New demands, better boards: Rethinking director compensation in an era of heightened corporate governance

New York University Law Review

Volumn 82, Issue 4, 2007, Pages 1102-1138

  Brown, Katherine M ^a  

^a NONE

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EID: 35349006982     PISSN: 00287881     EISSN: None     Source Type: Journal    
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References (350)

1. Chad Terhune & Joann S. Lublin, Coke Directors Agree To Give Up Pay if Company Misses Earnings Goals, WALL ST. J., Apr. 6,2006, at Al;
2. see also Press Release, Coca-Cola Company, The Coca-Cola. Company Announces New Compensation Plan for Directors (Apr. 5,2006), available at http://www2.coca-cola.com/presscenter/nr_20060405_corporate_ new_compensation_plan.html (announcing new compensation plan);
3. Graef Crystal, Things Won't Go Better with Coke Board Pay Plan, BLOOMBERG.COM, Apr. 12, 2006, http://www. bloomberg.com/apps/news?pid= 10000039&sid=a9KgEIsOU9YQ&refer=columnist_crystal (discussing new plan).
4. Press Release, Coca-Cola Company, supra note 1;
5. Stephen Taub, Coke Ties Board Pay to Performance, CFO.COM, Apr. 5, 2006, http://www.cfo.com/article.cfm/6768563/c_677 1225?f-ThisWeekinFinance040706.
6. Press Release, Coca-Cola Company, supra note 1;
7. Taub, supra note 2. The value of the units can also change as Coca-Cola's stock price fluctuates.
8. Terhune & Lublin, supra note 1.
9. Press Release, Coca-Cola Company, supra note 1;
10. Taub, supra note 2.
11. Another unique feature of the plan is that all directors are paid the same amount, regardless of their role on the board. Press Release, Coca-Cola Company, supra note 1.
12. Press Release, Coca-Cola Company, supra note 1. The eight percent figure represents the "mid-point of the Company's long-term performance target."
13. Id. The baseline for the growth calculation is the 2005 figure for earnings per share, adjusted for items impacting comparability,
14. Id. The board can also choose to reset the financial target each year, although a company spokesman indicated that the earnings-per-share goal will likely remain.
15. Terhune & Lublin, supra note 1.
16. Press Release, Coca-Cola Company, supra note 1;
17. Taub, supra note 2.
18. James Robinson, the chairman of the company's Committee on Directors and Corporate Governance added: "Shareowners understand that they are only rewarded when the Company performs .... The . . . Board will hold itself to the same standard. As the Company performs well, Directors will be appropriately compensated."
19. Press Release, Coca-Cola Company, supra note 1.
20. Terhune & Lublin, supra note 1 (quoting Buffett as having "never seen a system as good as Coke has now").
21. See infra Part II.C.4 (discussing criticisms of "payment-for-performance" plans).
22. See infra Part I.B.I for a discussion of the impact of these reforms on the structure and function of corporate boards.
23. Cf. Assaf Hamdani & Reinier H. Kraakman, Rewarding Outside Directors 4-5 (Harvard Law Sch. Law & Econ. Research Paper Series, Discussion Paper No. 578, 2007), available at http://ssrn.com/abstract= 959210 (arguing that market, reward-based systems of director compensation are inferior to negligence-based liability regimes and advocating use of "reverse negligence regime" or "leadership regime" to compensate directors).
24. E.g., In re Walt Disney Co. Derivative Litig., 906 A.2d 27, 35 (Del. 2006).
25. See generally LUCIAN BEBCHUK & JESSE FRIED, PAY WITHOUT PERFORMANCE: THE UNFULFILLED PROMISE OF EXECUTIVE COMPENSATION (2004) (arguing that public outrage is main control on excessive executive pay);
26. Symposium, Management and Control of the Modern Business Corporation: Executive Compensation & Takeovers, 69 U. CHI. L. REV. 751 (2002);
27. Rik Kirkland, The Real CEO Pay Problem, FORTUNE, June 30, 2006, at 78.
28. Most analyses of director compensation have focused on its relationship to the corporation's value. E.g., Eliezer M. Fich & Anil Shivdasani, The Impact of Stock-Option Compensation for Outside Directors on Firm Value, 78 J. BUS. 2229 (2005). In addition, the literature in the field of executive-compensation consulting focuses primarily on the mechanics and amount of director compensation.
29. E.g., JAMES F. REDA ET AL., C OMPENSATION COMMITTEE HANDBOOK 77-88 (2d ed. 2005).
30. REDA ET AL., supra note 11, at 78. The full board almost always approves the compensation recommended by these committees.
31. Id. Director compensation is usually reviewed every two or three years.
32. Id.
33. The term "outside director" is defined as "one who is neither an officer nor an employee of the corporation." 18B AM. JUR. 2D Corporations §1173 (2004). Outside directors generally have no operational responsibilities within the company.
34. E.g., Rowen v. Le Mars Mut. Ins. Co. of Iowa, 282 N.W.2d 639, 652 (Iowa 1979). For purposes of this Note, the term "director" means "outside director."
35. Nikos Vafeas, Determinants of the Adoption of Director Incentive Plans, 14 J. ACCT., AUDITING & FIN. 453, 455 (1999).
36. An inflexible approach is not possible for all firms, given the numerous differences between firms of different sizes and those at different stages in the corporate life cycle. This Note focuses on large corporations-the top two hundred firms ranked by annual revenues.
37. See Linda Zong, Emerging Trends in Board Total Compensation, COMPENSATION & BENEFITS REV., Mar.-Apr. 2004, at 45, 45 ("A typical board compensation program has included multiple components in varying balances that are dependent on the company's culture and particular goals.").
38. See Scott C Linn & Daniel Park, Outside Director Compensation Policy and the Investment Opportunity Set, 11 J. CORP. FIN. 680,681 (2005) ("The board of directors has a duty to oversee managers and monitor and approve decision-making all with an eye towards enhancing the interests of shareholders.").
