Thursday, April 06, 2006

How do you motivate a director?

Warren Buffett and the other directors of Coca-Cola have agreed to skip their pay if the company does not meet certain financial targets!

Will it work?

Academics and experts are divided on whether director pay is a big motivator that might affect how they perform their fiduciary duties. Unlike managers and executives, whose pay is substantial and may affect the decisions they make, directors' pay is seen as largely token and not significant enough to affect how they perform their duties.

Shleifer and Vishny(1988) recommend compensating outside directors with stock, in order to align their incentives with those of shareholders.

In contrast, Stout (2003) believes that performance-based compensation for corporate directors is not only ineffective, but may actually interfere with other non-pecuniary motives of directors, with unintended adverse consequences for their performance. She mentions the size of the monetary amount paid to directors in support of her view: “If we look at financial rewards alone, whether paid in cash or in shares, directors seem to have little reason to break a sweat in the boardroom” (p.4).
However, recent work by Yermack (2003) disputes this view by providing evidence in a sample of Fortune 500 firms that the incentives outside directors face through compensation, reputation, and retention decisions are sizeable.
Adams and Ferreira look at director pay from the point of view of meeting attendance fees in their 2004 working paper. They find that as small an amount as $1200 (okay, maybe not small to you and me, but small to a director whose salary is in the six or seven figures) can motivate directors to attend meetings.

Who is right? Comments, anyone?

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