Column: High Director Pay on Upswing

After years of increasing complaints about the perceived excessive compensation of public company chief executives, scrutiny is being focused on the paychecks of the people who set CEO pay.

Specifically, two union-affiliated pension fund groups recently challenged the directors at Countrywide Financial Corp., the large U.S. mortgage banking firm that's had a high profile in the unfolding subprime mortgage mess. They think Countrywide Chief Executive Angelo Mozilo makes too much money. One group, CtW Investment Group, said Countrywide's directors also are paid too much, a "likely source of the board's passivity."

Countrywide didn't reply to a request for comment. However, the purpose of this column isn't to weigh the merits of the complaint against Countrywide's board, but to explore the larger issue of directors' pay. Or, to put it another way: Who's guarding the guardians?

Countrywide isn't the only company where activist shareholders have found fault with CEO pay schemes as set by corporate boards. Usually, the complaint is that bonus targets are too easily achieved and aren't really in synch with shareholders' interests or the longer-term growth of the company.

So, one can easily imagine this won't be the last time large shareholders take on directors' pay, especially at companies where they already think top executives are overcompensated or where financial results are poor.

Indeed, directors' pay is on the rise. A recent Towers Perrin study found the median compensation for outside board members in Fortune 500 companies was $174,500 in fiscal 2006, up 8 percent from the prior year.

Directors' pay is growing in large part because the Sarbanes-Oxley Act requires them to be more vigilant and accept greater responsibility and risk. People have to be compensated for the extra work and the potential downside of litigation and dented reputations. Directors also increasingly are being compensated with options or restricted stock to align their interests with the shareholders they represent.

And directors' pay is becoming more transparent, now that the Securities and Exchange Commission has mandated it be spelled out more clearly for investors, just as the earnings of top executives.

So now, with remuneration rising and more facts out in the open, director earnings will increasingly become a divisive issue.

What to do? After all, directors set their own salaries.

Companies could let shareholders vote on directors' pay, but that poses the same basic problem that has led this column to object to plans to allow annual shareholder votes on CEO compensation. There's essentially no incentive, outside of some expectation of reasonableness, for shareholders to ever vote yes for CEO or director pay. Regardless of corporate results, the compensation will strike many as too high.

A better remedy is to make sure shareholders can vote out directors they think have failed to earn their pay. That means the "majority vote" system must be in place, meaning board candidates in uncontested elections must win more "yes" votes than "withhold" votes to retain their seats. More and more companies are adopting it, but perhaps there's a way to give a regulatory kick to make it universal.

If shareholders think directors pay themselves too much, they can vote them out. That's a power that ought to be used cautiously. If shareholders want qualified people to work as directors -- now that the job is more than a sinecure offering the chance to hobnob with other successful people at catered lunches -- they're going to have to pay up.

Neal Lipschutz is senior vice president and managing editor of Dow Jones Newswires.