39. See Board Watch-Study Shows Variations in Director Pay and Policies, DIRECTORSHIP, Apr. 2006, at 3, 3 (citing study conducted by Pearl Meyer & Partners on board of directors' pay and policies). This is largely a function of changes in law brought about by the Sarbanes-Oxley Act of 2002 and related modifications made by selfregulatory organizations (such as the New York Stock Exchange) to the definition of a director's "independence. "
40. These changes are discussed in detail, infra Part LB.
41. Michael Barrier, The Compensation Balance, INTERNAL AUDITOR, June 2002, at 42, 45 (quoting Todd DeZoort, director of Ph.D. program in accounting at University of Alabama).
42. See id. at 47.
43. For example, board members should not be influenced by concerns for their own finances when setting corporate policy.
44. Renée B. Adams, What Do Boards Do? Evidence from Board Committee and Director Compensation Data 4 (Eur. Fin. Ass'n, 2005 Moscow Meetings Paper, 2003), available at http://ssrn.com/abstract=397401.
45. Stephen Bryan et al., Compensation of Outside Directors: An Empirical Analysis of Economic Determinants 1, 3 (Sept., 2000) (unpublished paper), available at http://ssrn. com/abstract=244540
46. (citing DEL. CODE ANN. tit. 8, § 141(a) (2002)).
47. Id. at 1 & n.1, 3 (noting that board is responsible for correcting "severe corporate malfunctions").
48. Alisha Hornsby & Peter Opperman, Mercer Human Res. Consulting, Director Compensation Trends, PERSPECTIVE, Aug. 23, 2005, http://www.mercerhr.com/referencecontent. jhtml?idContent=l 189965.
49. See infra Part I.B.I for a detailed discussion of the corporate governance environment that was ushered in with the passage of the Sarbanes-Oxley Act of 2002, Pub. L. No. 107-204, 116 Stat. 745 (codified in scattered sections of 11, 15, 18, and 29 U.S.C).
50. Ivan E. Brick et al., CEO Compensation, Director Compensation, and Firm Performance: Evidence of Cronyism?, 12 J. CORP. FIN. 403, 404 (2006).
51. Adams, supra note 22, at 4.
52. Jannice L. Koors, Director Pay: A Work in Progress, CORP. GOVERNANCE ADVISOR, Sept.-Oct. 2006, at 25, 25;
53. see also Brick et al., supra note 26, at 404 ("The general purpose of the board ... is to advise and monitor top management....").
54. See Koors, supra note 28, at 25 (noting obligations of management to provide board with "far more detailed information" than previously provided).
55. See, e.g., Brick et al., supra note 26, at 404 (describing purpose of board as protection of shareholder interests).
56. Barrier, supra note 19, at 44 (quoting Diane Posnak, managing director of executive-compensation consulting firm Pearl Meyer & Partners).
57. It is impossible, however, to define the "long term" with any precision. JOHN MAYNARD KEYNES, A TRACT ON MONETARY REFORM 80 (1923) ("[The] long run is a misleading guide to current affairs. In the long run we are all dead. Economists set themselves too easy, too useless a task if in tempestuous seasons they can only tell us that when the storm is long past the ocean is flat again.");
58. see also, e.g., Bill Gerrard, Beyond Rational Expectations: A Constructive Interpretation of Keynes's Analysis of Behaviour Under Uncertainty, 104 ECON. J. 327,332 (1994) ("Long term expectations are formed in a situation of 'uncertainty'... in which agents have a very limited knowledge base with regard to future outcomes.").
59. Barrier, supra note 19, at 44 ("The board's role is to critique, evaluate, monitor, and oversee management, and it has to do that from a long-term perspective, There's a lot of pressure from Wall Street on the short term side, but that's management's concern." (quoting Peter R. Gleason, Chief Operating Officer and Director of Research at the National Association of Corporate Directors)).
60. See Brent M. Longnecker, Director Compensation Trends, CORP. BOARD, Mar.-Apr. 2004, at 7, 8 (expressing concern for director compensation plans that may preclude those from government or nonprofit sectors from serving on corporate boards).
61. See Nicholas van der Walt & Coral Ingley, Board Dynamics and the Influence of Professional Background, Gender and Ethnic Diversity of Directors, 11 CORP. GOVERNANCE 218, 228 (2003) (noting that boards containing members who are "almost always cut from the same cloth... lack the diverse perspective needed to challenge the thinking of management"). Much of the same reasoning for boardroom diversity across race and gender lines also applies to arguments for diversity of leadership experiences.
62. E.g., Lisa M. Fairfax, The Bottom Line on Board Diversity: A Cost-Benefit Analysis of the Business Rationales for Diversity on Corporate Boards, 2005 WIS. L. REV. 795, 810-37 (surveying business rationales invoked to assert that diversity has positive impact on corporation's profitability).
63. See infra text accompanying notes 82-84.
64. For example, some equity-based compensation packages may impose significant tax burdens for directors of moderate means. See infra notes 161-63 and accompanying text.
65. Pub. L. No. 107-204, 116 Stat. 745 (codified in scattered sections of 11, 15, 18, and 29 U.S.C).
66. H.R. REP. NO. 108-63, pt. 1, at 11 (2003) ("[t]he Sarbanes-Oxley Act [was] enacted in 2002 in response to a series of large-scale corporate scandals at companies like Enron, WorldCom, Tyco, Global Crossing, Adelphia, and Rite Aid.").
67. NYSE Listed Company Manual § 303A.01 (2007);
68. NASDAQ Manual § 4350(c)(1) (2007). Controlled companies, limited partnerships, companies in bankruptcy, and some other types of entities are exempted from this requirement. NYSE Listed Company Manual § 303A.00.
69. NYSE Listed Company Manual § 303A.02(a). The NASDAQ definition of director independence requires that independent directors have no relationships that would "interfere with thefir] exercise of independent judgment in carrying out the[ir] responsibilities." NASDAQ Manual § 4200(a)(15);
70. see also James S. Linck et al, The Effects and Unintended Consequences of the Sarbanes-Oxley Act, and Its Era, on the Supply and Demand for Directors 5 (Feb. 14, 2007) (unpublished paper), available at http://ssrn.com/abstract= 902665 (summarizing the effects of SOX, the NYSE rules, and the NASDAQ rules on board structure).
