numbers of shareholders involved, the board can comprise a voting block that is difficult to overcome.

However, there have been moves recently to try and increase shareholder activism amongst both institutional investors and individuals with small shareholdings.

1.3 Classification

Directors are traditionally divided into executive directors and non-executive directors. Broadly, executive directors tend to be persons who are dedicated full-time to their role in relation to the management of the company. Non-executive directors tend to be "outsiders" brought in for their expertise, and to lend a more impartial view in relation to strategic decisions. Many corporate reforms in the late 1990s and early 2000s were focused on increasing the number and role of non-executive directorships in public companies in the belief that an impartial view was more likely to restrain corporate excess and egos and reduce the likelihood of another major corporate scandal. This view is not new; similar recommendations were made by the Cadbury Committee in the United Kingdom in 1992.

In practice, executive directors tend to dominate board meetings simply by virtue of their much greater familiarity with the company and its internal workings.

Some countries also classify persons who are not actually directors as either de facto directors, or "shadow" directors. A de facto director is a person who is not actually appointed as a director, but acts as if they were (often because they wrongly believe that they have been properly appointed as a director). A "shadow" director is also not a director at all, but seeks to control the direction and management of the company without putting themselves forward as being able to do so.

1.4 The Future

Historically, director's duties have been owed almost exclusively to the company and its members, and the board was expected to exercise its powers for the financial benefit of the company. However, more recently there have been attempts to "soften" the position, and provide for more scope for directors to act as good corporate citizens.

Six factors to which a director must have regards in fulfilling the duty to promote success. These are:

the likely consequences of any decision in the long term

the interests of the company's employees

the need to foster the company's business relationships with suppliers, customers and others

the impact of the company's operations on the community and the environment

the desirability of the company maintaining a reputation for high standards of business conduct, and

the need to act fairly as between members of a company

PART 2 Compensation for Directors / CEO

2.1 Compensation for Directors / CEO

This is becoming an increasingly complex task and has created the need for innovation regarding the structuring of incentive plans. Not only or the CEO but for whole corporations, from the worker in the trenches, middle and upper management, the Chairman of the Board and all other board members. As it appears the CEO incentives are working (McLean, 1998), so the rest of the organization is being reorganized to focus on the betterment of the corporations position and being compensated for their efforts. Board members are not being left behind in their compensation packages but are being acknowledged as very important members of the overall team.

2.2 Roles of Directors in Compensation Management

In Business Law and the Legal Environment, Anderson, Fox and Twomey state "The board of directors has authority to manage the corporation". To accomplish this there are a number of roles that must be played out by directors.

This is normally accomplished by a series of regular meetings by the complete board and the structuring of various standard and sometimes special committees. The most common of these committees are the Compensation Committee which is responsible for the overall payments structure of the company from the CEO on down.

The Nominating Committee which typically identifies and selects new directors and leads the boards activities in management succession. And the Audit Committee which deals with reviews of financial performance, policy implementation and a company's strategic plan. A major portion of the role of the board is in its council, advice, approval and possibly even removal of the CEO.

Strategic direction of the corporation is in the hands of the board of directors, which is an important and often complex issue that requires special skills from board members.

All the roles are put into perspective by the A.M.A. study when it noted: "The role of the independent director is becoming more complex and more time consuming each year, and directors with the experience and time are becoming harder to find. The toughest challenge of all is to have the wisdom, courage and diplomacy to make the appropriate changes that meet the expectations of shareholders, employees and the financial community alike".

2.3 Firm Competitive as a Determinant of CEO pay

Firm competitive behavior as the independent construct as an initial attempt to examine the effects of firm competitive behavior on CEO compensation the researchers focus on two commonly studied dimensions of competitive behavior: aggressiveness or volume of a firm's competitive actions (Ferrier et al., 1999; Offstein et al., 2003; Young et al., 1996) and the variety or range of such actions (Ferrier et al., 1999; Nayyar and Bantel, 1994). Implicit theories of board decision-making, perception, attribution, and impression management were used to suggest the link between firm competitive behavior and CEO compensation. It is important to note, however, that the researcher do not argue that paying the CEO according to the firm's competitive behaviour improves firm's financial performance.

2.4 Competitive activity

Competitive activity is one of the foremost dimensions of a firm's competitive behavior (Gnyawali et al., 2003). Recall that a competitive action is an observable move undertaken by a firm (Chen, 1996; Smith et al., 2001). Competitive activity is a collection of such moves. As such, it is an indicator of quantity or volume of competitive actions. Firms that launch high volumes of competitive moves are likely seen as more competitively aggressive within the market.

