The effect of director compensation on firm performance.
Corporate governance advocates have strongly encouraged firms to include equity as part of directors’ compensation to help align directors’ interests with that of corporate stockholders. In response, firms have drastically increased their use of stock-based compensation for directors [Pearl Meyer & Partners, 2004]. While the argument in favor of stock-based director compensation is intuitively appealing, there is very little evidence of the efficacy of stock-based director compensation. In an effort to determine the effectiveness of this policy, this study uses multivariate regression to examine the relation between director compensation and firm performance. In contrast to prior studies that use an indicator variable to denote the existence of a stock-based director compensation plan [Bhagat et al., 1999; Hempel and Fay, 1994; Fich and Shivdasani, 2004], this dissertation calculates the value of the compensation. Valuing the compensation provides a stronger test of the hypothesis of a relation between director compensation and firm performance, as the use of an indicator variable treats all stock-based compensation as equal (i.e., a plan which provides its directors with a substantial amount of stock is treated as equal to a plan that gives only a minimal amount of stock-based compensation). Additionally, this study examines stock and stock option compensation separately, as the two forms of compensation are likely to differ in their motivational effects. The results of this analysis suggest that there is a relation between stock-based director compensation and firm performance. However, probably due to risk, directors appear to be motivated differently by stock compensation versus stock option compensation. Generally, stock compensation is negatively related to firm performance. However, at higher levels stock compensation is positively related to firm performance suggesting that, if directors are given enough stock compensation, it has a positive effect on firm performance. Alternately, stock option compensation is positively related to firm performance. However, at higher levels this relation also reverses suggesting that directors can have too much stock option compensation. Finally, stock option compensation is more effective if directors are also shareholders.
Sinclair, D.T. (2004). The effect of director compensation on firm performance. (Doctoral dissertation). Temple University.
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