71. See infra note 72 for a definition and discussion of interlocking directorates.
72. NYSE Listed Company Manual § 303A.02(b);
73. Linck et al., supra note 41, at 5.
74. NYSE Listed Company Manual § 303A.04(a), .05(a);
75. Linck et al., supra note 41, at 5.
76. NYSE Listed Company Manual § 303A.07(a)-(b);
77. Linck et al., supra note 41, at 5.
78. NYSE Listed Company Manual § 303A.07(a) cmt.;
79. Linck et al., supra note 41, at 5.
80. SEC Reg. S-K, Item 407(d)(5), 17 C.F.R. § 229.407(d)(5) (2007);
81. Linck et al., supra note 41, at 5.
82. NYSE Listed Company Manual § 303A.03.
83. Board Independence Will Cost Companies, INVESTOR REL. BUS., Feb. 24, 2003, at 4, 4 (citing survey by Hewitt Associates). The following fake want ad for a board member parodies some of the changes to the demands and nature of board service: Wanted: High-profile senior executive for extremely challenging part-time position. Proven track record as a risk-taker is essential, although position's objectives primarily involve risk management and risk avoidance. Must be willing to challenge senior management despite limited access to information. May face loss of reputation due to ridicule by media. High probability of being named in shareholder litigation at least once during tenure, with limited personal asset protection provided by the company. While service is part-time, must be on call for emergency meetings at any time. Cash compensation is about 50 percent of the per diem rate of full-time employment. Value of performance-based compensation is largely outside the candidate's control.
84. Carl R. Weinberg, What's Wrong with Director Pay-and How to Fix It, DIRECTORSHIP, Dec. 2004, at 10, 10.
85. Roles Central to Directors' Pay, FIN. EXECUTIVE, July-Aug. 2003, at 10, 10 (2003) ("The rewards and costs of directorship ... are in flux, driven by the ongoing upheaval in corporate governance. The demands and risks of board membership are rising, while nonfinancial rewards of directorship are declining."). The workload of directors has certainly increased. As a result, outside directors are precluded-whether formally by the company, or functionally by the amount of time board service now entails-from sitting on the boards of more than four public companies, with the typical number being two or three.
86. REDA ET AL., supra note 11, at 77-78;
87. Zong, supra note 16, at 49. The Institutional Shareholder Services (ISS) takes this one step further, recommending that voters withhold votes for "directors who are members of more than six public company boards or are CEOs of public companies and serve on more than two public boards other than their own."
88. Hornsby & Opperman, supra note 25.
89. REDA ET AL., supra note 11, at 77.
90. Id.
91. Id.
92. Pub. L. No. 107-204, § 404, 116 Stat. 745, 789 (codified at 15 U.S.C. § 7262);
93. Linck et al., supra note 41, at 8 n.8.
94. Pub. L. No. 107-204, § 404, 116 Stat. 745, 789 (codified at 15 U.S.C. § 7262);
95. SEC Reg. S-K, Item 407(d), 17 C.F.R. § 229.407(d) (2007);
96. Management's Reports on Internal Control Over Financial Reporting and Certification of Disclosure in Exchange Act Periodic Reports, Exchange Act Release Nos. 33-8238, 34-47986, 68 Fed. Reg. 36, 636 (June 18, 2003).
97. Koors, supra note 28, at 25 (describing atmosphere of increased pressure for majority voting, public criticism of boards, and changes in accounting and disclosure requirements):
98. cf. Zong, supra note 16, at 45 (remarking that "outside directors will be held to a higher degree of accountability than in the past").
99. 17 C.F.R. §§ 228.402, 229.402 (2006); Executive Compensation Disclosure, Exchange Act Release Nos. 33-8765, 34-55009, 71 Fed. Reg. 78, 338 (Dec. 29, 2006); Executive Compensation and Related Person Disclosure, Exchange Act Release Nos. 33-8732A, 3454302A, IC-27444A, 71 Fed. Reg. 53, 158 (Aug. 29, 2006).
100. Koors, supra note 28, at 30. The fact that director compensation must now be disclosed highlights that the SEC, the market, governance watchgroups, and shareholders are paying attention to this largely overlooked aspect of the corporate board.
101. E.g., Rebecca Smith & Jonathan Weil, Ex-Enron Directors Reach Settlement, WALL ST. J., Jan. 10, 2005, at C3 (remarking that ten former Enron directors agreed to pay $13 million personally toward $168 million settlement);
102. Jonathan Weil & Shawn Young, Tracking the Numbers/Outside Audit: WorldCom's Steep Price-Outside Directors' Failures Send Expensive Lessons on the Cost of Inattention, WALL ST. J., Jan. 7, 2005, at Cl (noting that ten outside directors of WorldCom agreed to pay $18 million of their own money to settle shareholder lawsuits).
103. Longnecker, supra note 34, at 11.
104. Director Pay on the Rise, DIRECTORSHIP, Mar. 2003, at 18, 18.
105. E.g., Adams, supra note 22, at 24. However, boards of larger firms and firms that face more uncertainty spend relatively less time monitoring, and growing firms spend relatively more time focused on business strategy.
106. Id.
107. See Brick et al., supra note 26, at 404 (hypothesizing that high director compensation is associated with culture that fails to produce constructive criticism).
108. Id. (defining "excessive" as exceeding compensation related to variables that proxy need for monitoring directors).
109. Id. at 404, 417, 419. The study found that a ten percent increase in director excess compensation corresponds to a one percent decrease in firm returns.
110. Id. at 419.
111. Id. at 404.
112. Id. ("The board may not effectively monitor executive performance because board culture inhibits constructive criticism . ..."),
113. Harley E. Ryan Jr. & Roy A. Wiggins III, Who Is in Whose Pocket? Director Compensation, Board Independence, and Barriers to Effective Monitoring, 73 J. FIN. ECON. 497, 523-24 (2004).
114. Zong, supra note 16, at 49 (citing study conducted by Hewitt Associates finding that ten to twelve percent of companies have separate roles for CEO and chairman positions);
115. see also Vafeas, supra note 14, at 457 (citing study showing that presence of outsiders on boards increases likelihood of replacing poorly performing CEOs).
116. Melvin A. Eisenberg, The Compensation of the Chief Executive Officer and Directors of Publicly Held Corporations, 39 CORP. GOVERNANCE INST. 103, 130 (1999).
117. Id. at 130-31.
118. Related to board independence from the CEO and management is the phenomenon of interlocking directorates-when the same individuals sit on the boards of different companies. See Matt Krantz, Web of Board Members Ties Together Corporate America, USA TODAY, NOV. 24,2002, at B1. Recent studies have found that these "cozy" board relationships limit effective monitoring by the board.
