The E3+O Process: How to Set Fund Director Compensation - January 2007 Print E-mail
Written by C. Meyrick Payne and Jay Keeshan   

Mutual fund boards typically evaluate their compensation annually or bi-annually, often using the traditional method of comparing their compensation to that of a peer group of directors with similar governance responsibilities; that is, similar assets under management and number of funds governed. They will often try to set their pay at the 50th percentile—or perhaps higher, say 75%—of the peer group pay range. This approach potentially facilitates a “Lake Wobegone” upward spiral effect, in which all mutual fund directors are “above average” and pay levels continue to ratchet up on their own momentum.
Whether these increases are merited or not, this “outside-in” method of setting director pay may not truly reflect a fair value for the job. A more solid and rational technique would involve evaluating the various aspects and requirements of the job to determine what rate of pay would be appropriate to attract, motivate, and retain appropriate and competent directors. This requires more of an “inside out” approach. The E3 + O methodology described below examines the effort, expertise, exposure, as well as an additional element—opportunity cost—involved with serving as a mutual fund director.


The primary metric of effort is the number of hours spent, which can vary widely based on the size of the complex, number of funds, number of board members, and other factors. The number of board meetings held yearly is often used as a key number to work with, with a “preparation factor” of anywhere from one to three hours spent preparing for every one hour spent in meetings. Travel may also be a factor for some boards.
Once an estimate of time expended is determined, it makes sense to select a “base hourly rate” to use as a starting point. Given the background that is typically expected for a director position, it is not unreasonable to start with the same hourly rate paid to the board’s independent counsel or perhaps to the fund’s audit firm. The rate can vary given regional differences, but is often in the $400-$600 per hour range.
Assessing the level of expertise helps to adjust the base hourly rate. There should be an evaluation of “degree of difficulty”; that is, how difficult the job is relative to director positions at other mutual funds. Typically governance of money market funds is rated with a lower degree of difficulty than an international bond fund. Global equity funds often require more oversight and knowledge than domestic equity funds. Some boards oversee a basic lineup of funds that rarely changes, while others must continually approve and oversee new funds that utilize the latest innovative financial strategies, requiring the directors to continuously educate themselves to stay up to date.
Each board should determine their “complex complexity” to see how they stack up against other boards.
There are two types of exposure: legal and public perception. The first has existed ever since mutual funds were legally recognized in the 1940s. Trustees are, of course, accountable for a great many responsibilities that are prescribed by the Investment Company Act and accompanying case law. The SEC has interpreted these responsibilities broadly, and continually stresses reliance on the independent trustees as primary guardians of the investor’s interests. While most suits against directors are eventually dropped or dismissed, exposure to depositions and legal preparation is substantial.
Against this backdrop arises another kind of exposure—the rough justice of public opinion. With the growing importance of mutual funds to America’s retirement future, the press has paid much more attention to directors lately, with the result that their names may wind up in their local newspapers, which can potentially affect their business or personal lives.
Opportunity Cost
The final area of evaluation relates to opportunity cost. Independent trustees must remain independent, which may preclude them (and possibly their families) from serving on other boards or engaging in other business activities. Additionally there are numerous restrictions of what fund directors, and their immediate families, can invest in. As a final check on the base rate being applied to the effort expended, comparisons should be made to what the directors could (or do) earn outside their position as a fund director.
The E3+O method for determining trustee compensation, when used in conjunction with the more traditional approach of comparing against peer group data, presents a rational and readily defendable process. This could turn out to be crucial if the directors are ever hit with a lawsuit or, perhaps more likely, inquiries from the press or shareholders.

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