The compensation committee involves a group of people put together to decide on the remuneration especially for senior management. The committee is also responsible for determining alternate methods of compensation such as stock options, profit sharing, incentives and other fringe benefits. They also broadly oversee HR aspects such as attraction, motivation, development and retention with respect to compensation.
Although traditionally the board of directors have taken up this role, organizations are slowly evolving to accommodate a separate committee equipped with the right expertise. Due to corporate governance purposes it is advised to ensure that maximum number of members of the committee are independent. This means the majority of committee does not personally benefit from the compensation packages designed by them. Independency eliminates personal biases and scope for fraud while promoting objectivity and transparency.
An advantage of the compensation committee is that they design pay packages that are in line with the interests of the managers as well as the shareholders, hence eliminating the agency problem. Furthermore the committee has the ability to tailor the compensation structure to reflect the organization’s objectives. For instance, stock options could be offered in order to induce a sense of ownership in the employees.
However a disadvantage is that compensation committees are not always aware of the economic determinants of optimal remuneration designs. Hence they are required to hire external compensations consultants which results in an increase in overall cost.