119. Stuart L. Gillan, Recent Developments in Corporate Governance: An Overview, 12 J. CORP. FIN. 381, 386 (2006)
120. (citing M.J. Conyon & M.R. Muldoon, The Small World Network Structure of Boards of Directors (Univ. of Pa., Working Paper, 2004)
121. and D.F. Larcker et al., Back Door Links between Executives and Executive Compensation (Univ. of Pa., Working Paper, 2005)). For instance, when CEOs serve as outside directors on other boards, they might endorse certain compensation packages that would be desirable to them as CEOs, rather than as board members.
122. See Dan R. Dalton & Catherine M. Daily, Directors and Shareholders as Equity Partners? Handle with Care!, 31 COMPENSATION & BENEFITS REV. 73, 77 (1999) (noting that "[t]he most common occupation of an outside director is that of CEO of another firm" and that CEOs are predisposed to favor stock option plans). Interlocking directorates also have the negative effect of reducing diversity both among and within corporate boards.
123. Ryan & Wiggins, supra note 68, at 500, 523 (finding that "shareholders' economic interests are best served when the board remains independent" and that "[t]o the degree that the board remains independent, director compensation provides incentives more closely aligned with those of the shareholders").
124. See Bryan et al., supra note 23, at 2-3. Agency costs are the "social and private costs of an agent's actions due to incomplete alignment of the agent's and owner's interests."
125. James S. Ang et al., Agency Costs and Ownership Structure, 55 J. FIN. 81, 81 (2000).
126. Eisenberg, supra note 70, at 131-32.
127. Barrier, supra note 19, at 47 (quoting Todd DeZoort, director of Ph.D. program in accounting at University of Alabama).
128. One survey of directors found that "compensation and major stock ownership ranked least among all the possible reasons for joining a board and that compensation ranked least among all the potential personal benefits derived from board membership." Jay W. Lorsch, The Fuss Over Director's Pay and Pensions-Is Stock Ownership Really the Answer?, DIRECTORSHIP, June 1996.
129. Claudia Zeitz Poster & Mark R. Ullman, Director Pay: What Makes Sense Today, DIRECTORS & BOARDS, 3d Quarter 2006, at 42, 44 (quoting one director as remarking, "At the end of the day I am driven by my sense of duty and responsibility to be genuinely helpful").
130. See id. (listing responses from directors that generally indicate understanding of seriousness of their role and desire to help management achieve its goals).
131. Lorsch, supra note 77.
132. Id. The director went on to state that he had been better able to handle many situations at his own company because of similar experiences he had encountered as an outside board member.
133. Id.
134. The educational benefit that board service confers on directors who serve as managers of other companies is not the same as the phenomenon of interlocking directorates, discussed supra note 72.
135. A recent survey of directors of over twenty companies in the Fortune 500 provided additional insights into the self-identified role of the board, as well as board members' motives for board service. See Poster & Ullman, supra note 78. The directors indicated that they take their position as mentors to management quite seriously, as their decision to join a board is based "at least as much on whether they believe they can add value [to management] as on their assessment of the risk and time demands."
136. Id. at 44.
137. See Fich & Shivdasani, supra note 11, at 2231-32 (discussing CEOs who serve as outside directors on other firms' boards).
138. Lorsch, supra note 77.
139. Poster & Ullman, supra note 78, at 44-45.
140. Shareholders, NACD Want Directors To Be Paid in Stock, INVESTOR REL. BUS., Apr. 3, 2000, at 8, 9 (quoting Roger Raber, President of National Association of Corporate Directors (NACD)). Raber continued: "Boards shy away from an individual who wants to join because ... the company pays quite well. Getting greedy about compensation is a definite red flag in the recruitment process. Companies that chase potential directors with money are making a mistake."
141. Id.
142. See infra Part II.C.2.a for a discussion of the psychological effects of compensation on board members, regardless of their level of personal wealth.
143. Poster & Ullman, supra note 78, at 44-45.
144. Id.
145. See infra text accompanying notes 161-63.
146. See infra Part II.C.2.a.
147. "Reputation capital" is the term given to signify that reputation is an intangible asset that can enhance an individual's or firm's profitability and marketability. CHARLES S. FOMBRUN, REPUTATION: REALIZING VALUE FROM THE CORPORATE IMAGE 81 (1996).
148. Cf. Fich & Shivdasani, supra note 11, at 2231-32 (discussing under-diversification of risk as cost of stock option plans, due to risks to reputation capital inherent in board service).
149. Linn & Park, supra note 17, at 682 (citing studies).
150. Vafeas, supra note 14, at 458 (citing studies).
151. Telephone interview with Frederic W. Cook, Founding Director, Frederic W. Cook & Co., in New York, N.Y. (May 14, 2007).
152. Id.
153. Cf. Barrier, supra note 19, at 45 (noting it is unlikely that particular compensation system will encourage directors to cheat).
154. Id. (citing Todd DeZoort, director of Ph.D. program in accounting at University of Alabama).
155. Id. (quoting Todd DeZoort, director of Ph.D. program in accounting at University of Alabama).
156. See Dalton & Daily, supra note 72, at 76 (noting that stock options awarded by boards to themselves pose "public relations problems").
157. See 17 C.F.R. §§ 228.10, 229.10 (2006);
158. Executive Compensation Disclosure, Exchange Act Release Nos. 33-8765, 34-55009,71 Fed. Reg. 78,338 (Dec. 22, 2006);
159. Executive Compensation and Related Person Disclosure, Exchange Act Release No. 33-8732A, 71 Fed. Reg. 53, 158 (Aug. 29, 2006);
160. Nikos Vafeas, Operating Performance Around the Adoption of Director Incentive Plans, 68 ECON. LETTERS 185, 190 (2000).
161. Longnecker, supra note 34, at 11.
162. Cf. Longnecker, supra note 34, at 8-9 (noting that both market and directors view equity ownership as impetus for active involvement by board members).
163. See generally CMA CANADA, MEASURING AND IMPROVING THE PERFORMANCE OF CORPORATE BOARDS 18-30 (2002), available at http://www.aicpa.org/ audcommctr/down load/ measuring%20and%20improving%20performance%20of%20corporate%20boards. pdf (listing factors used to assess corporate success).
