Director compensation and firm value: A research synthesis

Abstract

This article provides a synthesis of academic research on director compensation, the ultimate purpose being the identification of practices that are measurably linked with value creation. From a methodological perspective, mapping director compensation into firm performance is extremely difficult as there are many other aspects of governance and management that ultimately affect firm performance. The article focuses on specific components or aspects of director compensation. What is deemed to be the ‘Best’ practice in director compensation evolves over time. In parallel, the popularity of stock options as a compensation strategy for corporate directors has waned, with full-value equity unit grants (typically with vesting and ownership conditions) emerging as the preferred approach. Similarly, while earlier findings show stock option grants as a director compensation tool to be value enhancing, more recent findings revisit the issue and mostly support the use of full-value unit equity-based compensation. Overall, it appears that equity-based compensation for directors translates into value creation by enhancing directors’ monitoring focus. However, its effectiveness is conditional upon a firm's context, with greater improvements in performance being observed when firms start from a weak governance base. Moreover, there are several ethical dimensions, which must be addressed in the elaboration of any director compensation strategy. The article concludes with some additional observations and some recommendations useful to practitioners and that may guide academic research as well:

  1. 1

    Director compensation must be high enough to attract high-caliber individuals and to reward them for their responsibilities, but not so high as to potentially impair their objectivity, judgment and independence.

  2. 2

    Director compensation must be set in a transparent and objective way, with clear benchmarks that reflect the most plausible talent markets.

  3. 3

    A significant proportion of director compensation must be ‘locked in’ for the long term (5–10 years).

  4. 4

    Director compensation must not be based upon the attainment of short-term objectives or goals, but rather based on the long-term success of the organisation predominantly while not encouraging excessive risk taking.

This is a preview of subscription content, log in to check access.

Notes

  1. 1.

    The purpose of this article is not to review the role of boards of directors but rather to investigate the impact of their commonly accepted responsibilities on compensation strategies. For reviews on the role of boards of directors, refer to Keasey et al (2005); Leblanc and Gillies (2005); Solomon (2007); and Monks and Minow (2008).

  2. 2.

    There is also an alternative, or more comprehensive, view of directors’ role. More specifically, directors may also be perceived to be responsible toward the firm itself. In that regard, directors’ key responsibility is to manage tensions between stakeholders (clients, suppliers, employees, shareholders and debt holders) that may undermine the firm's future. In other words, the board is at the nexus of political or power bargaining between firm stakeholders (for example, Leighton and Thain, 1997). Such a stakeholder approach to board governance is also consistent with some legal precedents, such as the BCE case (see Tory and Cameron, 2009).

References

  1. Beatty, R.P. and Zajac, E.J. (1994) Managerial incentives, monitoring, and risk bearing: A study of executive compensation, ownership, and board structure in initial public offerings. Administrative Science Quarterly 39: 313–335.

    Article  Google Scholar 

  2. Bebchuk, L., Grinstein, Y. and Peyer, U. (2007) Lucky Directors. Harvard Law School, Discussion Paper 573.

  3. Becher, D.A., Campbell, T.L. and Frye, M. (2005) Incentive compensation for bank directors: The impact of deregulation. Journal of Business 78 (5): 1753–1777.

    Article  Google Scholar 

  4. Bhagat, S., Carey, D and Elson, C. (1999) Director ownership, corporate performance, and management turnover, The Business Lawyer 54 (May): 885–919.

  5. Boumosleh, A. (2007) Director Compensation and Board Effectiveness. University of Alabama. Working paper.

  6. Bryan, S.H. and Klein, A. (2004) Non-management Director Options, Board Characteristics, and Future Firm Investments and Performance. New York University Law and Economics Research Paper No. 04-009. Available at SSRN: http://ssrn.com/abstract=550506 or DOI: 10.2139/ssrn.550506.

  7. Canadian Coalition for Good Governance. (1995) Corporate Governance Guidelines for Building High Performance Boards. Toronto, Canada: Canadian Coalition for Good Governance.

  8. Canadian Coalition for Good Governance. (2005) Corporate Governance Guidelines for Building High Performance Boards. Toronto, Canada: Canadian Coalition for Good Governance.

  9. Certo, S.T., Dalton, C.M., Dalton, D.R. and Lester, R.H. (2007) Boards of directors’ self interest: Expanding for pay in corporate acquisitions? Journal of Business Ethics 77: 219–230.

    Article  Google Scholar 

  10. Denis, D.K. (2001) Twenty five years of corporate governance research …and counting. Review of Financial Studies 10 (3): 191–212.

    Google Scholar 

  11. DeFond, M. and Hung, M. (2004) Investor protection and corporate governance: Evidence from worldwide CEO turnover. Journal of Accounting Research 42: 269–312.

    Article  Google Scholar 

  12. Elson, C. (1996) Director compensation and the management captured board: The history of a symptom and a cure. Southern Methodist University Law Review 50: 135–173.

    Google Scholar 

  13. Ertugrul, M. and Hegde, S. (2007) Board Compensation Practices and Agency Costs of Debt. University of Toledo, Working paper.