2.5 Competitive variety

Competitive variety is another well-recognized dimension of a firm's competitive repertoire. Unlike competitive activity that indicates the volume of competitive actions, competitive variety reflects the breadth, range, and scope of a firm's competitive repertoire (Ferrier et al., 1999; Gnyawali et al., 2003). Firms that launch actions across several fronts such as marketing, R&D, and distribution demonstrate greater competitive variety than those that pursue many activities of a limited range (Nayyar and Bantel, 1994).

2.6 CEO compensation as the dependent construct

It appears that CEOs may consciously influence their pay. For instance, CEOs favour and encourage acquisitions that increase the size of the organization, which, in turn, is used to justify higher pay (Kroll et al., 1990; Tosi et al., 2000).

Also, CEOs may realize that their impact over firm performance is rather limited, so some may be driven to identify outcomes that are more proximal and which they have control over, such as firm size. This notion is supported theoretically, as well. Astley and Van de Ven (1983) suggest that senior managers are constrained by the amount of determinism exacted by the environment.

Some CEOs, in highly deterministic industries, may be regulated to more symbolic, and less substantive, roles. Hence, CEOs identify and showcase the outcomes in which they tend to have more immediate control. Said differently, CEOs are motivated to decouple their pay from actual firm performance (Dyl, 1988;Westphal and Zajac, 2001).

While CEOs may influence their pay levels, it is the BOD in general, and the compensation committee, in particular, which decides upon and approves CEO pay. Often, the arrival of a pay decision is un-scientific and involves power, politics, and perceptual processes (Cutting and Kouzmin, 2000; Schaffer, 2002; Westphal and Zajac, 1995b).

At the most elemental level, pay decisions are predicated on evaluating, appraising, and assessing the CEO's performance. Traditional methods of evaluating CEO performance, such as market or accounting based measures have received criticism because they are greatly influenced by environmental forces beyond the control of the manager, or can be calculated or manipulated in ways that belie actual firm performance (Gomez-Mejia and Balkin, 1992).

With traditional marketing and accounting measures discounted, directors may rely on other proxies to assess performance (Finkelstein and Hambrick, 1996; Puffer and Weintrop, 1991).

Unfortunately, board members face a great many constraints and are largely viewed as ineffective monitors of executive activity and performance (Cutting and Kouzmin, 2000; Finkelstein and Hambrick, 1996; Mace, 1971). For these reasons, directors may rely on short cuts that are influenced by their perceptual filters (Schaffer, 2002).

Thus, rather than attending to traditional performance surrogates such as firm size, we explore how alternative proxies or short cuts, such as the volume and variety of firm actions, influence a CEO's pay.

PART 3 Decision-making Process for Setting Directors Compensation

3.1 Benchmark-Compensation

When companies are investigating the methods and amounts of pay for their boards, they commonly use surveys of comparative companies as benchmarks. They select a compensation committee, which is more often comprised of outside directors, and usually enlist the help of outside consultants. The consultants' job being the gathering and presentation of the comparative data for the committee's further use and decision-making. In this way the monitoring of the relevant and latest methods of compensation are presented and analysed, and any new trends identified for consideration. A review of any recent trends can lead to the changing or modifying of the current practices to align with others in the industry or common field. Although bench-marking is a common practice it is not the only, or indeed the most decisive element in setting directors compensation. But it does provide a good starting place or touchstone on which to base decisions of method and magnitude.

3.2 Stock Option Compensation

One trend firmly in place is the use of stock and stock options as a medium of payment. "Last year 78 per cent of all companies compensated their directors with some sort of company stock" (Korn/Ferry, 1998). This stock comes in a number of ways and is often left in part to the choice of the board member. A retainer may be offered as all cash, a combination of cash and restricted stock, cash and stock options, or even all stock of some kind. In 1997 only 3.1 per cent of combines paid their directors 100 per cent in stock, but it is an upward trend, rising from 1.7 per cent in 1995(A.M.A., 1998). The more pervasive method of using stock as a compensation medium is in the use of granting stock options as a separate part of the overall compensation plan.

3.3 Skill-based Compensation

Many other factors are to be considered depending upon the roles the directors are to play. For example if a particular skill is evident in one or more directors that is of more importance to the corporation's needs, they may be paid on a differing basis to another director.

