Board compensation datapoints of the day

By Felix Salmon
March 11, 2011
Duff McDonald's October profile of Rajat Gupta:

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Should there be some kind of cap on director compensation? The question arises in Duff McDonald’s Fortune profile of Rajat Gupta from October:

His long career as a well-connected corporate consigliere made Gupta highly coveted as a director. Between 2006 and 2009, Gupta picked up seats on the boards of five public companies — American Airlines parent AMR, global outsourcer Genpact (of which he is also chairman), Goldman Sachs, audio equipment giant Harman International, and Procter & Gamble. He also joined the supervisory board of Russia’s Sberbank and the board of the Qatar Financial Centre. Altogether, those positions paid him more than $3.2 million in 2009.

Gupta has drawn criticism for his hefty board income. He left his position with Sberbank in June. But in 2008, he was paid $525,000 — more than he made for his Goldman board seat — to sit on the board of the bank, the largest in Russia and Eastern Europe by assets, while the next-highest-paid director earned only $110,000. The question of whether he could actually be “independent” while being paid $525,000 was a serious enough one that RiskMetrics, the corporate-governance watchdog based in Washington, D.C., advised minority shareholders to vote against his nomination in 2009. He was reelected anyway.

If a director is being paid half a million dollars a year by a company, that seems to me a pretty effective way in which the management of the company can capture the director. And earning $3.2 million in one year from non-executive board positions alone is just bonkers.

But wait a minute, Gupta has a rival in the insane-board-remuneration stakes! Step forward Cathie Black, who contrived to take home $3.3 million from IBM last year. Admittedly, that wasn’t all for one year’s work: she retired from the board and cashed in all the shares she held in the IBM Deferred Compensation and Equity Award Plan, under which her $260,000 annual director’s fee gets paid out in stock and held by the company.

I do understand that board members of big corporations are often very wealthy people, and that therefore it takes large sums of money to so much as get their attention. But that’s not always the case. Here’s Warren Buffett, in his latest annual letter:

The directors who represent you think and act like owners. They receive token compensation: no options, no restricted stock and, for that matter, virtually no cash. We do not provide them directors and officers liability insurance, a given at almost every other large public company. If they mess up with your money, they will lose their money as well. Leaving my holdings aside, directors and their families own Berkshire shares worth more than $3 billion. Our directors, therefore, monitor Berkshire’s actions and results with keen interest and an owner’s eye.

I’m particularly impressed, here, by the lack of D&O insurance — although I suspect that the directors might just buy their own insurance personally. But this, to me, is pretty much the ideal board, comprised of real owners of the company, who don’t need to be attracted with quarter-million-dollar annual retainers or Deferred Compensation and Equity Award Plans. As an individual shareholder, I’d be much more comfortable being represented by a Berkshire-style board than by the kind of people who feel the need to charge $525,000 a year for their services.

Comments
7 comments so far

“As an individual shareholder, I’d be much more comfortable being represented by a Berkshire-style board.”

How about this… pay travel expences directly, 1st class (or private), 5-star Hotel to attend the meetings and then your only financial reward would be a large stock award. Let’s restrict half of it for 5 years and half of it FOREVER.

When you die your kids can sell it or you can gift it to charity but as long as you’re breathing than you own the stock. That would incent boards to think about the truely longterm health of a company in the same way Buffett does.

Posted by y2kurtus | Report as abusive

This is why corporations hate ‘activist shareholders,’ in other words those who hold a lot of stock and want the corporation to be responsive to its owners. Management doesn’t want owners with a real stake monitoring its activities, it wants well paid lackeys.

Posted by 3oosion | Report as abusive

For Berkshire, the lack of D&O isn’t a big deal. Berkshire is big enough and liquid enough to self-insure:
http://www.iii.org/insuranceindustryblog  /?p=2014
and
http://bit.ly/eM0ED1

Posted by RZ0 | Report as abusive

Self insurance is usually not a good idea. The issue isn’t financial ability to pay, it’s the legal ability to pay.

For example, under Delaware law, there are circumstances under which a corporation can’t pay its directors, yet a third party (such as an insurance company) can.

Posted by 3oosion | Report as abusive

Management does not set board compensation, so there’s no reason this would be a mechanism to “capture” a director. Directors comp (and, indeed, CEO comp) is set by the Compensation Committee of the Board of Directors, which, for companies listed on US exchanges at least, includes only independent directors.

I’m not sure why a cap on director comp would be helpful though. Some companies need to attract qualified independent directors and paying them well is one way to do so. Not every company is in Buffett’s fortunate position of having enough well-aligned and well-qualified shareholders with time to spare.

(None of this is to defend the specific compensation arrangements of Rajat Gupta, which seem excessive and well above market.)

Posted by right | Report as abusive

RZO- While a primary concern of the limitations of indemnification is the indemnifying parties ability to pay (which you aptly point out isn’t much of a concern for Berkshire), another limitation is that to benefit from indemnification you have to meet a conduct threshold (not act in bad faith, not be negligent- depends on the state of incorporation’s law), while insurance you do not. Of course, most people would think a conduct threshold to avoid personal liability is a good idea…

Posted by AdamJ23 | Report as abusive

The effect is even more interesting when you consider board members who give the appearance of being independent, e.g., academics and college presidents, for whom the director’s fee is a very substantial income supplement. For example, Mary Sue Coleman, President of the University of Michigan, is one of two academics who are members of the board of Johnson & Johnson. The $200K plus that they receive is more significant to them than it is to many board members who are wealthier. The academics appear to be independent but often are the least independent because the prospect of losing an amount of money that would change one’s financial life is not something anyone wants to face.

Very useful when it comes to having a vote against being acquired (and losing that board position) or against firing a CEO (like Bill Weldon at JNJ).

Posted by DHume | Report as abusive
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