What is a Compensation Committee?

The Compensation Committee functions as a permanent board committee that manages the salary and compensation decisions for all company executives. Its main task involves developing compensation policies that support the company’s strategic objectives, performance targets, and shareholder interests.

Publicly traded companies need to follow specific governance and regulatory requirements that apply to their compensation committee operations. These include rules established by the U.S. Securities and Exchange Commission (SEC) and stock exchanges like the NYSE or Nasdaq.

What are the key responsibilities of a compensation committee

The compensation committee has a broad and technically detailed mandate. Some of its key responsibilities and functions include:

• Approving of total executive compensation, which includes salaries, bonuses, equity awards, benefits, and severance payments.
• Creating and managing short-term and long-term incentive programs.
• Developing specific performance indicators that will measure its success.
• Establishing a system to guarantee salary increases match employee performance and the creation of long-term value.
• Examining equity compensation programs, including stock options and restricted shares.
• Comparing salary levels with similar organizations to maintain salary standards that are both competitive and appropriate.
• Measuring how much compensation-related risk employees take in their work.
• Ensuring the company follows all requirements, such as legal standards, regulatory rules, and disclosure obligations.
• Presenting recommendations and decisions to the board of directors.

The Changing Role of the Compensation Committee

The role of the compensation committee has evolved significantly over the past few decades. The board used to make executive pay decisions in an informal manner, which gave management excessive control over the process.

Corporate governance reforms, together with shareholder activism and high-profile pay disputes, created a need for organizations to focus more on independent and transparent oversight. Compensation committees these days are also expected to address or manage areas like ESG incentives, clawback policies, and internal pay equity.

Composition of a Compensation Committee

A compensation committee is typically composed entirely of independent directors who do not hold executive positions. Independence functions as the essential requirement that prevents conflicts of interest during executive salary determinations. For U.S. public companies, they must adhere to stock exchange rules requiring committee members to have no material ties with the company or its executive team.

Members possess professional knowledge about finance, human resources, executive leadership, and corporate governance. Committees typically hire outside experts who serve as compensation consultants and legal advisors to deliver market information, regulatory advice, and risk assessments.

A compensation committee retains complete decision-making power, although management can offer its suggestions and recommendations.