As the recent spate of corporate scandals bring to light extravagant, and in some cases illegal, executive compensation plans, companies now must contend with increased investor scrutiny of the perquisites and benefits they offer their executives. In this interview, attorney Yale D. Tauber offers insight into negotiating and crafting appropriate compensation plans to recruit and retain the best executives in this new era, without stepping over the line into excessiveness.

BNA: What aspects of an executive compensation package should corporations reevaluate in light of the new corporate climate?

Tauber: Corporations should reevaluate their total rewards and remuneration program for senior executives periodically, not just in light of the new corporate climate but in light of changing economic conditions, business performance and strategy, and organizational design.

Competitive base salary and benefit levels based on an executive's responsibilities can usually be readily determined. Except in recruiting situations, other pay elements should generally not be fixed, guaranteed, or calibrated to match or exceed what is paid by other companies with different strategies and degrees of business success. To be fair to investors, companies should provide short-term and long-term pay opportunities that vary based on performance of the enterprise, business unit, or individual.

Companies should take the same balanced, sharing formula approach with equity awards, like stock options or whole share awards such as restricted stock. Chasing intended grant values up or down through various market inflections sets up management to gain regardless of whether investors gain or lose. That is not an equitable sharing of risks and rewards.

A company should determine how much of its invested capital investors should be willing to share with management by transferring an equity stake to them—expressed in shares or percentages of shares outstanding rather than dollar value. The company also should determine what performance contingencies investors will want to place on such transfers.

Tauber: Golden parachutes should replicate, not increase, the level of remuneration that had been paid to executives who lose their positions in a change-in-control situation. The level of remuneration to be protected should be based on recent performance and cover some future period of employment that the executive reasonably expected to be protected as a severance period in the event of termination.

Examples of increased remuneration would be providing an executive who has not received performance-based pay (due to poor performance) with performance-based pay as part of his or her severance, or providing three years of severance pay following a change-in-control for an executive who would have only one year's worth of severance in other circumstances.

''Overdosing'' on stock options occurs when numerous grants are made under various market conditions in an attempt to provide an intended grant value each year. That assures that management will gain no matter how shareholders make out. True equity awards should not provide win-win opportunities to management. They should provide management with an equity stake that will appreciate in value with long-term business success and lose value if that success is not achieved.

Tauber: Base salary and benefits need to be competitive for the level of responsibilities executives are expected to discharge. This means that those elements of compensation should be set at more or less a median level. The short-term and long-term award opportunities should be leveraged upon achievement of strategic and shareholder value-creating performance objectives. If performance objectives are not achieved, or if they are exceeded, that should make a significant difference in the rewards received by management.

The size of the award opportunities should be calibrated to the degree of difficulty in achieving the performance targets, the value to the company of achieving those targets, and the portion of that value that investors should be willing to share given the relative degrees of risk assumed by them (by investing their financial capital) and management (by investing their human capital).

If target performance objectives are set at a level that half of comparable companies achieve in any year, median level award opportunities would seem appropriate (assuming the performance measures correlate with shareholder value) with appropriate upside opportunities for exceeding target performance. If, on the other hand, only top quartile companies achieve the level of performance the company sets as its target, then 75th percentile level award opportunities would seem appropriate. The investment community should be willing to tolerate every company setting such goals and award opportunities because only 25 percent of their portfolio companies will actually achieve those goals and have to pay awards at that level.

Finally, management should have an equity stake that represents a fixed ''carried interest'' in the appreciation in value of the enterprise. The size of that stake will vary with the degree of risk inherent in the business.

Tauber: Just as audit committees, and especially the committee chairs, are now required to have a degree of expertise and to be more proactive in their processes, so should compensation committees. It is not enough to show up at meetings to listen to management and a consultant hired by management present detailed reports and approve their recommendations. The committee should have a predetermined ''template'' for a pay-for-performance approach that it uses to test the logic of management's proposals. I should note that committees at companies listed on the New York Stock Exchange will be required to have a written charter that addresses the committee's purpose, duties, and responsibilities and an annual performance evaluation.

Draft compensation reports should be circulated to the committee in sufficient time for them to study matters in detail, ask questions, and request additional information or analyses. And the committee should consist of truly independent directors and should either have or hire people with the expertise to delve into the details and understand the alternative courses of action and consequences for the company.

Tauber: Certainly director pension plans are dinosaurs that should be extinct. That's a given. So also should various other directors' benefits become things of the past. But the more current question is what role, if any, should stock options play in directors' pay? Should directors be paid in the form of a vehicle that has come under such recent criticism for focusing management too heavily on spikes in the stock price within specific time periods? Or, rather, should directors be paid retainers and fees exclusively in cash and shares of stock?

Tauber: The big financial issues in these situations are (1) sign-on bonuses and guarantees of initial years' bonuses regardless of performance, (2) severance arrangements—should things go awry—that go beyond protecting an executive's reasonable expectations for remuneration had things worked out better, and (3) deferred compensation arrangements that appear to be fair compensation for the company's use of the executive's otherwise current compensation but that, in fact, have significant economic cost to the company.

On the non-financial front, I'd say that particular care needs to be taken to spell out an executive's position, reporting lines, responsibilities, and authority; the company's expectations for performance or a process for determining and communicating that in advance of each performance period; and workable processes for internal and external dispute resolution.

Tauber: First of all, he or she should speak up, before the meeting if possible. If the compensation committee has a properly proactive process, committee members will have ample opportunities to review drafts in detail, ask questions, and request additional information or analyses. This will allow management to craft changes to accommodate committee concerns before positions get ''frozen'' at a formal meeting where proposals have been made. However, if this fails, each committee member should be free to state his or her opinion at an open discussion at the meeting. If this is not the case, members should consider resigning. Finally, each member should be free to vote as his or her judgment and conscience dictates.

Tauber: Congress currently is considering that matter. Even the authors of the law disagree on whether split-dollar life insurance and other arrangements come within the law's prohibition on public companies, directly or indirectly; extending credit; arranging for the extension of credit; or renewing an extension of credit to directors or executive officers in the form of a personal loan. This law contains a narrow exception for certain credit extended by financial institutions in their normal course of business, on terms no better than those made available to the general public. Also, existing loans may be maintained without modification or extension.

Tauber: Not too many. For a company listed on the New York Stock Exchange (assuming it is incorporated in a state that does not require shareholder approval with a broad enough charter), the committee could only make employment-inducement equity awards or adopt tax-qualified or excess-benefit plans or plans related to mergers or acquisitions without shareholder approval. Even for non-listed companies, however, the standard has now been set, and investors will expect the opportunity to approve or disapprove equity plans. Otherwise, with new disclosure requirements relating to equity plans, investors will be reminded in the proxy that they were deprived of this opportunity each time they are asked to vote on anything, including a board slate.