What You Should Know About Compensation Committees

The roles and responsibilities of compensation committees may vary based on the type of organization. 

In this article, we will provide an overview of what a compensation committee is and discuss how it differs between nonprofit and for-profit organizations. Additionally, we’ll touch on the main functions of a compensation committee and explain who can become a member. So, without further ado, let’s dive in.

What is a compensation committee?

A compensation committee is a group of people within a corporation charged with defining and reviewing executive compensation. Essentially, this means the compensation committee determines the salary and other forms of compensation that company executives are to receive.

A compensation committee draws its authority from the corporation’s board of directors, by which it is appointed. Typically, compensation committees work both a managerial and a strategic function, are tasked not only with establishing and reviewing compensation packages but also with ensuring these fall within the broader set of corporate values and goals.

Are compensation committees different in nonprofits? 

If you are wondering whether there are any fundamental differences between a nonprofit’s compensation committee and that of a for-profit corporation, the answer is: some, but not much. 

While the main tenets of compensation are similar for nonprofits, nonprofit boards are commonly more closely regulated. There is an expectation that impartiality and fairness are to be the guiding principle, as much as possible.

In the US, for instance, a nonprofit must meet three requirements when establishing executive compensation to preserve its tax-exempt status. These requirements are:

1. Compensation must be determined by a body within the corporation appointed especially to that end (the compensation committee). The members of this body must have no conflict of interest regarding the compensation packages. This means that, for example, the CEO cannot be a member of the committee.
2. The committee must base its deliberations on relevant and reliable data. The recommendation here is that members of the committee should examine the standards set by other nonprofits acting under the same conditions (same region, industry, etc.) and determine compensation terms accordingly.
3. The basis for the committee’s decisions and the committee’s deliberations must be well documented.

However, there may be special demands placed on publicly-traded companies. That is the case with corporations listed on the NASDAQ or the New York Stock Exchange (NYSE), which require and regulate the presence of compensation committees. 

For instance, the NYSE regulates the conditions under which a committee may hire an external compensation consultant or advisor, while also determining that a committee should feature two independent directors and requiring the committee to perform and publish annual evaluations of its effectiveness in keeping procedures and attaining strategic targets.

Most often, the above principles also apply to for-profit organizations. The key difference is that, for nonprofits, they can be taken as a necessary legal requirement for maintaining their nonprofit status.

Who can take part in a compensation committee?

More often than not, compensation committees include members of the board of directors. However, the process of forming a compensation committee needs to take several other criteria into account. Specifically, compensation committee members should have a reason for being there. Factors often taken into account for the selection process are:

• Previous experience. Members should have a skill set and expertise relevant to the responsibilities and duties of the committee. Things like a background as a corporate financial advisor or a solid knowledge of industry standards can make someone a valuable addition to the team.
• No conflict of interest. As mentioned in the previous section, it makes more sense not to include committee board members who are affected by the compensation package decisions.
• Strategic and managerial ability. As we’ll see below, there is a lot that goes into determining executive compensation. It’s a good idea to select compensation committee members who are sure to be effective in this area.

Of course, these are just broad guidelines to follow. There will be other aspects to keep in mind — more self-evident, but just as important, such as leadership skills, compatibility between members across the committee, and so on.

Duties and responsibilities of compensation committee members

Besides the obvious task of determining compensation packages components, many other elements fall under the purview of the committee. The duties and responsibilities attributed to compensation committees fall within different areas and can be divided into several categories, such as:

Compensation 

Through careful evaluation of industry standards and the corporation’s own goals, the committee is tasked with drawing a well-documented compensation plan that is then to be recommended to the board of directors. Such plans should be reviewed periodically and can include:

• Executive salary
• Short- and long-term incentives and other bonuses
• Health, dental, and life insurance benefits
• Vacation and personal days
• Company-established savings/investment funds or retirement plans, such as a 401(k)
• Other perquisites such as company-leased vehicles, accommodations, or devices

Compliance 

The committee should ensure that everything is done in accordance with company bylaws and the committee’s own charter. Decisions should also conform with industry best practices and ethical standards and, if relevant, with any external requirements, such as by an IRA or NYSE mentioned above.

Documentation

This naturally follows the previous point. Besides the initial task of drawing a compensation charter, it is essential that any deliberations, decisions, and recommendations made to the board of directors should all be clearly documented. 

Evaluation

The committee should have an established mechanism through which to assess its success in achieving goals, fostering growth, fulfilling ethical standards, and keeping with the company’s strategic vision.

Other 

For many companies, the compensation committee plays a key advisory role, helping determine where compensation plans fit within the broader landscape of industry goals and corporate values. 

Conclusion

As you can see, compensation committees are integral to ensuring transparency and fairness in internal corporate transactions, as well as preventing the potential disruptions caused by conflicts of interest. 

Besides the job of researching and determining executive compensation plans, compensation committees are also instrumental as an advisor body for the larger context of a corporation’s place in the market, its mission, and long-term objectives. As such, their place in the structure of any major corporation cannot be underestimated.

FAQ

How many nonprofit organizations have a compensation committee?

Compensation committees are common primarily in large, well-staffed organizations. In other cases, their tasks are fulfilled by an executive committee or an especially assigned task force. 

What does the compensation committee do?

Compensation committee reviews and decides on executives’ salaries and other means of compensation, such as incentives, bonuses, benefits, vacation pay, etc. Additionally, the compensation committee is responsible for ensuring compliance, evaluating executive-level performance, and maintaining uniform documentation of all their decisions and procedures. 

How often does a compensation committee meet?

A compensation committee traditionally meets on a quarterly basis. Each quarter focuses on specific areas of the organization’s compensation planning. This way, a Q1 meeting centers on reviewing last year’s metrics, while a Q4 meeting decides on the benchmarks and policies for the upcoming year.

Is the compensation committee required?

Compensation committees are a must for corporations that went public and are generally recommended for all large organizations, including non-profits.