164. See supra notes 1-6 and accompanying text.
165. Press Release, Coca-Cola Company, supra note 1;
166. Taub, supra note 2.
167. Press Release, Coca-Cola Company, supra note 1;
168. Taub, supra note 2.
169. press Release, Coca-Cola Company, supra note 1.
170. Terhune & Lublin, supra note 1.
171. Annual retainers are used almost universally as a form of compensation. Zong, supra note 16, at 49 (citing survey conducted by Hay Group). These retainers are usually paid in cash, equity, or some combination thereof.
172. REDA ET AL., supra note 11, at 78. In 2002, the median annual retainer paid by a Fortune 50 company was $50,000.
173. Zong, supra note 16, at 49-50.
174. Board members are paid (usually in cash) for attending board meetings as well as committee meetings, regardless of whether they attend in person or by telephone. REDA ET AL., supra note 11, at 79. If the telephone meeting is short and informal, sometimes the fees associated with the meeting will be ignored.
175. Id. In 2002, the median board meeting fee paid by Fortune 50 companies was $1200, and the median committee meeting fee was $1000.
176. Zong, supra note 16, at 49 (citing survey conducted by Hay Group).
177. As a result of their "increased time commitment and additional responsibility," board committee chairpersons are usually compensated for their services, either on a per meeting or (more commonly) a fixed retainer basis. Hornsby & Opperman, supra note 25. Chair retainers are generally about twenty percent of the value of the annual retainer, and they range between twenty and 150 percent more than committee retainers.
178. Zong, supra note 16, at 46 (citing study conducted by Pearl Meyer & Partners). An "evolving rule of thumb" is that the audit committee chair fee should be roughly three times the committee fee received by the regular audit committee member, and that the compensation committee chair fee should be double that of the committee fee received by the regular compensation committee member.
179. Id. (citing recommendation of Frederic W. Cook & Co.).
180. Historically, many companies also provided their directors with retirement plans. NAT'L ASS'N OF CORPORATE DIRS. BLUE RIBBON COMM'N, DIRECTOR COMPENSATION: PURPOSES, PRINCIPLES, AND BEST PRACTICES, at ix (2001). Director retirement plans are nearly obsolete today.
181. Shareholders, NACD Want Directors To Be Paid in Stock, supra note 85, at 8.
182. E.g., Koors, supra note 28, at 28;
183. Shareholders, NACD Want Directors To Be Paid in Stock, supra note 85, at 8.
184. In this section, trend analysis is based on a comparison of director compensation in 2004 with director compensation in 2005. See generally Koors, supra note 28 (compiling analyses of changes in director compensation from 2004 to 2005 and discussing longer term trends in director compensation).
185. In 2005, the average total director compensation for a firm in the top two hundred was approximately $195,000. Koors, supra note 28, at 26-27. Within the top two hundred firms, the total amount of director compensation varied between $36,250 and $931,337.
186. Board Watch-Study Shows Variations in Director Pay and Policies, supra note 18, at 3 (citing study by Pearl Meyer & Partners). The latter figure (belonging to UnitedHealth Group) was "something of an anomaly," as it was more than twice that of the next highest paying company and was the result of stock option awards.
187. Id. (citing study by Pearl Meyer & Partners). The company is now under formal investigation by the SEC for options backdating.
188. Robert Simison, SEC Investigates UnitedHealth over Stock-Options Practices, SUN-SENTINEL (Fort Lauderdale, FIa.), Dec. 27, 2006, at ID. The wide variation in total director compensation is entirely due to differences in the value of the equity granted to board members.
189. Board Watch-Study Shows Variations in Director Pay and Policies, supra note 18, at 3.
190. See Koors, supra note 28, at 25, 28.
191. This change may result from new accounting rules mandating options expensing, i.e., treating options as a corporate expense on the income statement, see REDA ET AL., supra note 11, at 80, and "longtime governance concerns that stock option awards tend to promote a focus on short term price growth,"
192. Koors, supra note 28, at 29. An additional (and more cynical) explanation for this trend stems from the fact that the recent dive in the market had a negative effect on directors' option holdings,
193. see Zong, supra note 16, at 47 (noting market slump's impact on option values), putting some of these options "out-of-the-money, " meaning that the strike price is greater than the current market price of the stock,
194. see Hannah Clark, Stock-Option Stashes Grow for CEOs, FORBES.COM, Feb. 28, 2007, http://www.forbes.com/corporategovernance/ 2007/02/27/ceo-stock-options-leadgovern-cx_hc_0228options.html.
195. Although not required by the SEC, nearly three-quarters of the top two hundred companies employ director stock ownership guidelines. Koors, supra note 28, at 31. Share ownership requirements are endorsed by a number of governance proponents, and therefore the newfound prevalence of such guidelines may be a response to the heightened governance environment.
196. See id. (noting support for share ownership programs by NACD and other corporate governance proponents and increase in public disclosure of existence of share ownership guidelines).
197. See supra Part LB.
198. See Linck et al., supra note 41, at 1 (analyzing supply and demand effects on director compensation);
199. Zong, supra note 16, at 50 (noting how high demand for outside directors will increase their compensation).
200. See Zong, supra note 16, at 50 (noting that "fewer CEOs will be available for directorships as companies seek to avoid exposing their top executives to the new time demands and potential risk of reputation derived from board service").
201. Eg., Gillan, supra note 72, at 385.
202. Barrier, supra note 19, at 45-47 (citing Todd DeZoort, director of Ph.D. program in accounting at University of Alabama).
203. But see id. at 47 (citing Charles M. Elson's position that cash payment creates alignment between directors and those paying out cash).
204. Because it is not dependent on the company's performance, cash compensation best enables director independence. However, excessive director compensation in any form (cash or otherwise) may indicate that a board is not performing as an effective corporate monitor on behalf of the shareholders. See supra notes 62-68 and accompanying text.
205. Sterling Baldwin & Leonard I. Wilson, Beyond Stock-Related Compensation for Directors, CORP. BOARD, Nov.-Dec. 1998, at 15.
206. See Board Games, ENTREPRENEUR, July 2006, at 66, 66 (remarking that "[t]he turbulent IPO market" has spurred potential directors "to require a portion of their compensation in cash instead of just equity").
