A notable evolution is taking place in privately held companies as the role of compensation committees is being enhanced or, in many cases, newly created in organizations. Knowing the compensation committee’s responsibilities and impact is an important strategic decision for owners, executives and key stakeholders.
Some business owners don’t believe they need a compensation committee because the company is too small or they don’t want a formal structure. But most understand the compensation committee’s responsibilities and positive impact. Companies without a designated compensation committee can still achieve its benefits by managing some compensation duties through the board or a segment of the board’s membership.
What is driving this evolution?
Some for-profit private companies find they need to mirror public company practices around compensation committees. As compensation committees further evolve and mature, they can also provide a form of governance and accountability around key objectives outside of compensation that drive long-term growth and stability, such as succession planning, employee engagement and culture. Also, an independent compensation committee can provide the direction and support to facilitate a management transition when companies migrate beyond the owner/CEO to either an outside CEO or the next generation of the family, or when private equity has been introduced.
What are the compensation committee’s fundamental responsibilities to private companies?
Key responsibilities of private company compensation committees include:
- Ensuring the company has a thorough compensation plan for the CEO and direct reports, with links to the company’s business and strategic plan. The compensation package should be highly competitive and performance-based.
- Approving or helping develop the executive compensation strategy. The compensation strategy should take into account how much the company wants to pay in relation to its market. It should also keep in mind how the company compares itself to its peers. Questions that should be addressed separately, include those involving base salary, annual salary and long-term incentives. The amount of pay at risk reflects several factors and needs to be aligned to the market, the company’s mission, specific business environment considerations and objectives to attract, retain and motivate talent.
- Reviewing and setting the compensation for the CEO and direct reports, including short- and long-term incentives. The purpose is to ensure executive pay rewards long-term value creation and performance.
- Reviewing what actions are being incentivized annually. Are goals profit-based, operational and strategic? How do the goals link back to the business plan, the budget, industry benchmarks and historical performance? If it exists, is the long-term incentive plan rewarding results the company is trying to achieve, and does it help build wealth and support retention?
- Ensuring the company has committee members who are independent of management and ownership, and are capable of offering valuable and objective insights.
As compensation committees mature, what other responsibilities would they handle?
Over time, compensation committees would be expected to play a role in:
- Ensuring there is a robust succession plan for the CEO and direct reports. The board as a whole would be actively involved in developing or, at minimum, monitoring those plans. Succession plans are critical to the ongoing stability of companies.
- Providing oversight over employee engagement issues, leadership and talent development. Compensation committees should create a culture that supports their company’s mission and values, which are crucial to long-term growth, recruitment and retention.
- Addressing risk-mitigation issues, such as executive physicals and critical key person insurance. Compensation committees must ask if there is adequate life insurance for the CEO to cover the hard and soft costs that would occur in the event of a death.
- Reviewing and approving executive-level employment agreements, including change of control, severance and post-employment agreements.
- Reviewing and approving board compensation.
The compensation committee or advisory board that performs these responsibilities – or part of them – supports long-term growth, valuation and stability. Companies should review their charters and the qualifications of their committee/advisory board members to ensure they have the right talent to oversee these responsibilities.