Criticism of pension plans for outside directors of corporations fails to recognize that, in the long term, this form of compensation can serve as useful an incentive in achieving corporate objectives as compensation in stock. This similarity means, too, this pension part of the compensation for an outside director can be placed in just as much at risk as compensating these directors in stock.
Shareholders are putting more focus on compensation for outside directors, or directors who don't hold management positions with the company. Most recently, pension benefits have become a big issue. A few companies, in the face of shareholder criticism, have recently dropped pensions they had provided for outside directors. As more companies address the issue, they would make a mistake in simply singling out this one part of the compensation package. Instead, they should review outside directors' compensation from a total compensation perspective to decide how each piece serves to achieve the incentive the corporation wants to encourage.
The criticism of pensions for outside directors stems from the notion that excessive compensation to these directors impairs their ability to act independently of the corporations compensating them.
Those who see directors' compensation as excessive have suggested that much or all of it should be paid as stock, that additional fees for meeting attendance should be eliminated, and that all retirement programs should be abolished.
The critics wishing to abolish director retirement plans often argue that these plans amount to double-dipping by outside directors, most of whom have worked and have earned a pension somewhere else. Of course, many people leave a job after retirement and go on to work somewhere else where they accrue pension benefits, or work two jobs, each of which provides pension benefits.
Although we are not addressing total compensation per se, no one can realistically analyze retirement programs (or any benefit program) except as part of total compensation. A company should value the various elements of director compensation separately and then aggregate the amounts. Once the company knows the overall cost of its directors' compensation program, it can knowledgeably discuss the program's appropriateness. The company can then communicate to shareholders and other interested parties its view that directors' pension costs are part of total compensation costs -just as many companies have come to view the costs for employees' pensions.
Employers set up pension programs to provide employees with a build-up of assets over their working years that will generate an income stream after retirement. This promise of an income stream helps employers attract and retain employees and facilitates the orderly transition of employees off the payroll. The benefit amount, usually payable for life after retirement, is typically a function of years of service and either pay at retirement (e.g., an annual amount of 1% of final pay for each year of service) or pay over the working career.
The directors' pension plan should be designed to achieve these same objectives (effective recruitment, retention and timely retirement). However, there are significant differences in the design of directors' plans. First, the amount of benefit is usually set equal to the retainer or direct compensation paid. Second, the period over which this amount is payable after retirement sometimes is a function of the number of years of board services (e.g., payable for the lesser of 10 years or the period of board service.) Third, since directors' pension plans are nonqualified, assets to fund benefits can't be set aside on a tax-effective basis prior to payment.
Thus, to some degree, the pension portion of a director's compensation is at risk, dependent on the future viability of the company. If the company does not survive (or thrive) for 10 years after the director retires, the source of that deferred compensation is at risk. Putting compensation at risk in this fashion seems to achieve the same end urged by those who want all compensation to be in stock.
In fact, some would argue that the relatively long payout period presents the director with a more effective incentive to act in the long-term best interest of the company than either providing all compensation currently in stock (too much short-term emphasis) or in cash (little or no long-term incentive).
Several surveys on this issue have indicated that at least two-thirds of large companies have directors' pension programs. The 1995 proxy material materials for the 30 companies in the Dow Jones Industrial Index show 24 of them have retirement plans for non-employee directors. Of these, 15 have benefits payable for life and 20 have benefits equal to 100% of retainer in effect at retirement.
For large companies looking at the issue, it would be advisable to develop a strategy for looking at directors' compensation from a total compensation perspective.
Part of that strategy includes reviewing the design of the current retirement plan, accurately valuing the plan and, possibly, communicating the value of the total package not only to other interested parties, but also to the directors themselves.
Mark Maselli and Alan Glickstein are principals of Kwasha Lipton L.P., Fort Lee, N.J.
