Under the spotlight

In the more than a dozen years that Clem Wilkes Jr. has served as a director of Mountain States Health Alliance, the compensation arrangement with the hospital system's chief executive has undergone plenty of changes.

The Johnson City, Tenn.-based system's top executive no longer receives an automobile as a job perk. The board of directors has restructured the CEO's retirement payouts. And every three years, the board reviews incentives tied to financial and quality performance. The changes, says Wilkes, keep Mountain States in line with evolving regulations and standards.

But change has not been limited to the CEO's payment arrangement. The board itself has evolved to keep pace with new expectations for not-for-profit governing boards, which have grown in recent years along with public scrutiny.

Media and public concern over executive compensation has grown with the intense focus on U.S. healthcare spending. Time magazine published a special report this year that was highly critical of executive compensation at not-for-profit hospitals.

U.S. Sen. Chuck Grassley (R-Iowa) also has raised the issue. “Hospitals have to ask themselves whether they're doing everything possible to fulfill their charitable mission before setting executive salaries,” he said earlier this year.

Ongoing interest in not-for-profit hospital governance and executive compensation from state attorneys general, watchdog groups and congressional committees has led in recent years to increased disclosure of executive pay and perks. The Internal Revenue Service expanded its reporting requirements for not-for-profit governance and highly paid executives five years ago—and in doing so required organizations to make the information public. Failure to do so can jeopardize hospitals' tax breaks.

For board members who live and work in communities that their hospitals serve, that means scrutiny can come from neighbors as well as regulators, especially when the town newspaper publishes executive pay at the local hospital. “Any board member might be asked in the grocery store: 'Why did you decide to pay our CEO that much?' ” says Pamela Knecht, president of Chicago-based consulting firm Accord Limited.

In response to increased scrutiny, directors and trustees are “not just sitting back and responding to things,” but have grown more proactive, says Douglas Hastings, a healthcare attorney in the Washington office of Epstein Becker & Green.

Some states and hospital trade groups have responded with new training and certification for hospital governing boards. At least a dozen states offer some education for directors and trustees, according to research published by the American Journal of Medical Quality in 2011. In New Jersey, hospital board training has been required by law since 2009.

In Tennessee, where Mountain States Health Alliance owns seven hospitals, state hospital association board certification requires members to demonstrate knowledge of their fiduciary duty, which includes oversight to ensure that profits are invested to serve the hospitals' charitable mission and do not instead enrich executives.

Directors and trustees say they are conscious of public scrutiny of executives' compensation.

Mountain States directors were the first full health system board to earn the state's hospital governance certification, Wilkes says.

All directors for Mountain States review compensation disclosures before they are made public. Outside consultants brief the board on the elements of compensation and the process for setting the chief executive's pay. “It's not a surprise,” he says.

Increasingly, the work of setting and evaluating a hospital CEO's salary and bonuses is done by a board compensation committee, a subset of the board entirely composed of independent directors or trustees—those without financial ties or potential conflicts of interest.

Sixty percent of all hospital governing boards surveyed by the Governance Institute in 2011 operated a compensation committee, up from 54% in 2009 and 48% two years earlier. Results are not yet available for this year. Also more prevalent are governance or nominating committees, which identify the balance of skills needed by the board and recommend or select those who may be best suited for various committees such as finance, strategic planning, quality, investment and compliance, as well as compensation. The 2011 Governance Institute survey found nearly three out of four boards included a governance or nominating committee, compared with 67% four years earlier.

Faye Hummel, a University of Northern Colorado nursing professor, joined the Platte Valley Medical Center's compensation committee four years ago and was named chairwoman this year. She says committee members at the 70-bed hospital in Brighton, Colo., must recruit and retain talented executives in a competitive market while also meeting the local community's culture and expectations.

“We are community members,” Hummel says. “We live here. We use this hospital. Our friends use this hospital. We absolutely believe that we are up for any of that public scrutiny.”

Platte Valley wants its compensation committee makeup to reflect a balance of members from its overall board, she says, and its committee charter does not call for specific skills.

But regulators want compensation work by boards to be limited to independent board members. Review and approval of the board's compensation process by independent board members is one standard that boards must meet to satisfy the IRS' criteria for good governance oversight of executive compensation. That policy is “as strict as it gets,” says Accord's Knecht.

Sean Patrick Murphy, senior vice president and corporate general counsel for Solaris Health System, Edison, N.J., says executive compensation is one area where boards have clear regulatory guidance. Still, questions arise with variations in board practice or executive compensation. “If they're doing what they are supposed to be doing, it should be defensible, legally and morally,” says Murphy, a governance expert.

Boards must disclose to the IRS and the public their performance on the IRS' good-governance criteria, which include whether the board compared compensation to other similar organizations and whether the board documented its work as it went through the process.

That greater transparency should focus boards' attention, Murphy says. “If board members weren't vigilant about this in the past, they have good reason to be now.”

Experts in compensation provide the Platte Valley board with compensation data from comparable organizations, which the board can then analyze and apply to their hospital, she says. “We have to be very thoughtful and strategic about ensuring our organization remains healthy,” Hummel says, and executive recruitment is one avenue to do so.

A tough market for top talent influences boards' decisions. “We certainly don't want to overcompensate, but we feel just as strongly about undercompensating,” says Lyle Knight, immediate past chairman of the Billings (Mont.) Clinic board of directors. “We offer amenities in Billings, but they also offer certain amenities in New York City. We know we have to compete.”

Recruits to the Billings Clinic compensation committee, who are recommended by its governance committee and approved by the full board, have worked for or audited large companies or served on for-profit corporation boards. That gives them valuable experience and insight into compensation at sophisticated or national organizations, Knight says.

“That's probably the best training,” he says. “We look for personal experience.”

Some boards have seen their compensation committees broaden their duties to include setting compensation for highly paid physicians employed by the hospital system, Knecht says. “We're seeing a bigger role for compensation committees than just the compensation for the CEO and senior executives.”

The IRS requires disclosure of not-for-profit hospitals' most highly compensated employees, which can include physicians.

Children's Hospital of Wisconsin in Milwaukee three years ago overhauled its governance after hiring a new chief executive. It employs roughly 100 doctors and dentists and adopted a policy to review physician compensation in response to regulatory interest in not-for-profit compensation, says Peggy Troy, the hospital's president and CEO. “There's a spotlight on it.”

Doctors whose compensation exceeds the market's 75% percentile face board review when productivity measures don't seem to justify that compensation level. The board must automatically review any doctor with compensation that ranks in the top 10%.

“It was in all of our best interests to have the process and the outliers reviewed at the board level,” she says.

Follow Melanie Evans on Twitter: @MHmevans