3.4 Hourly-based Compensation

Board of Directors may spend much more time on company business, may be the chair of one or more committees and thus may deserve more of some kind of compensation. The decisions they are responsible for may have a more profound impact on the direction of the company, its future and its prospects of further success. One such accepted method of basing levels of compensation relevant in these cases could be the comparison of CEO and executive pay per hour. Given that a director may and should spend less time on company business than the CEO, an appropriate hourly rate based on the CEO pay may be used as a gauge. It may follow that the CEO earning $1,000,000 per year but spending 80 hours a week on company business averages out to approx. $240 per hour. What is a director worth relative to this figure, who may spend an average of only 3 or 4 hours a week on company business, given that these hours are spent in large part conferring with or advising the CEO and company executives.

3.5 Percentage-based Compensation

A percentage of the CEO hourly rate may be the way to correctly create the required balance. This may equate to $180 or $200 per hour, or approx. $40,000 per year, a rate that is more than justifiable, well within the ranges of director pay, and often less than the prevailing rate for business consultants. In effect this "portrays the value of the director's time spent on company business" (Overton, 1998) and to many directors time is a commodity in increasingly short supply.

3.6 Talent-based Compensation

This method may also be used in cases where a specific talent is deemed necessary due to a change in the business environment or strategic direction of the company's business. A special talent which is in short supply may require a different compensation level relative to their members of the board, and thus a different percentage of the CEO pay can be applied (Overton, 1998).

3.7 Meeting Allowance Compensation

The result of all the above mentioned methods of setting compensation levels has produced average compensation for outside directors which include: Annual retainers paid mostly in the form of cash of $25,000. Supplemented by payments per meeting averaging $1,200, and with an average board member attending approximately 16 meetings per year, this adds up to a payment for service addition of $19,200.

The compensation is further enhanced by stock payments of various kinds at an average value of $26,748 (Sabow, Hinkson, Marino, Denmark, 1998). As an illustration of the structuring of a compensation package by a leading company, the following structure of Dana Corporation's board is offered as it was rated one of the best five boards, by Mac Fadden Holdings Inc. in their seventh annual board review by Robert W. Lear and Oris Yavitz: "Dana takes a unique approach to director compensation. In addition to a standard board retainer fee of $20,000 and a committee retainer of $2,500 ($5,000 for chairmen), a $1,000 fee is paid for each board or committee meeting attended.

3.8 Attendance Compensation

To encourage maximum participation, directors are also paid an attendance fee for all committee meetings they attend, whether or not they are officially members. Dana discontinued its director retirement plan in 1996, substituting a stock option plan that grants 3,000 shares of stock annually. The company's executive compensation plan also seems well under control. It drives hard for the top 60 executives to meet stock ownership targets within five years. Thus, both the directors and the executives are building strong stock positions in the company.

PART 4 Organic Organizational Compensation For Executives

4.1 The Emerging Organic Organization

Pay systems have traditionally been predicated on the "size" of the job. The main task in the administration of pay has been to equitably determine a level of pay for any given job in the organization, primarily based on the relative size of the job. Other components were usually factored into the equation such as the market forces for such a job and the organization's philosophy of pay. The outcome of the equation resulted in each job's rate of pay. This rate was usually stated as a range of pay to give employees some latitude to move upward through tenure, cost of living and/or merit increases.

Under this system, the highly trained scientist working in a high-tech firm, managing a large budget, a large number of people and very profitable projects for important clients could well expect a large pay package. Conversely, a clerical assistant responsible for more repetitive work in a not-for-profit organization would receive (and expect) a much smaller pay package. Many of current pay systems and, more importantly, the thinking about the whole field of compensation are based on this "job size" method of pay.

However, in today's highly networked, ever-changing organization, jobs are also constantly changing, necessitating a reconsideration of our traditional practices of pay and compensation. The purpose of this paper is to examine how the evolution of organizational structures has affected our compensation systems and to speculate on the trends that will likely affect our thinking about pay and compensation in the years ahead.

4.2 Contemporary Organization Structures

4.2.1 Hybrid Organization

It is evident that the evolution of organization structures will continue. For instance, in 1996, Lentz (1996) wrote of the emergence of the "Hybrid Organization" which decentralizes decision-making to the business unit level while centralizing administrative functions at the corporate level. Lentz argues that such an organization is more competitive since it is able to cut costs while increasing customer responsiveness.

