The director as employee of management.

• Author: Elson, Charles M.
• Position: Corporate director - Response to Hoffer Kaback, Directors & Boards, Winter 1996

Mr. Kaback's thesis that paying directors in stock may impede improved corporate governance, and, therefore, cash-based compensation is preferable, is fatally flawed in two major respects.

First of all, it ignores the primary reason for the call for a shift to stock-based compensation. The most significant problem facing corporate America today is the management-dominated, passive board of directors. A common occurrence in many of our largest corporations, passive boards are responsible for excessive executive compensation and, more importantly, poor corporate performance. The board, created to monitor management in order to ensure effective decisionmaking, has evolved into a body that, in its most extreme form, simply "rubber stamps" executive prerogative. Management, no longer checked, freely engages in conduct that is slothful, ill-directed, or self-dealing - all to the corporation's detriment.

Because of dispersed shareholding patterns in many of America's leading corporations, management appointees comprise most corporate boards. And, as largely nominees of management and subject to management approval in relation to retention, the interests of the directors have become more aligned with the group that selected and retained them than with the stockholders. This is the real origin of the board passivity vis-a-vis management oversight that we grapple with today.

Cash-based director pay only further compromises outside director independence from management, thus fueling this troublesome passivity. Cash compensation, along with board pensions and generous consulting arrangements, treat the outside director as an employee of management, rather than a fiduciary of the shareholders. The outside director's stake in the enterprise is not one reflecting the performance-based concerns of ownership, but instead reflects the interests of a highly salaried company employee. Outside directors, whose compensation is unrelated to corporate performance, have little personal incentive to challenge their management benefactors. Eager not to "bite the hand that feeds them," it is little wonder that boards become so passive and subject to management domination.

To incentivize the outside directors to view management not from the perspective of a loyal employee, fearful of discharge, but from the viewpoint of an owner concerned with overall profitability, they must become substantial shareholders. Stock-based compensation is the simplest and most effective...