The announcement of a new NACD webinar series on Skepticism for audit committee members raised the question to us of the application of “professional skepticism” in the compensation committee context. Some degree of skepticism is part of being an independent director and that includes compensation committee activities, but with different parameters than for an audit committee:
- An effective compensation committee needs to have a strong working relationship with management. In the normal operation of a compensation committee, skepticism would be a limited factor. For example, ensuring that the committee receives the information that it needs (rather than routinely challenging management proposals) could be characterized as appropriate professional skepticism.
- Outside auditors are required to apply professional skepticism in their audit activities. Compensation committees also should expect some degree of professional skepticism from their independent compensation consultants. That skepticism should be reflected, for example, in a consultant’s independent analysis of realizable compensation from an equity grant. However, the personal opinions of the compensation consultant should play a lesser role in their advice than do the professional opinions of outside auditors because there is no GAAP for compensation design.
- A compensation committee can rely on the professional advice of in house counsel and outside counsel for the company as to legal compliance questions without a requirement to be skeptical. However, an appropriate degree of skepticism may lead a compensation committee to seek independent counsel in extraordinary situations, such as in how to apply compensation committee discretion in a change in control situation.
Skepticism does play a role in the activities of a compensation committee, but it should be essentially the same degree of skepticism that independent board members apply to all of their activities.