Creating a Compensation Committee Charter

Nicholas J Price
5 min read

Compensation committees were born out of the need to ensure good governance in the area of board and executive compensation. In recent years, a couple of notable trends are emerging around the topic of executive compensation. First, there is an increased emphasis on best practices for executive compensation that includes non-binding 'say on pay' votes by shareholders, as required by the Dodd-Frank Act. Second, corporations are trending toward increasing dialogue with shareholders regarding the appropriateness of executive compensation plans and how well those plans align with executive performance.

In response to these trends, many corporations have created compensation committees to demonstrate their commitment to good corporate governance standards and to provide assurance to shareholders that boards have done their due diligence in developing executive compensation plans. A compensation committee charter outlines what the compensation committee needs to do and how they should do it. The components to a compensation committee charter essentially mimic the elements of other board committee charters. The four main components include:

  • Purpose Statement
  • Membership
  • Meetings
  • Authority and Responsibilities

Purpose Statement of a Compensation Committee Charter

The purpose statement of a compensation committee charter consists of a few sentences or a short paragraph that states who established the committee and why they established it. The paragraph usually relays the general purpose of the committee. In addition, the purpose statement states who the committee reports to, which may be the full board, another committee such as the executive committee, or the officers of the company. If the committee was formed to support laws or regulations, the compensation committee charter may reference them in the statement.

Here is an example of a purpose statement by Coca-Cola Co.: '

The Compensation Committee is established by the Board to have overall responsibility for evaluating and approving compensation plans, policies and programs of the Company applicable primarily to the Company's Senior Executive Group, which includes all officers of the Company subject to Section 16 of the Securities Exchange Act of 1934, as amended, and such other members as the Committee may designate from time to time.'

Committee Membership

The next section of a compensation committee charter describes how many members should be appointed to the committee. The statement may give a minimum or maximum number if it doesn't provide an exact number.

The section on committee membership may include any requirements for committee members, such as whether they need to be independent board directors, have financial expertise or meet some other requirement. This portion of the charter should also state how committee members get appointed and the grounds or rules for removing them from the committee. It should also state what constitutes a quorum for the purpose of appointing or removing members from the committee.

The American Cancer Society provides an excellent example of how to create the membership section of a compensation committee charter. It reads as follows: '

The Committee is composed of the Chair of the Board, the Vice Chair, the Board Scientific Officer, the Secretary/Treasurer, the Immediate Past Chair, and up to two additional members, all of whom must be 'independent voting members' of the Board without a 'conflict of interest,' as such terms are defined in the attached EXHIBIT B. The Chair of the Board will appoint the Committee chair from its members. Any question regarding a Committee member's independence, conflict of interest or appearance of a conflict of interest will be reviewed by the Board for final resolution. Committee members are appointed by the Chair of the Board and approved by the Board. Committee members serve one-year terms beginning January 1st and ending December 31st of that same year or until the new Committee is appointed by the Chair of the Board.'

Note that this example clearly prohibits committee members who have a conflict of interest.

Board Meetings

It's important for committee members to have clarity on how frequently the board expects them to meet. The section on meetings details the frequency of meetings and may include a minimum number of meetings. This section will also tell the committee members whether they can meet by teleconference or videoconference, and whether they can use unanimous consent resolutions. The section on meetings usually instructs the committee to maintain minutes of their meetings and to file their books and records with the company, as in this example of meeting requirements written by McKesson:

'Meetings of the Committee will be held from time to time and in any event at least twice per fiscal year, in response to the needs of the Board or as otherwise determined by the Chairman of such Committee, and the Committee shall provide reports to the Board. In lieu of a meeting, the Committee may also act by unanimous written consent resolution. The Committee will maintain written minutes of its meetings and will file such minutes with the books and records of the Company.'

Compensation Committee Authority and Responsibilities

The section on committee authority and responsibilities is the nuts and bolts of the compensation committee charter. The contents of this section will vary widely depending on the duties and responsibilities that the board grants to this entity. Boards typically organize this section by numbering the various points in consecutive order.

Unlike some other types of committees, boards may give some authority to their compensation committee. These points may detail whether the committee has the authority to seek outside guidance and expertise, whether the committee has the authority to approve compensation for any executives, and any other areas of authority or limitations of their authority.

In creating the compensation committee charter, boards will describe the duties and responsibilities of the committee, including how often the committee will review its own performance. Usually, the committee is responsible for recommending changes in the committee's charter to the boards. Finally, the committee charter should list the date the charter was approved or updated.

A Board Portal Offers a Secure Platform for Compensation Committee Confidentiality

The work of a compensation committee is highly sensitive and requires a strong degree of security. Compensation committee members can rely on the strong security of a board portal by Diligent, which allows committee members to participate in meetings remotely if they choose.

The portal provides a secure arena in which committee members can exchange documents securely online. The portal also offers secure, cloud-based storage for committee agendas and meeting minutes. Diligent's board management software is exactly the tool that committees need to ensure that the compensation committee is fulfilling its duties under the charter.