207. NAT'L ASS'N OF CORPORATE DIRS. BLUE RIBBON COMM'N, supra note 113, at vii;
208. see also Barrier, supra note 19, at 44 (noting that most common form of payment for directors is both cash and stock).
209. Zong, supra note 16, at 47.
210. Restricted stock compensation plans normally provide for an annual grant of a prespecified number of shares, or an amount of shares equal to a pre-specified amount of money. Vafeas, supra note 14, at 455. Board members are prohibited from selling the shares so long as they remain on the board,
211. see Barrier, supra note 19, at 44 (quoting Charles M. Elson, Director of Center for Corporate Governance at University of Delaware), or until a specific restriction period lapses,
212. Vafeas, supra note 14, at 455. Directors receive dividends and can vote the stock during the restriction period.
213. Id.
214. Similar to restricted stock, deferred stock is delivered at the end of a board member's service on the board. See, e.g., Michael Rothfeld, Review of Decbions, NEWSDAY, Feb. 25, 2007, at A6 (noting that director would have access to deferred stock after tenure on board);
215. Client Alert, Frederic W. Cook & Co., Inc., Heads-Up on Deferred Compensation Guidance: IRS Guidance on Provisions of American Jobs Creation Act of 2004-StockSettled SARs of Public Companies Permissible;
216. Transition Rules Provided 2 (Dec. 22, 2004), available at http://www.fwcook.com/alert_letters/12-22-04%20Heads-Up%20on%20 Deferred%20Compensation%20Guidance.pdf (noting that grant of deferred stock gives recipient right to receive shares in future). The deferred stock units allow the director to participate fully in the growth (or decline) in the stock price throughout her tenure on the board.
217. Weinberg, supra note 49, at 11. Generally, the director can earn dividend equivalents (through the deferred stock units) that she may convert into additional deferred stock units.
218. Id.
219. See, e.g., David S. Hilzenwrath & Derek Willis, 2005 Compensation for Top-Earning Executives Grew with Stock Option Awards, WASH. POST, July 10, 2006, at D1 (discussing executive compensation using stock options).
220. Vafeas, supra note 14, at 455.
221. Id.
222. Barrier, supra note 19, at 44 (citing Charles M. Elson, director of Center for Corporate Governance at University of Delaware).
223. Hornsby & Opperman, supra note 25.
224. NAT'L ASS'N OF CORPORATE DIRS. BLUE RIBBON COMM'N, supra note 113, at ix.
225. Id. at x;
226. Zong, supra note 16, at 48;
227. see also Weinberg, supra note 49, at 11 (remarking that roughly one-fifth of major U.S. companies disclose ownership guidelines for outside directors, and that most common approach is to require directors to own shares equal to about five-times their annual board retainer within five years).
228. See Poster & Ullman, supra note 78, at 45 (noting that equity ownership "works to reinforce engagement" among directors).
229. See id. at 47 ("Stock provides [directors with a] psychological link between [their] efforts and the building of enduring shareholder value.").
230. Longnecker, supra note 34, at 8.
231. Id.
232. Id. at 9;
233. Lorsch, supra note 77.
234. E.g., Vafeas, supra note 14, at 454.
235. See, e.g., Dalton & Daily, supra note 72, at 75 (remarking that "equity holdings presumably would sharpen directors' interest in the value of their stock").
236. Vafeas, supra note 14, at 454 (asserting that director incentive plans are "ultimately intended to promote shareholder wealth maximization by reducing agency costs").
237. See, e.g., Dalton & Daily, supra note 72, at 75;
238. Shareholders, NACD Want Directors To Be Paid in Stock, supra note 85, at 8 (explaining how equity compensation aligns directors' and shareholders' interests);
239. Vafeas, supra note 14, at 455 (noting that "many firms are [using equity compensation] to guide directors towards developing shareholder-like interests").
240. Eisenberg, supra note 70, at 138
241. (quoting Charles M. Elson, The Duty of Care, Compensation, and Stock Ownership, 63 U. CIN. L. REV. 649 (1995)).
242. Longnecker, supra note 34, at 9.
243. Shareholders, NACD Want Directors To Be Paid in Stock, supra note 85, at 8.
244. Id. (quoting Ed Archer, Vice President of executive-compensation research firm Pearl Meyer & Partners);
245. see also Barrier, supra note 19, at 45 ("With straight stock, [directors] actually suffer a wealth diminution if the [share price] falls. If the value goes down, [directors] feel the pinch of the decline in value." (quoting Charles M. Elson, Director of Center for Corporate Governance at University of Delaware) (second alteration in original)).
246. Weinberg, supra note 49, at 11.
247. See supra note 32 and accompanying text for a discussion of the difficulty of defining the "long term."
248. See supra notes 56-59, 91-94 and accompanying text.
249. Joshua Ronen et al, The Effect of Directors' Equity Incentives on Earnings Management, 25 J. ACCT. & PUB. POL'Y 359, 380 (2006).
250. Id. at 362.
251. Id. at 362, 380. Earnings management distorts the information available to the market and decreases the firm's value (by shifting management's efforts away from other areas onto earnings management).
252. See id. at 380.
253. Barrier, supra note 19, at 45 (quoting Michael J. Halloran, partner in Mercer Human Resource Consulting).
254. Some experts argue that full-value stock provides no "motivation to ensure that there's a solid, long-term plan in place." Id. (quoting Michael J. Halloran).
255. Id.
256. Indeed, one study found that the adoption of an equity ownership plan for outside directors had no effect on a firm's operating performance (measured alternatively by return on assets, asset efficiency, and return on sales). Vafeas, supra note 101, at 187-88. However, the study noted that equity ownership plans may be adopted "offensively" rather than "defensively."
257. See id. at 189 (hypothesizing that adoption of incentive plans may "pre-empt performance problems").
258. Id. at 189-90. However, equity compensation may have its place. For instance, the value of equity ownership may change throughout the company's life cycle, which is why a one-size-fits-all approach to director compensation is not possible. As an example, the appeal of equity compensation to directors of start-up and high-growth companies is that it keeps fixed-cost expenditures low and provides significant upside potential.
