Structuring Board of Directors’ Compensation Contracts: An Optimal Incentives Perspective

Abstract

Boards of directors have been the subject of much research in various business disciplines. Boards are purported to serve as representatives of shareholders, oversee the implementation of the chosen strategy and provide useful external links and contacts to facilitate firm success. We know what we want boards to do, but how do we ensure they will do it? This leads to the issue of how best to compensate board members. This paper explores the relationship between board members’ compensation structure and subsequent firm performance. Based on a sample of 1721 directors and 158 firm year observations, compelling evidence suggests a moderate level of performance-based compensation for BOD members is associated with maximum firm performance.