Tuesday, April 18, 2006

More on motivating directors and Coke's decision

In an earlier post, I had sifted through the studies that examined how directors must be paid. This was sparked by Coke's recent decision to pay directors only if the company performs well - variously called incentive based pay or pay for performance.

I recently came across a related study by Tod Perry at Indiana entitled "Incentive Compensation for Outside Directors and CEO Turnover". Dr. Perry concludes from his study that directors whose pay depends strongly on performance are more likely to fire CEOs following poor performance.
Checking to see if managers are fired when they deserve to be is a good way to measure the effectiveness of a board - far better than measures based on performance of a firm, for example, which may not be in the board's hands.

So this is more evidence that Coke is taking a step in the right direction.

Does the market think so?
I did not know this, but Gerety, Hoi and Robin (("Do Shareholders Benefit from the Adoption of Incentive Pay for Directors?") find that the market on average reacts negatively to announcements of incentive-pay plans for directors.

Attached is a graph of Coke's share price over the last 3 months, courtesy Yahoo! Finance. The announcement appeared in the WSJ on 04/06. There seems to have been a slight share price drop the day before, but no significant drop on 04/06.
Hmm. Perhaps the presence of Warren Buffett on the board reassured investors some!

Update: Graef Crystal, a Bloomberg news columnist, does not like Coke's new compensation plan either.

"It's one thing to give directors some free shares or even option shares, because what they ultimately earn is dependent on the judgment of thousands upon thousands of individual investors buying and selling company shares.

It's entirely another thing to pay directors based on goals they set themselves.
Coca-Cola needs to scrap its new plan, while other corporate boards need to stay away from this dumb idea. "

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