259. Longnecker, supra note 34, at 9.
260. Barrier, supra note 19, at 44 (citing Barbara H. Franklin, former U.S. Secretary of Commerce).
261. See supra notes 34-35 and accompanying text for a discussion of the benefits of a diverse board.
262. Barrier, supra note 19, at 44 (quoting Barbara H. Franklin, former U.S. Secretary of Commerce).
263. Compensation in the form of equity is still "income" for tax purposes. Regardless of whether directors hold or sell any stock received as compensation, they must pay income tax on it upon receipt. See I.R.C. § 61(a) (2000) ("[G]ross income means all income from whatever source derived . . . ."); Treas. Reg. § 1.61-1(a) (1960) ("Gross income includes income realized in any form, whether in money, property, or services. Income may be realized ... in the form of services, meals, accomodations, stock, or other property, as well as in cash." (emphasis added)).
264. Longnecker, supra note 34, at 8-9. This also puts the director at odds with the typical diversified shareholder.
265. See infra notes 232-34 and accompanying text.
266. Barrier, supra note 19, at 45 (quoting Todd DeZoort, director of Ph.D. program in accounting at University of Alabama). For example, when the board decides to undertake a stock buyback, this can increase the price of the company's common stock, therefore enhancing the directors' wealth if they have an equity stake in the company. Because the board controls the timing of stock buybacks, they have the power to do so in a number of ways that could maximize their personal benefit, such as immediately after any restrictions on resale by directors lapse, or in order to put any stock options they possess "in the money" (i.e., the increase in share price will make it profitable for directors to exercise their options, given the strike price).
267. Dalton & Daily, supra note 72, at 76.
268. This would put the board on both sides of the transaction-and therefore may subject them to liability for breaching their duty of loyalty to the shareholders - if they stood to benefit in a way not shared by all of the corporation's shareholders. See Feldman v. Cutaia, No. 1656-N, 2006 Del. Ch. LEXIS 70, at *22-26 (Apr. 5, 2006) (denying motion to dismiss plaintiff's claim that directors who undertook stock repurchase plan which significantly benefited them personally breached duty of loyalty).
269. Baldwin & Wilson, supra note 126.
270. See supra note 33 and accompanying text.
271. E.g., Dalton & Daily, supra note 72, at 77.
272. Id. at 77-78. Restricted stock also threatens director independence and is criticized as creating a subtle conflict of interest. If a company requires that restricted stock be forfeited once the director is not renominated for board membership, there is a danger that directors may avoid taking actions that may displease management.
273. Longnecker, supra note 34, at 9.
274. Barrier, supra note 19, at 45.
275. Id. (quoting Dana R. Hermanson, Director of Research of Corporate Governance Center at Kennesaw State University). Some scholars argue that because one would never pay outside auditors in stock, audit committee members (at the very least) should not be paid in stock either. Id. (quoting Todd DeZoort, director of Ph.D. program in accounting at University of Alabama).
276. See Weinberg, supra note 49, at 11 (noting that British and European directors are expected "to serve the interests of all the company's stakeholder groups").
277. See generally John Armour, Simon Deakin & Suzanne J. Konzelmann, Shareholder Primacy and the Trajectory of UK Corporate Governance (ESRC Centre for Bus. Research, Univ. of Cambridge, Working Paper No. 266, June 2003), available at http://www.cbr.cam.ac.uk/pdf/WP 266.pdf (discussing stakeholder model as applied to British and Continental European companies).
278. See infra notes 211-13 and accompanying text (advocating more refined, mandatory equityholding requirements for corporate directors).
279. Barrier, supra note 19, at 44-45 (quoting Michael J. Halloran, partner in Mercer Human Resource Consulting). Options are also an attractive form of compensation currency, particularly for small companies facing higher levels of risk and lower availability of cash.
280. See Greater Use of Cash Compensation for Technology Directors Is Predicted, CORP. BOARD, Jan.-Feb. 2003, at 28, 29;
281. Shareholders, NACD Want Directors To Be Paid in Stock, supra note 85, at 8 (equating giving full-value grants to giving cash, which only large companies can afford).
282. One study found that this is particularly true when a firm has an abundance of investment opportunities and faces a high likelihood of takeover. Bryan et al., supra note 23, at 22-23. In these situations, stock options have a greater potential for payout compared to straight stock grants. Id. at 23.
283. Fich & Shivdasani, supra note 11, at 2230, 2233.
284. Id. at 2230.
285. Id.
286. Id. Market-to-book ratio measures how much a company is presently worth, as compared to the amount of capital invested into it by current and past shareholders. See id. at 2239 (calculating market-to-book ratio as "market value of the firm's equity at [year's end] plus the difference between the book value of the firm's assets and the book value of the firm's equity at [year's end], divided by the book value of the firm's assets at [year's end]").
287. Id. at 2230.
288. Id.
289. Id.
290. Id. at 2230, 2252.
291. Shareholders, NACD Want Directors To Be Paid in Stock, supra note 85, at 8.
292. Weinberg, supra note 49, at 11.
293. See Shareholders, NACD Want Directors To Be Paid in Stock, supra note 85, at 8 ("When directors receive a large number of options, their interests may mirror other options holders-namely management. This can develop a profile of a company that is too willing to take on risks that may not be justified." (quoting Ken Bertsch, then-current TIAA/CREF Director of Corporate Governance)). Option grants may "inadvertently encourage directors to support risky strategies in the hope of significant payoffs, instead of properly balancing upside opportunity with downside risk."
294. Weinberg, supra note 49, at 11.
295. Barrier, supra note 19, at 45 (quoting David Hoare, Executive Chairman of Virgin Express Holdings PLC).
296. Zong, supra note 16, at 47.
297. Baldwin & Wilson, supra note 126.
298. See supra Part I.C.2.
299. See Dalton & Daily, supra note 72, at 76 ("At the board of director level, the directors are setting their own performance goals. This could create the appearance of a conflict of interest." (quoting Ira Kay of Watson Wyatt Worldwide));
300. Stephen Taub, Coke Director Pay Plan Raises Eyebrows, COMPLIANCE WEEK, Apr. 18, 2006 ("If compensation is based on goals [that the board itself is] setting, you can ultimately say they are not disinterested. They can set the goals low." (quoting Pearl Meyer, executive-compensation consultant, Steven Hall & Partners)).
