Board of Directors Pay / Phantom Stock, CompDoctor December 1998

Q: As the senior member on the boards of several smaller manufacturing companies, I need information about board compensation but cannot find good comparisons for smaller companies. What do other small companies pay their board members, and how is it structured? -J.B.

CompDoctor: Congratulations, J.B., you've hit the jackpot. As luck would have it, yours truly (and my associates, with whom you don't mess around, if you know what I mean) just completed a survey of the 70 smallest publicly traded companies in Minnesota, all of them under $300 million in annual revenue. Ka-ching! So grab a 99-cent shrimp cocktail, pull up a Naugahyde stool, and I'll explain the information you've just won.

In our survey, we found that most small companies pay both a retainer fee and a per-meeting fee. In exchange for the retainer fee, CEOs expect their board members to read company materials and come to meetings prepared. After all, you are responsible for governing the company wisely. And if you want the status afforded by that list of board positions on your risumi, you've got to work hard to keep the company afloat.

The main purpose of the per-meeting fee is to make sure that people show up. Some small companies also offer stock options to board members when they sign on.

But hold on to your chips, because cashing them in won't make you rich. We found that the average board member retainer fee at small companies falls just shy of $4,000, with a high of about $10,000 and a low of one big goose egg. The numbers tend to vary in proportion to company size (measured by annual revenue). Our survey also found that non-manufacturing companies pay more, on average, than manufacturing firms.

The average per-meeting fee is more consistent, with a low of $290 per meeting and a high of $830. If you're the type to count cards, you might think that a company would try to make up for low retainer fees by paying a higher per-meeting fee, or vice versa - but that's not necessarily the case.

Overall, if you attend six board meetings per year, your total compensation could range from $2,600 to just over $16,000. On average, a board member's total compensation runs about $7,500. (What - you expected more dough? Are you talkin' to me?)

Clearly, no one takes on board membership for the money. In fact, if you calculate the hourly rate, you'll find it's more watered down than the drinks served at the slot machines. Just remember, J.B., if you're like most other board members, you are really doing this for a friend. And if you stay in the game long enough, you may be the odds-on favorite for pit boss when the current CEO folds his hand.

Solid advice On phantom stock plans

Q: We are interested in offering long-term compensation for our executives. The problem is that we are privately held and stock is not available to give them. What else can we do to instill a sense of ownership and to reward our executives for growing the company? -C.S.

CompDoctor: Psst. Hey, C.S., do you like ghost stories? Good, because I would suggest that you conjure up something called a phantom stock plan. Until recently, phantom plans stood lurking in gloomy obscurity, so skittish were lantern-bearing CFOs about their intangible nature. But gradually they've gained visibility, and now phantom plans float freely through the hallways of many a corporation, helping to attract and retain key executives.

Phantom stock plans are but shadows that mimic their corporeal counterparts. Although shares of real stock can be traded at will, phantom shares take on value only when vesting is achieved. A phantom stock plan does not require investment or confer ownership, so its recipient does not have voting rights. However, the recipient bears less risk than stockholders if the company falters, and only stands to gain from the upside growth of the company.

A phantom shareholder also can defer taxes on the benefit until the payout date, which could be three years or more from the date of the grant. You can't do that with real stock.

Phantom stock plans are advantageous for the company, too. Because phantom shareholders lack voting rights, you can issue all the new shares you want without altering the governance of the company. (Phantom stock does not directly dilute the value of real outstanding shares.) And the plan can be designed so that executives receive no benefit unless vesting limits are met and the company's value is increased. With a phantom plan, you - not the market - will decide how to measure share value. Many companies use book value, but you can use revenue, operating income, or a combination of your favorite measures. Once you've done that, you grant the executive a certain number of shares, and the change in their value over time becomes the value of the plan to the recipient.

Still in the dark? Shhh - there's more.

I must tell you, C.S., that as soon as you invite a phantom in, you also get a monster in the cellar. For financial accounting purposes, phantom shares must be treated as expenses when accrued, but the company does not receive its income tax deduction until the benefits are paid out. Although this may sound like a heavy tax burden, the timing difference actually benefits the company, since the value of the phantom shares remains on the company balance sheet until the payout date.

In addition, coming up with cash to cover payouts can be tricky, because a phantom stock plan must be "unfunded" in order to remain an unqualified plan under ERISA (Employee Retirement Income Security Act) requirements. And while the problem is not insurmountable - there are ways to cover cash flow events outside of funding the plan - it can make executives nervous if bankruptcy looms, turning the phantom plan into a "promise to pay" that may never materialize. In essence, there will always be a risk of forfeiture.

Despite the bone-chilling details, a phantom stock plan makes good sense for private companies. Sure, you could simply defer your executives' earned bonuses until a long-term goal is achieved, but an offer of phantom stock may retain them longer, pay them better, and keep the company spirit alive in the executive suite.

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