When I told a physician friend I was asked to write an article about executive compensation, he responded that executives are paid too much and that boards rubber-stamp the process. Such a response from a highly regarded physician indicated the need to clarify and improve the perception, at least, and perhaps the substance of the executive compensation process.
I cannot write about executive compensation without including its tacit connection to executive evaluation. If compensation is based upon merit, as it should be, then compensation ultimately should depend upon evaluation results. In addition, I prefer to call the committee with responsibilities for compensation the "executive evaluation and compensation committee," henceforth referred to as the compensation committee. Including the word evaluation in the committee's title conveys the message that compensation is based upon an evaluation of executive performance.
The current era of public concern about corporate misdeeds has led to heightened scrutiny of executive compensation at tax-exempt organizations as well.
The result is that boards must tread a fine line in an attempt to retain accomplished executives and, at the same time, avoid any hint of impropriety.
During my career in healthcare, I have seen executive compensation from three different perspectives: as a senior executive, as a trustee and as a governance consultant. The following are three brief accounts highlighting the importance of appropriate compensation and sharing information with the full board.
When I was a senior hospital executive, a corporate leader took office as the new board chairman. He immediately increased compensation for all senior executives to an appropriate level in an effort to retain talent. I was pleased with not only my increased income, but also by the recognition of my efforts.
When I was a hospital trustee, the chief executive officer's salary was not disclosed by the compensation committee until the recruitment of a new CEO. I resented not being informed earlier and felt that the full board was entitled to such information.
As a governance consultant, I worked with a board whose committee members who didn't serve on the compensation panel were concerned that they did not know how the CEO's evaluation and compensation were determined. Once this concern was conveyed to the board chair, a compensation policy was developed. Once they understood the process, the full board became more comfortable with what their colleagues on the compensation committee were doing.
Boards and executives should know how the following words are used in the context of executive compensation:
* Executive: The CEO and potentially others for whom the board or compensation committee conducts an evaluation and compensation process or whose compensations are reported on Internal Revenue Service Form 990.
* Compensation: The base salary, performance bonuses and other compensation per the IRS.
* Section 4958: The section of the IRS code that deals with executive compensation for tax-exempt organizations. If it is determined that there has been unreasonable compensation, not only the individual(s) receiving the compensation, but also the directors who approved the compensation, can be penalized. Although this article refers to compliance with federal regulations, attention should also be given to applicable state regulations.
* Disqualified person: A director who has a relationship with the executive or the organization that could impair that person's ability to make independent decisions regarding compensation. Special attention should be given to directors who are physicians so that no physician on the committee could benefit (or appear to benefit) from potential executive recommendations, e.g. capital purchases.
* Education: Educate directors and executives through appropriate literature and educational programs presented by experts in the field of executive compensation. Magazine articles such as "A higher standard" (June 27, p. 6) and publications by the Governance Institute and the Center for Healthcare Governance are very informative.
* Policy: The board approves an executive evaluation and compensation policy stating the process by which the board (or a delegated committee) evaluates the executive and determines appropriate compensation above, within or below fair market value; the process by which the full board is engaged; and guidelines for sharing information with key stakeholders.
* Charge: The board approves the charge for the compensation committee or the group given authority to carry out the aforementioned policy.
* Structure: Compose the compensation committee in compliance with Section 4958-as an independent committee with no disqualified persons as members. If the board as a whole conducts the evaluation and compensation process, special attention should be given to recusing any disqualified individuals.
* Performance expectations: The compensation committee should establish and evaluate executive performance expectations. Link compensation changes to evaluation results. Be sure to document positive evaluation results to aid justification of above-average compensation.
* Comparable data: Base compensation ranges upon comparable market data obtained from similar organizations or an independent source.
* Board role: If the authority for evaluation and compensation has been delegated to the compensation committee, the full board should be informed of specifics of the evaluation results and the compensation.
* External review: Consider having someone with knowledge of Section 4958 compliance review the structure, process and outcomes of the compensation system. Larger organizations should budget for an independent compensation consultant. The boards of smaller institutions should assess whether or not the benefit of such professional advice outweighs the consulting costs and the risks of noncompliance with the IRS code. In a recent survey by the American College of Healthcare Executives, 41% of hospitals reported using an external consultant.
* Form 990: Accurately complete IRS Form 990 showing full compensation and consider adding explanatory information where necessary.
* Documentation: Routinely document the entire procedure including the decisionmaking process that determined the executive compensation, especially if the result is above fair market value.
* Release information: Prepare and release information (including Form 990 information) via various means (Web site, annual reports, local media, etc.) to the community and key stakeholders (physicians, insurers, etc.) regarding the organization's approach and rationale for executive evaluation and compensation.
By following these recommended steps, boards and executives will improve the process of executive evaluation and compensation. Boards and executives should champion as much transparency in the process as possible. Ideally, the organization should release information before the media report on the Form 990s.
I presume my physician friend didn't know the salary of his CEO. If he knew the amount and, more importantly, the rationale for determining the appropriate compensation, I hope he would have had a much better attitude about executive compensation.
Samuel Friede is director of the Governance Initiative at the Health Policy Institute. He is also assistant professor and director of external relations for the Department of Health Policy and Management at the University of Pittsburgh's Graduate School of Public Health.
* Make sure executives are educated regarding appropriate compensation.
* Form the compensation committee in accordance with Section 4958, ensuring it is a totally independent committee without any disqualified individuals.
* Compare proposed compensation ranges with market data.
* Have someone with Section 4958 compliance knowledge review compensation system and outcomes.
* Routinely document the entire procedure, including the decisionmaking process that determined the executive compensation, especially if the amount is higher than fair market value.
* Prepare and publicly release information (including IRS Form 990) via various means to the community at large and stakeholders regarding the organization's approach and rationale for executive evaluation and compensation.