So you’ve finally decided to add an outside, independent director to the board of your privately-held A/E firm. You’ve even identified several candidates. Now the question is what (if any) compensation to offer them. For an independent party to take on the time and responsibility of serving on your board, you expect some level of compensation is appropriate, but how much?
Before addressing that question, here are a few background statistics on board compositions in the A/E industry. According to a 2015 study on ownership and ownership transition conducted by ROG together with Practice Lab (Boston, MA), of the 57 A/E firms participating, the average board consisted of five directors with a lower quartile of three and an upper quartile of seven, and 25% of the surveyed firms reserved at least one board seat for an outside director.
Anecdotal observations suggest that the larger the firm and the more distributed and active its internal stock market, the more likely it is to have one or more outside directors. Additionally, firms that sponsor employee stock ownership plans (ESOPs), particularly 100% ESOP-owned firms, are more likely to have outside directors. In fact, we frequently see independent ESOP trustees insisting on outside directors when negotiating the terms of an ESOP transaction to ensure a higher level of corporate governance. A recent study conducted by the National Center for Employee Ownership (www.nceo.org) reported that approximately two-thirds of responding firms had at least one outside director.
This trend toward outside directors at ESOP-owned companies have been driven by a number of recent court cases and regulatory actions, according to David Solomon, an attorney at Levenfeld Pearlstein specializing corporate law. Solomon indicates that, “there is a strong trend for ESOP trustees to insist that the board of directors of an ESOP company include several outside, independent directors, and in many cases the trustees will ask for the board to consist of a majority of outside directors. The goal of this request is to both show that the ESOP trustee has some control over activities of the board, such as a decision to pay a control premium in a stock transaction, as well as to add a level of accountability and professionalism to the board room that is many times lacking in a closely-held, privately owned company. This level of oversight and implementation of professional governance practice has the effect of protecting the employees’ investment in the company through their ESOP participation which is a positive development.”
Having established the value of independent outside directors, the question of how to compensate them remains. The aforementioned NCEO study explored the subject of outside director compensation (note that this study includes firms outside the A/E industry). The study found that among the 241 respondents with outside directors, the median annual compensation was $12,000, with a fairly wide range from a lower (10th percentile) of $2,600 top a high (90th percentile) of $40,160. The most common form of payment for outside directors was a fee per meeting at 47%, with the median respondents holding four meetings per year. The second most common form was a fixed retainer at 37%.
In deciding what to offer your outside directors, consider the following:
This discussion of how much compensation to pay outside directors raises another interesting question. If you compensate outside directors, can and should you also pay additional compensation to internal (employee) directors? After all, a director’s role and responsibilities are distinct from their role and responsibilities as an employee or manager. While still uncommon, some firms provide additional compensation to internal directors. This can be a way to reinforce the distinction of the internal directors’ roles as a member of the board and their roles as employees.
In summary, outside directors can bring value to boards that internal directors often cannot. This value can include: Outside perspective uninhibited by internal politics; Expertise in subjects such as law, finance, human resource, etc.; The “been there, done that” experience of a retired industry executive, and much more. So what is that worth to your firm? Survey data above suggests a fairly wide range of compensation, but here, the old adage “you get what you pay for” rings very true.
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