Head Compensation: The Process, The Product and the Reporting

Head Compensation: Understanding The Changing Rules
August 1, 2015
In Defense Of Head Compensation
August 1, 2015
Show all

Head Compensation: The Process, The Product and the Reporting

Long before the Intermediate Sanctions Act and the requirement of a “safe harbors” analysis to benchmark the compensation of school heads, Littleford & Associates recognized an important need and potential benefit to independent schools, their boards and their heads. This was the need for an annual review, facilitated by an outside independent expert, of the head’s compensation and benefit package. This should occur within the context of supportive discussions involving the head and a small board subcommittee. The purpose of the discussion was to allow the head to feel valued and treated fairly and for the board AT THE SAME TIME to have an opportunity to influence school outcomes through a constructive, mutually productive head evaluation process.

The purpose of such reviews, when this consultant initiated this effort in 1982, was to:

  1. Assist boards in paying a head competitively and appropriately, thus helping to ensure longevity of leadership;
  2. Track the replacement costs to find and hire a new head in various independent school markets;
  3. Assist boards in ensuring that a long serving valued head can retire with dignity and feel treated fairly;
  4. Construct a useful annual evaluation process- a process often either neglected or unintentionally done poorly, but one that every school and every head needs;
  5. Develop through confidential discussions of propriety information the most accurate database available to benchmark the marketplace for school heads;
  6. Assure all parties that the methodology of compensation made sense for the school as well as for the head and the head’s family. The “methodology” referred to the “b uckets” in which schools allocate money for head compensation such as housing, deferred compensation, auto, life insurance, club memberships, tuition assistance for children, purchase of permanent housing, etc.
  7. Explore creative ways to allocate the available resources for administrative compensation that fit the local needs and may, in most cases, save the school money.
  8. Track the behavior and “thinking” of boards in setting head compensation

More than 22 years later, Littleford and Associates has expanded and improved the accuracy of its database and remains in the forefront of identifying trends in head compensation.

In light of the apparent expected IRS spotlight on compensation for school heads, NAIS is preparing a news bulletin about the absolute necessity for schools to report annually and accurately their compensation to NAIS “STATS ONLINE”. Heads have not always done so in the past because they did not want their compensation information to be easily available for access and interpretation. Basic privacy and assurance of some discretion seemed to be the reasons why some heads did not complete the forms at all, and others disclosed information selectively to NAIS.

Appropriately, NAIS has called for the need for more vigilant, accurate reporting on the IRS Form 990 as well as heightened awareness of trends in head compensation and in the reporting of that data.

The 990 forms have, in fact, become increasingly accurate, and the IRS is indeed pressing for full disclosure of all forms of compensation. It is important, however, not to become overly reliant upon the 990’s for data and to maintain some perspective in viewing them: The forms as viewed on Guidestar.com are almost always at least two years out of date and for those who are experienced in researching them, it can be seen that schools use a wide variety of approaches in filling out the forms, and not just in reporting compensation. Certain forms of compensation, such as school owned housing, are consistently missing.

Attention to process must not be neglected in the desire and necessity to comply with the requirements of outside regulatory agencies. The need to engage in a meaningful and professional dialogue between a small board subcommittee and the head of school has become even more crucial given the challenges facing our schools and their leaders today.

    1. Goals of the Benchmarking Process

Boards NEED to do an annual assessment of a head’s compensation. However, the purpose should not be solely to ensure that the head is not overpaid in comparison to “safe harbors” norms or paid in a way that would not pass muster as a tool of compensation for a non profit (such as a “split dollar life insurance policy”). Boards should ALSO ensure that there is a PROCESS in place that ties compensation and evaluation together in a supportive, objective manner annually.

Many boards either forget to review their heads’ compensation and the contract rolls forward without a compensation change, or it comes to a “dead end” with the board seeming to be unaware of that fact or of the fact that the head feels very uneasy about having been “forgotten.” The PROCESS of an annual head compensation review is fully as important as the PROCESS of an annual goal centered evaluation. They should and can be tied together very productively.

A school can pay a head a very competitive salary and often tie elements of it, such as deferred compensation, to specific goals and outcomes. However, the ultimate package must be justifiable in total value compared to similar group of schools on a regional and often national basis as well. The package must also be tied in some way to similar practices of HOW other similar schools divide the compensation into its various component parts or “buckets”. The selection of the “peer” group of schools against which to be benchmarked must be thought through carefully.

This consultant, in volunteering to respond to questions from a state’s Attorney General’s office about the compensation decisions of a client was asked this question FIRST: how was the compensation decision related to the head’s written annual performance evaluation, and how that might compare to the evaluation of performance of other heads in similar schools? That question raised an intriguing set of assumptions by a state government agency, i.e., comparing one school head’s performance to another. It reminded this consultant of the US News & World Report desire to rank NAIS schools, a goal that NAIS opposed as prompting an inappropriate kind of comparison.

