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Increasingly we find that private companies are adopting public company governance practices such as using formal Compensation Committees consisting of internal or external Board members.
Unlike publicly traded companies where a Board Compensation Committee is a requirement, private companies establish formal Compensation Committees for reasons such as the desire for:
- A more defined and objective process. This is welcome in delicate situations such as where there are conflicting shareholder interests that need to be aligned, or there is a perception that management has undue influence on setting their own pay levels.
- Additional Board-level attention and/or external compensation expertise. This may be necessary when companies establish new key executive compensation plans or need to have one point of contact to negotiate employment contracts with key executives.
A Compensation Committee is able to take a “deep-dive” into specific compensation issues in a manner that would be more difficult and/or impractical with an entire Board.
Below we outline the key aspects of well-run Compensation Committees:
Purpose: Typically, the Compensation Committee’s purpose is to carry out the responsibilities delegated by the Board relating to the review and determination of the performance and compensation of the Chief Executive Officer and the executive team. Each company’s Board needs to decide whether the Compensation Committee itself has the authority to approve compensation decisions, or makes its recommendation for Board approval.
Membership: Compensation Committees are usually comprised of a small select number of members, which can be a sub-set of the Board of Directors and can be supplemented by independent outside advisors, if desired. As an example, one of our private company clients has a Compensation Committee which consists of internal Board members supplemented by an external compensation consultant and a long-time outside advisor. Ideally, the Compensation Committee should include at least one member with compensation experience and/or a member with related, although not necessarily direct, subject matter expertise.
Duties: The duties of the Compensation Committee are to review the compensation and performance of the Chief Executive and, to some extent (to be defined by each company), the members of the executive team. The Compensation Committee also typically reviews compensation levels and plans (annual incentive, long-term incentive, supplemental benefit and perquisites) and major agreements (employment, severance, change of control, etc.). It may also review non-executive officer compensation and broad-based plans on a periodic basis, as and when appropriate. Increasingly, the role of CEO succession planning is also being assigned to the Compensation Committee.
Operations: We recommend that companies establish a Compensation Committee Charter and Calendar. The Charter specifies the Compensation Committee’s role, duties, responsibilities, and membership, as well as its operations (such as the number of meetings per year, review of its own performance, etc.). The Calendar sets the schedule of topics to be addressed at each of its meetings throughout the year. For instance, at the Q1 meeting, the Committee will review and approve salary increases for the upcoming year, bonuses for the prior year and equity grants. Topics would also be outlined for the remaining fiscal quarters. By having both of these documents, the purview and process of the Compensation Committee are clear to all constituents (Board members, shareholders, and management).
While it takes some time for private companies to recognize the benefits of establishing a Compensation Committee, we find that Boards come to appreciate having a dedicated and knowledgeable resource that can regularly address compensation issues on its behalf.