301. Poster & Ullman, supra note 78, at 46.
302. Taub, supra note 190.
303. Poster & Ullman, supra note 78, at 42.
304. Taub, supra note 190.
305. See REDA ET AL., supra note 11, at 81 (asserting that such type of compensation is avoided due to "inherent conflicts it engenders").
306. Id. (noting that payment-for-performance is appropriate for management, given that they "run the day-to-day business of the company and, therefore, have more direct effect on the attainment of particular financial performance measures"). In contrast, the view regarding director compensation is that "long-term stock price movements [should] be the primary performance measure." Id.;
307. see also Barrier, supra note 19, at 47 ("We all want the companies we work for to do well, but I don't think you can link my work to that performance so directly and then expect me to be tough when it comes to making decisions and saying what needs to be said." (quoting Todd DeZoort, director of Ph.D. program in accounting at University of Alabama)).
308. Barrier, supra note 19, at 47 (quoting Charles M. Elson, director of Center for Corporate Governance at University of Delaware).
309. Dalton & Daily, supra note 72, at 78. The fundamental problem with this type of payment-for-performance scheme is that what you measure is what you get; i.e., whenever a specific benchmark is used to measure "performance," directors will focus on achieving that particular benchmark.
310. E.g., Business Success: You Get What You Measure, http://www.kpmg.ca/en/services/enterprise/issuesResultsBusinessSuccess.html (last visited Feb. 18, 2007).
311. Taub, supra note 190.
312. Poster & Ullman, supra note 78, at 46.
313. Id.
314. See, e.g., Dalton & Daily, supra note 72, at 75 (citing results of three hundred empirical studies and concluding that linkage between executive pay and corporate financial performance is "relatively trivial, when it exists at all").
315. Heather Brewer, Snap Judgments, Bus. L. TODAY, July-Aug. 2006, at 10, 10 (discussing Coca-Cola's compensation plan).
316. See Taub, supra note 2 ("It's hard to be objective if you are continuously rewarded for blessing the recommendations of the management teams . . . . Directors are then put in the same shoes as management." (quoting David Swinford, Senior Managing Director of Pearl Meyer & Partners)). One set of commentators made the following remark on this point: "If we think stock options will buy management, then Coke's plan will buy directors."
317. Poster & Ullman, supra note 78, at 44.
318. Coca-Cola Co., Current Report (Form 8-K), at 3-4 (Apr. 5, 2006).
319. Poster & Ullman, supra note 78, at 47.
320. Id.
321. Longnecker, supra note 34, at 8.
322. Id. ;
323. see also supra notes 34-35 and accompanying text (discussing merits of board composed of members from both corporate and noncorporate sectors);
324. supra notes 161-62 and accompanying text (discussing tax obstacles to accepting stock as income).
325. See REDA ET AL., supra note 11, at 83 (noting that drawback of one-size-fits-all approach is that it "presumes that all directors provide equal service to the company, which in many circumstances is not the case").
326. See Vafeas, supra note 14, at 458 (noting benefits of equity ownership by directors, such as increased incentives to monitor management).
327. Longnecker, supra note 34, at 8 ("Offering directors a paycheck gives them some latitude in determining their own cash flow needs balanced against stock ownership requirements.").
328. See supra text accompanying notes 135-37 (discussing director equity-holding requirements).
329. See supra Part II.C2.a.
330. See supra Part II.C2.b.
331. See supra notes 135-37 and accompanying text.
332. Cf. Weinberg, supra note 49, at 11, 15 (discussing limitations of inflexible approach to director share-ownership requirements).
333. See supra notes 76-85 and accompanying text (discussing nonmonetary reasons for board service).
334. See supra notes 56-59 and accompanying text (noting changes in external incentives to monitor).
335. An analysis of the various tax issues presented by board member compensation is beyond the scope of this Note.
336. See supra text accompanying notes 138-39.
337. Poster & Ullman, supra note 78, at 44. One director summarized the role of equity ownership as follows: "Stock encourages engagement; even though it's not a lot of money, it is a medium that I think I can influence." Id. at 44.
338. Cf. Eisenberg, supra note 70, at 137-38 (describing pre-SOX need to align directors' thinking with shareholder interests).
339. See supra Part II.C.2.a-b for a discussion of the benefits and drawbacks of equity compensation.
340. See supra text accompanying notes 138-42.
341. See Longnecker, supra note 34, at 8.
342. Zong, supra note 16, at 48. When directors are all required to hold the same amount of the company's stock, those directors who rely on the income from board service (as opposed to independently wealthy directors) may face situations in which they feel compelled to resign in order to liquidate the wealth they hold in the form of the company's stock. Put differently, one-size-fits-all equityholding requirements impose a differential burden on directors of limited financial means.
343. RICHARD C. BREEDEN, RESTORING TRUST, REPORT TO THE HON. JED S. RAKOFF, THE UNITED STATES DISTRICT COURT FOR THE SOUTHERN DISTRICT OF NEW YORK, ON CORPORATE GOVERNANCE FOR THE FUTURE OF MCI, INC. 77-81 (2003).
344. Zong, supra note 16, at 52.
345. Id. at 52-53 (noting Breeden report's recommendations for MCI).
346. Dalton & Daily, supra note 72, at 77.
347. See, e.g., Christopher T. Pickens, Note, Of Bookies and Brokers: Are Sports Futures Gambling or Investing, and Does It Even Matter?, 14 GEO. MASON L. REV. 227, 244 (2006) (noting that investors diversify their portfolios in order to reduce variance on their investment returns).
348. See generally Edwin J. Elton & Martin J. Gruber, Modern Portfolio Theory, 1950 to Date, 21 J. BANKING & FIN. 1743 (1997).
349. See Gregory Scott Crespi, Maximizing the Wealth of Fictional Shareholders: Which Fiction Should Directors Embrace?, 32 J. CORP. L. 381, 426 (2006) (calling for rejection of "fictional undiversified shareholder");
350. Henry T.C. Hu & Jay Lawrence Westbrook, Abolition of the Corporate Duty to Creditors, 107 COLUM. L. REV. (forthcoming Oct. 2007) (manuscript at 32), available at http://papers.ssrn.com/sol3/ papers.cfm?abstract_id=977582 (noting that "modern financial theory tells us that, as a first approximation, management does not have to ascertain or consider the diverse risk and time preference of the company's shareholders").