4.2.2 Cellular Organization

Again, the "cellular organization" is described by Miles et al. (1997). The cellular organization's structure is very fluid, based on the principles of member ownership, entrepreneurship and self-ownership. Academics such as Watkins and Drury (1999) at the University of Bristol in the UK even look far enough ahead to try and understand how professional roles will change and what skills will be required of those who work in the emerging structures which replace hierarchical structures.

4.3 Organic Organization

New type of structure, the Organic Organization. What is perhaps most noticeable about this type of organization design, is that it really has little structure or design at all. Rather, like Topsy, it just grows. It is continuously changing to meet the ever-changing needs of the organization in pursuing its purpose and dealing with its environment. This organization does not manage change. Rather it operates under a new paradigm: management of continual growth and evolution.

In a very real sense, this organization is designed to manage discovery. Quickness, flexibility, and teamwork appear to be the requirements for employees in this type of organization, for it is an organization that relies on knowledge, learning and a strong culture to prosper.

By definition, the only relative stability in this type of structure is the core - a few key executives who pursue a clearly delineated and relatively stable organizational mission within equally strong values. Even this core will tend to change, but more slowly since it anchors the organization. The surrounding elements tend to be teams of individuals that form and re-form, constantly changing to meet the demands of customers, stakeholders, competitive threats, environmental changes, specific projects and so on.

Accountability to the core will primarily be through goals and standards (task accomplishment, financial results, service or product standards and so on). But the elements will have great latitude in how they accomplish their purpose, within ethical guidelines. The command and control structure of the hierarchical organization will largely be replaced with networks and matrices of commitments.

Individual roles are defined by the work required of the team. The organic organization is not a future construct, it is happening now. TCG, ABB, Nike, Motorola and others are grappling with the issues of highly flexible and networked organizations that can rapidly evolve and provide tomorrow's competitive edge. Technical and Computer Graphics (TCG) in Sydney, Australia is a striking example of the organic concept although they refer to their organizational structure as being "spherical" (Miles and Snow, 1995).

Based on the idea that they can be no more flexible externally than they are internally, TCG is really a group of highly entrepreneurial small companies that has become the largest privately owned computer service business in Australia. Highly networked, these small firms (of typically 5-10 professionals) identify a market niche, form a partnership of both internal and external resources and capitalize on the specific business opportunity.

4.4 Pay Option in Organic Organization

As considering the implications of such a constantly changing organization, it becomes evident that developing a logical job-based pay system for the organic organization requires a major review of how jobs are assessed and how remuneration systems are structured.

In response, organic organizations will need to review the existing pay practices and significantly modify the existing systems as well as consider other different and even radical systems. Some of these methods of pay are considered below.

4.4.1 Paying for individual output

Pay for performance systems are perhaps the original type of pay scheme. After all, piecework and sharecropping are pay for performance systems that were certainly used extensively long before the industrial revolution. For the purpose of this discussion, such individual pay for performance systems can be divided into two types, namely, performance appraisal-based and incentive-based. Performance appraisal-based systems

Considering the number of employees involved, performance appraisal-based systems are the most common pay for performance system. The trend to performance based pay has long been evident in the US and is now growing in Britain. A survey by the Institute of Personnel and Development in the UK reported that 43 per cent of respondents had performance-related pay (Armstrong and Brown, 1998). Under this system, a judgment is made about an individual's performance, and his or her pay rise reflects that judgment. The intent is that the outstanding employee receives a relatively large pay increase while the poorly performing employee will receive little if any. Over time, outstanding employees will tend to cluster at the top of the pay range while others will be scattered throughout the pay range according to their level of contribution. Incentive-based systems

Incentive-based pay systems are those in which a tangible, measurable goal is established. Achievement of the goal then triggers a previously identified reward, the reward sometimes being incremental. A common example is the sales bonus. Commonly calculated on monthly sales, the individual sales person may trigger one level of payment for hitting her target, an additional amount for exceeding the target by a set amount and so on. Along with the sales bonus, the other very common incentive is the executive bonus that often comes through schemes such as stock options as well as cash. Additionally, it can also be argued that the system of tipping for good service in restaurants, particularly in North America, is yet another incentive-based pay scheme.

4.4.2 Paying for Knowledge or Skills

Paying for skills is a substantial departure from the traditional pay systems that pay for jobs. The stark difference is that rather than evaluating a job, each individual is evaluated. The individual employee's pay is based on what they know or have the ability to do within the organization, not what they actually do. In short, they are paid for what they can put into the job, not the size of the job or their output from the job.

