Board Directors Should Be Paid Only in Equity, if we pay directors solely in restricted equity, they’re more likely to do their job.
Even here in Malta this issue arises with relevant importance and validity , partly because the high number of foreign companies present in Malta, in order to be compliant with international standards for tax purposes (see the case of dummy company and tax inversion) , must have a board of directors with directors and NON EXECUTIVE DIRECTOR , residents in Malta, supporting and providing clear and convincing evidence that the foreign company is effectively managed from Malta.
Furthermore having a NED with international experience in the BOARD, reinforce widely the diversity, independence and compliance requirements for a better Corporate Governance, Leadership and Business results
30+ years Board, Governance, Investment’s experience and practice for YOUR BOARD needs and solutions
When a corporate scandal breaks – like the recent one at Wells Fargo or earlier ones at Lehman, Enron, or Qwest – the question is always raised: what was the board of directors doing while the managers in these companies were involved in such unprofessional behavior? The answer is that, like most of us, directors respond to incentives. And my research suggests that those incentives need to change.
Director compensation typically consists of a cash component (retainer), smaller cash amounts paid for attendance at board and committee meetings, and incentive compensation in the form of stock and stock option grants which vest over a period of a few years. During the past decade, the prevalence and importance of stock ownership guidelines has increased significantly for the S&P 500 companies.
But the gradual evolution of director compensation doesn’t go far enough. I propose that compensation of corporate directors should consist only of restricted equity. By “equity” I mean stock and stock options. By “restricted” I mean that the director cannot sell the shares or exercise the options for one to two years after their last board meeting. I believe corporate directors should not be paid any retainer fees or other cash compensation. Of course, this change wouldn’t prevent every scandal or solve every problem with corporate governance. But it would help channel director attention toward longer-term profitability.
My research supports such a change. In two recent studies, my co-authors and I looked at the relation between director stock ownership and company performance for the largest U.S. companies. In one study, we looked at the performance of the 1,500 largest public U.S. companies during the period 1998-2012. We measured performance using the company’s return on assets, adjusted for the company’s industry and size. And we controlled for the company’s leverage, R&D intensity, board size, and its transparency to analysts. In the second study study, we considered the S&P 500 companies during the years 2003-2007, using the same controls. In both studies we found that companies in which directors owned more stock performed better in future years. We also found that directors who own more stock are more likely to discipline or fire the CEO when the stock price performance of their company has been sub-par in the previous two years.
There are drawbacks to this proposal, but they can be mitigated. If directors are required to hold restricted shares and options, they would most likely be under-diversified, and would be concerned with lack of liquidity. The proposal could also lead to early director departures, as directors seek to convert illiquid shares and options into more liquid assets (after the one- to two-year waiting period). To address these concerns, I recommend that directors be allowed to liquidate 10-15% of their awarded incentive restricted shares and options each year.
If we want directors to further the long-term health of the companies they serve rather than falling asleep at the wheel while malfeasance spreads, we need to provide them with the right incentives. If we pay directors solely in restricted equity, they’re more likely to do their job.