  14. Feltham, G. and Wu, M.G.H. (2001) Incentive efficiency of stock versus options. Review of Accounting Studies 6: 7–28.

    Article  Google Scholar 

  15. Fich, E. and Shivdasani, A. (2005) The impact of stock option compensation for outside directors on firm value. Journal of Business 78: 2229–2254.

    Article  Google Scholar 

  16. Frederick, W. and Cook & Co (2008) The 2008 Director Compensation Survey: NASDAC 100 vs. NYSE 100. Cook & Co: New York.

    Google Scholar 

  17. Gerety, M., Hoi, C.-K. and Robin, A. (2001) Do shareholders benefit from the adoption of incentive pay to directors? Financial Management 30: 45–61.

    Article  Google Scholar 

  18. Hambrick, D. and Jackson, E. (2000) Outside directors with a stake: The linchpin in improving governance. California Management Review 42: 108–127.

    Article  Google Scholar 

  19. Hillman, A. and Dalziel, T. (2003) Boards of directors and firm performance: Integrating agency and resource dependence perspectives. The Academy of Management Review 28: 383–396.

    Google Scholar 

  20. Institute of Corporate Directors and Towers Perrin. (2007) Changing Roles and compensation for canadian directors: 2007 directors. Compensation Proxy Report.

  21. Keasey, K., Thompson, S. and Wright, M. (2005) Corporate Governance: Accountability, Enterprise and International Comparisons. Chichester, West Sussex, England: John Wiley & Sons.

    Google Scholar 

  22. Khalil, S., Magnan, M. and André, P. (2008) The adoption of deferred share unit plans for outside directors and shareholder wealth. Corporate Governance: An International Review 16 (3): 210–224.

    Article  Google Scholar 

  23. Leblanc, R. (2004) Preventing future Hollingers. Ivey Business Journal Online 69: B1.

    Google Scholar 

  24. Leblanc, R. and Gillies, J. (2005) Inside the Boardroom: How Boards Really Work and the Coming Revolution in Corporate Governance. Mississauga, Ontario, Canada: John Wiley & Sons.

    Google Scholar 

  25. Leighton, D.S.R. and Thain, D.H. (1997) Making Boards Work. McGraw-Hill Ryerson.

    Google Scholar 

  26. Lublin, J.S. and Bulkeley, W.M. (2006) IBM ends director stock options as payment in favor of retainers. The Wall Street Journal 192: A1.

    Google Scholar 

  27. McClain, G.M. (2007) CEO bargaining, outside director remuneration and board of director monitoring. PhD Thesis, University of Arkansas.

  28. Monks, R.A.G. and Minow, N. (2008) Corporate Governance, 4th edn. Chichester, West Sussex, England: John Wiley & Sons.

    Google Scholar 

  29. Morck, R., Shleifer, A. and Vishny, R. (1989) Alternative mechanisms for corporate control. The American Economic Review 79: 842–852.

    Google Scholar 

  30. Perry, T. and Shivdasani, A. (2005) Do boards affect performance? Evidence from corporate restructuring. Journal of Business 78 (4): 1403–1432.

    Article  Google Scholar 

  31. Ryan, H. and Wiggins, R. (2004) Who is in whose pocket? Director compensation, board independence, and barriers to effective monitoring. Journal of Financial Economics 73: 497–524.

    Article  Google Scholar 

  32. Shivdasani, A. (1993) Board composition, ownership structure and hostile takeovers. Journal of Accounting and Economics 16 (1–3): 176–198.

    Google Scholar 

  33. Sivaramakrishnan, S. and Kumar, P. (2002) Optimal incentive structures for the board of directors: A hierarchial agency framework (11 October). Available at SSRN: http://ssrn.com/abstract=339180 or DOI: 10.2139/ssrn.339180.

  34. Solomon, J. (2007) Corporate Gove rnance and Accountability, 2nd edn. Chichester, West Sussex, England: John Wiley & Sons.

    Google Scholar 

  35. Speller, A.C. (2001) Essays on outside director compensation. PhD Thesis, State University of New York Binghamton.

  36. St-Onge, S., Magnan, M., Raymond, S. and Thorne, L. (1996) L'efficacité des régimes d’option d’achat d’action: Qu’en sait-on? Gestion, revue internationale de gestion 21 (2): 20–31.

    Google Scholar 

  37. Tory, J.C. and Cameron, J. (2009) Directors’ duties after BCE: Supreme court of Canada decides. Corporate Governance Report 4 (1): 1–4, http://www.torys.com/Publications.

    Google Scholar 

Download references

Acknowledgements

We thank the Institute for the Governance of Public and Private Organizations (HEC-Concordia) for its financial support.

Author information

Affiliations

Authors

Corresponding author

Correspondence to M Magnan.

Rights and permissions

Reprints and Permissions

About this article

Cite this article

Magnan, M., St-Onge, S. & Gélinas, P. Director compensation and firm value: A research synthesis. Int J Discl Gov 7, 28–41 (2010). https://doi.org/10.1057/jdg.2009.13

Download citation

Keywords

  • board of directors’ compensation
  • governance
  • literature review
  • incentive plans
  • stock options