Suffice it so say, such a system requires substantial thoughtfulness and resources to develop and implement. The challenge is to develop meaningful and accepted methods of assessing those skills or knowledge.

4.4.3 Paying for Team Results

Since teams are often the source of an organization's output rather than individuals, does it make sense to somehow base at least some of the individual's pay on his or her team's performance? The best known of such pay systems is called Gain Sharing. This system was developed in North America over 20 years back with roots going even further back (O'Dell, 1981). It appears to work best in settings where team results can be precisely measured. In a simplified example, a production team, each month, might be responsible for producing X number of widgets at a budget of $Y's. If the team produces more widgets for that budget or produces its quota of widgets at less than the budget, this gain is calculated. Most commonly, the gain is split, 50 per cent goes to the company and 50 percent to the team. Both parties' win. Gain sharing is one of the few incentive-based pay systems that has enjoyed measurable success.

4.4.4 The Future of Directors Compensation in Organic Organization

As considering the implications for managing human resource systems in the organic organization, it is clear that creating a pay system which is perceived as being fair and motivational by the workforce, while supporting the aims of the business, will indeed be a challenge. As current organization structures are evolving, it can speculate: The demise of the traditional job evaluation process

There will almost certainly be little value in traditional job evaluation systems since they will have little meaning to the organic organization's broad diversity of knowledge workers. Indeed, job descriptions will become an artifact of the past. Rather, "people descriptions" will be employed, but primarily for recruitment purposes. Those people who then have the personal characteristics, skills and desired experience will likely enter an organization that has a remuneration system, quite unlike traditional systems. The evolution of cafeteria pay systems

A number of organizations have implemented "cafeteria" benefit systems for their employees. Under such systems, the younger worker with a mortgage, family and car payments can select a substantially different set of benefits than the more mature worker who is beginning to plan for retirement. The cost of each employee's benefits to the employer is the same. But what those benefits represent to each worker is highly individualized.

It is probable that organic organizations will develop a cafeteria pay system. Each employee's compensation will be individualized. He or she will have a "core" rate of pay based on the individual's level of skills. That "core" pay can be increased through a knowledge-based pay system, customized to meet the organization's needs. Jobs will be designed around the individual

As knowledge workers become increasingly sought after, employers will begin to design jobs to fit the individual: their talents, aspirations, development needs, and interests. The employer that can offer such employment possibilities will have a clear advantage in attracting and retaining employees. In a similar vein, Wrzesniewski and Dutton (2001) thoughtfully propose that employees craft their jobs by designing tasks, relational configurations and the job's social environment. Pay administration will cease as a Separate HR Function

Rather than the current "paternalistic" system of terms and conditions, the organic organization's knowledge workers will much more likely be seen as partners in the organization. Rather than defining an employee's pay, benefits, hours of work and so on, the organic organization will try to create a total "work experience". Pay will be integrated within a total "HR Environment" which includes not only everything we traditionally think of as pay, benefits, and working conditions, but much more. This highly individualized "HR Environment" might provide options for specialized working hours, free home computing and internet resources, additional time off, a guarantee of specialized training, the opportunity to work on a certain type of product, project or equipment and so on.


Effective Compensation for the Board of Directors is crucial in managing the organization. Throughout the traditional compensation and organizational structures, the compensation might be effective but the findings from the group project found out that there are several dynamic ways to compensate the Board of Directors. Board of Directors, CEO, and Executives as the key performers are actually can be compensated through out the several strategies that have been given in PART 3 which is for the Board of Directors and CEO, PART 4 which is for the executives whom being seen as individuals basis. Organic Organization actually does not change the way to compensate the key performers, but it is enhanced and developed more strategies to compensate. Projection of the future compensation in organization can be taken as a new approach for the compensator to compensate the individuals regardless of their position in lower management level but toward their achievement and their human talent and skills. For highest rank which is the BoD, CEO, and Executives there are few strategies to compensate them effectively. Individual compensation will not be sufficient in motivating the individuals think creatively, but team compensation is another dimension that should be seen and found ways to be compensated. Team commitment which created synergy power will gain competitive and effective strategy in future direction. Compensation either for individuals or even for Board of Directors should not be seen as just agenda that needed to be done, but it should be taken as the strategy in maximizing the synergy and commitment of individuals within the organization. Effective Compensation Strategy for Board of Directors is really an elementary basis to achieve synergetic commitment of every each individual within the organization.