TOPIC: COMPANY LAW

Topic: Company Law

Topic: Company Law

Introduction

Unlike CEO compensation, outside (non-employee) director compensation is designed for a group of individuals. Depending on the firm, outside directors may receive an annual retainer, meeting fees, committee fees and equity awards.3 Any differences that may exist in compensation across individual outside directors for a given firm in a given year typically result from serving on different committees, serving as chair of a committee, serving as lead director or differences in meeting attendance. Director compensation is not designed based on the unique characteristics that a particular director brings to the board.

Another important feature of director compensation is that equity compensation may be awarded either as fixed-value grants or fixed-number grants (e.g., [Hall, 1999] and [O'Byrne, 1995]). If the equity award is fixed-value, it is set at an explicit dollar amount (e.g., 50% of the annual $50,000 retainer is awarded as stock), then the specific dollar level of compensation is divided by share or option price to determine the number of shares or options granted in a given year.4 Fixed-number grants give the director the same number of options (or shares) each year. The firm's choice of fixed value versus fixed number is important, since the latter allows compensation to fluctuate with stock or option prices without any explicit action or change to the compensation contract.

Much of the existing empirical research on director compensation has focused on determinants of director compensation (e.g., Bryan et al., 2000; Brick et al., 2006), the relation between the firm's investment opportunities and director compensation (e.g., Linn and Park, 2005), firm responses to changes in the regulatory environment (e.g., [Ryan and Wiggins, 2004], [Linck et al., 2006] and [Becher et al., 2005]) and the market reaction to the adoption of equity based director incentive plans (e.g., [Vafeas, 1999], [Gerety et al., 2001] and [Fich and Shivdasani, 2005]). Despite the expanding literature regarding director compensation, few have focused on analyzing the design and structure of outside director compensation (notable exceptions include

The purpose of this paper is to document recent changes and trends in the design and structure of outside director compensation, and to analyze how firms adjust director compensation on an annual basis. We first identify the individual components of director compensation and document changes in these components through time. Our sample consists of compensation data for 237 Fortune 500 firms during the sample period 1998 to 2004. We find that total compensation rises nearly 45% over the seven-year sample period compared to roughly a 16% increase in the consumer price index. In addition, both the use and structure of equity compensation changes substantially over the sample period. Specifically, we document an increase in the relative use of fixed-value equity versus fixed-number equity awards.

Next, we examine changes in director compensation over time and assess whether firm behavior is consistent with firms targeting a market level of director compensation. The underlying premise of our analysis is that firms seek to maximize shareholder value, and optimal director compensation is one aspect of this ...