A marked rise in director pay continued in 2005, according to the study, as total pay increased by almost 14 percent--from an average of $126,325 in 2004 to $143,807 in 2005. The jump comes on the heels of a more than 23 percent increase from 2003 when total average pay stood at $102,400.

The 2005 spike stems from a combination of rising cash pay levels and increasing stock prices that fueled the value of long-term equity awards, the study found, while median total compensation for a typical director also increased in 2005 by about 15 percent.

"As directors work harder and face potential greater liability, they are demanding higher pay for themselves," CompensationStandards.com editor Broc Romanek told Governance Weekly. "Higher pay also helps with growing recruitment and retention issues."

Greater Retainers and Committee Fees
This year's study notes that annual retainers remain the most prevalent component of director pay. In 2005, 96 percent of all companies provided retainers, compared with 95 percent in 2004. The median board retainer value for 2005 stood at $35,000--an 8 percent increase over 2004. The average retainer, $41,033, was up 13 percent. The majority of companies pay the board retainer in cash only, but 15 percent pay a combination of cash and unrestricted shares, and 2 percent use shares only, according to the study.

The highest average retainers are by large companies in terms of both market cap ($56,597 for the S&P 500) and revenue ($65,629 for those with $10 billion plus in revenue), and by companies in the consumer staples sector ($52,963). The most significant one-year increases in retainer value, however, were found in the S&P SmallCap (18 percent increase to $29,718) and those firms with less than $500 million in revenue (which recorded a 12 percent increase in the average value to $24,432), and among companies in the telecommunications sector, where the average retainer rose 23 percent, to $47,459.

A significant recent trend is the practice of paying more to committee chairs. As of 2005, chairs of the audit, compensation, and nominating committees received extra pay 80 percent, 73 percent, and 59 percent of the time, respectively. The study found that these fees usually take the form of additional retainers, with audit committee chairs receiving approximately $10,000 extra, on average, and compensation and nominating committee chairs each earning just over $7,000 extra.

The growth in director pay packages may not come without consequences, analysts caution. "Boards need to tread carefully here as more investors are seeing director pay as the next governance battle," Romanek warns. "And more importantly, since directors set their own pay levels, greater pay might lead to courts finding independence of boards compromised if pay is set too high. This is a universal claim in every compensation lawsuit brought in the last few years and likely will continue to be so."

Such thinking may have spurred Coca-Cola Co. to amend its director pay policies to stipulate directors would be paid only if certain financial goals are met. The company announced this week that it would no longer provide directors an annual retainer of $125,000, of which $50,000 is paid in cash and $75,000 accrued in share units.

Instead, directors would be awarded equity share "units" each year equal to a flat fee of $175,000, but realization would be tied to performance conditions based on earnings per share. When the performance target is met at the end of the performance period, the share units will be payable in cash. Should the performance target not be met, however, "all share units and hypothetical dividends would be forfeited in their entirety," the company said in an April 5 press release.

The approach is novel, analysts say, while warning such incentives may prompt directors to focus on short-term gains, thereby diverging their interests from those of most shareholders.

Continued Decline in Classified Boards
The study's examination of board practices found that the number of companies with staggered board elections continued to fall, declining from 61 percent overall in 2004 to 59 percent in 2005. That trend is driven by the increasing number of boards at S&P 500 companies that have moved to annual elections. In 2005, 53 percent of S&P 500 firms had classified boards, down from 56 percent the prior year. At the current rate, the majority of S&P 500 directors will be subject to annual election by the end of 2006.

Moreover, the use of classified board structures among the MidCaps and SmallCaps declined for the first time, albeit modestly. Companies in those indices had the same percentage of classified boards in both 2003 and 2004 (66 percent for MidCaps and 62 percent for SmallCaps), but the proportions dropped 2 percentage points and 1 percentage point, respectively, in 2005.

A steady decline in the prevalence of classified boards among all S&P 1,500 companies can be attributed to a marked reduction in their use by large cap S&P 500 firms. One reason may be the disproportionate shareholder scrutiny of high-profile companies.

From 1999 to 2005, S&P 500 companies have faced 220 shareholder proposals to declassify the board, for example. During the same period, MidCap companies faced only 43 such proposals, and SmallCap companies faced only 18.

In past years, support for shareholder proposals to declassify tended to be stronger at S&P 500 companies; however in 2005, average support among S&P 500 companies was 68 percent, compared with an average of 73 percent among MidCaps and 71 percent among SmallCaps.

It appears to be only a matter of time before classified board structures are no longer the norm at U.S. companies, the study finds, backing the view of many governance watchers who believe that staggered boards are no longer critical for maintaining management control.

"In light of increased institutional activism, they [boards] no longer see value in maintaining classified boards long-term," University of Delaware professor and noted governance expert Charles Elson said. "Boards are realizing they have limited value in preventing a takeover."

Committee Independence Increases
Average audit committee independence has climbed steadily over the last five years, and the percentage of companies with fully independent audit committees has increased most dramatically, rising 15 points since 2001, to 85 percent as of 2005, the study found. Independence levels also continue to rise slowly on both compensation and nominating committees, reaching an average of 94 percent and 92 percent, respectively, as of 2005.
The average number of audit committee meetings also continued to increase, to nine in 2004 (as reported in 2005), up from eight in 2003, seven in 2002, and five in 2001--suggesting that the surge is not just a reaction to the auditing scandals of 2001 and 2002, but rather reflects new demands on audit committee members stemming from Sarbanes-Oxley requirements.

Compensation committees met an average of five times in 2004 (as reported in 2005), the same as the prior year, although large companies averaged six meetings of this key committee. Although nominating committees met on fewer occasions--four times per year on average--that is double the frequency of their meetings in 2002. In 2005, only 2 percent of the companies in the study did not have a formal nominating committee.

Those trends will continue, according to Elson, who notes that regulatory pressure, shareholder activism, and litigation by investors will ensure companies do not backtrack on improving board practices.