That Office, which has no relationship to the IRS or the Intermediate Sanctions Act, can, if pressured or prompted to do so, investigate the compensation of any CEO of any non profit under state law. This is within the purview of the Charitable Trust Division of a state’s Attorney General’s office.

Thus schools, when setting compensation, need to have an awareness not only of IRS expectations and guidelines but those of the charitable trust division of their own state as well.

    1. Benchmarking Data and Preparing Documentation

In order to assist its US and US based 501 (c) clients in satisfying the reporting requirements of the IRS, Littleford & Associates has been producing “safe harbor” letters for clients for 22 years. In addition, in the past two and one half years, our Firm has also been producing a “Rebuttable Presumption of Reasonableness Checklist” referred to recently by NAIS and suggested by a former IRS agent, Steve Miller.

This checklist is a more specific, narrower comparison of the head’s compensation to those in a similar marketplace. It further cites the time of decision, the parties involved in the decision; attests to their lack of a conflict of interest; and cites the outside source or sources utilized in making the decisions (in this case, Littleford & Associates).

Littleford & Associates has 22 years of data gathered from independent schools and other non profit educational organizations and agencies relating to the compensation of the CEO. While the data and its accuracy are increasingly important to all clients and potential clients, equally important is the PROCESS of understanding the data, comparing “apples to apples”, and for each “bucket”, understanding what is “normal” and what is not “normal” for compensating a head of school.

National, international and regional associations often organize their statistics on teacher or head compensation for convenience by region, school size, grade range, budget, endowment, boarding or day, single sex or coed. These are logical categories, but in the reality, there is some, but not an automatic correlation between these school characteristics and what a head of school is paid. Often a highly endowed school pays less than a less wealthy school.

Our Firm’s research and experience indicates that the most highly compensated heads tend to be those who are male; those who move every seven years; and those who are naturally more assertive. The other factor which significantly influences head compensation is the occupation of the board chair and of the compensation committee members.

Our work further suggests that those who are compensated less tend to be those who were promoted from within; those who were the founding heads and have stayed longer than ten years; and female heads except for a small highly paid group.

Increasingly, compensation is being tied more closely to performance, but historically, that has often not been the case.

    1. “Optics” and Transparency

As part of the exercise, it is also important to know the “optics” of any decision made, that is, what would this decision look like in the public eye, on the front page of the local paper, no matter how competitive and fair the ultimate compensation decision?

In California, for example, it is almost impossible to recruit a head without a head’s home or a significant loan package to help a head buy a home. Many California Universities have used the same tools to ensure that the booming costs of housing there do not make it impossible to hire and keep educators of talent. However, with more scrutiny on loans to executives flowing from the corporate realm to the non profit realm, how does this appear today from the point of view of the “optics”?

The school needs to stay competitive in the marketplace for school heads but at the same time, it must provide assurance to the parents, the board, and the media that it has exercised appropriate due diligence in setting head compensation and that of its four other highest compensated administrators. The school must have accurate documentation as proof of its compliance. It needs to know that it can rely on objective professional expertise to assist the school, if challenged. Littleford & Associates provides this consultation for the head of school position and for all other top administrative positions.

More and more of our clients now use our firm annually for a written benchmark and invite us back every two or three years for a formal onsite review with a compensation committee of the Board. In some cases, the compensation committee asks us to address the entire board on the topic of head compensation in general, the nature of the package, its placement in the marketplace, its ability to be defended or criticized and its competitiveness in attracting and retaining capable heads of school.

With all of the recent emphasis on “transparency”, and there is a need for it, it is important to note that if the head’s compensation package is disclosed to the entire Board, it should be done so most judiciously and accompanied by appropriate education on the subject. Despite our best efforts to train boards in the importance of respecting confidentiality, the behavior of boards on this matter varies widely.

  1. Conclusion

Littleford & Associates works only for boards not heads. Our firm believes that it is a conflict of interest to work for both parties on this topic. We facilitate a process to hold and conclude head compensation discussions that both parties will support. We neither recommend a package, nor any particular aspect of a package nor do we recommend how to fill out 990 forms. We do lay out the practices of similar schools in a clear fashion so that the compensation committee of the board will feel comfortable and informed in making an appropriate compensation decision.

Thus, the PROCESS is fully as important as the ultimate compensation outcome. In the midst of the discussion about potentially increased IRS scrutiny of head compensation and the personal liability of board members, all boards must pay attention to process and not just the mechanics of setting compensation and ensuring compliance.

John Littleford
Senior Partner