How Do You Optimally Compensate Corporate Board Members?

1. How Do You Optimally Compensate Corporate Board Members?

2. Why might the CEO (and other senior managers) act in the best interest of shareholders? External Control Mechanisms • Capital markets. • Mergers, tender offers, proxy fights. • Large shareholders will monitor. • Institutional investors (shareholder proposals). • Managerial labor market. • Product markets: Bankruptcy (not very efficient). • Shareholder lawsuits.

3. Why might the CEO (and other senior managers) act in the best interest of shareholders? Internal Control Mechanisms • Self-interest: Managers also own shares. • Management compensation contracts. • Board of directors • Board members are elected by shareholders. • Is the Board nominating committee unduly influenced by the CEO? • Independent board members will monitor. Bhagat-Black (Journal of Corporation Law, 2002). • Self-interest of board members: Board members own shares.

4. Sample: 1724 publicly-listed U.S. companies during 1992-1996. Large firms: S&P 500 Annual sales (roughly) over $3 billion. Small firms: S&P Small-Cap 600 Annual sales (roughly) under $0.4 billion.

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6. Average Number of Shares Granted to A Corporate Director in U.S. During 1992-1996 All Firms Small Large 300 . 250 200 Number of Shares Granted 150 100 50 0 1 2 3 4 5 Year: 1=1992, 5=1996

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8. Dollar Value (*$1000) (Including Options) of Shares Owned by the Median Director in Small, Mid-Size, and Large US Companies in 1993 3500 . 3000 2500 2000 Median $1000 Mean 1500 1000 500 0 Small Mid-Size Large

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14. Table 4, Panel A Larger companies are more likely to compensate their directors with stock. Table 4, Panel B Smaller companies are more likely to compensate their directors with stock option. Companies with greater growth prospects are more likely to compensate their directors with stock option.

15. What is the impact of directors’ ownership of stock and stock-option in disciplining CEOs of poorly-performing U.S. companies?

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17. Table 8 Poorer performing companies are more likely to experience discipline-related CEO turnover.

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19. Table 9 Regression Result Poorer performing companies are more likely to experience discipline-related CEO turnover, especially as the median director’s ownership of (dollar value) stock and stock-option increases.

20. Takeaways • Larger companies are more likely to compensate their directors with stock. • Smaller companies are more likely to compensate their directors with stock option. • Companies with greater growth prospects are more likely to compensate their directors with stock option. • When board members own more stock and stock-option, they are more likely to discipline the CEO of a poorly-performing company.