Should directors ever sell?

• Author: Meyer, Pearl
• Position: Director Accountability

What if directors were required to hold for the duration...to not sell their shares during their board term? Would that be a progressive 'post-Enron' reform to enhance board oversight of management and strengthen the sense of shareholder representation? Nine experts in granting, receiving, and consulting on director stock awards weigh in with their answers.

Don't 'straight-jacket': Flexibility is a key issue

FEW SUPPORTERS of good corporate governance would question the benefits of sustained share ownership by board members. The 200 largest U.S. industrial and service companies (the "Top 200") currently deliver an average 62% of board pay in equity -- well over the minimum 50% goal set by the National Association of Corporate Directors. As board pensions have disappeared, stock has become the prime vehicle for delivering retirement funds, with more than one-third of the Top 200 deferring or restricting shares until retirement on a mandatory basis and other companies permitting elective deferral in shares.

However, imposing a blanket prohibition on the sale of stock by sitting directors in the wake of Enron would backfire as surely as have other "one-size-fits-all" attempts to regulate corporate pay. In truth, there is nothing inherently wrong or unseemly about an outside director selling stock in the company he or she oversees, in compliance with existing insider trading rules. There are far less drastic and more positive strategies to align the interests of board members with shareholders, without sacrificing members' financial flexibility.

Flexibility is a key issue as boards increasingly have recruited members with more varied backgrounds and expertise in recent years, including academics and other candidates who might not be as financially well endowed as those from corporate ranks. The goal of diversity in turn has helped prompt a trend toward the increased customization of board pay to accommodate members' individual circumstances. More than three-quarters of Top 200 boards now allow members to choose the form or timing of their compensation, sometimes with a financial incentive to exchange cash for some form of equity.

For less prosperous board candidates, particularly those who, prior to their service, held company stock on their own (and who therefore had demonstrated their interest in the company), a ban on selling shares during their term could well be a disincentive to join the board. At the same time, sitting directors might be less inclined to exchange cash compensation (which is immediately available) for illiquid stock, while those faced with a financial need or hardship could end up stepping down prematurely to free up their shares. Other unintended and likely reactions would be reversal of the continuing trend to pay directors principally in company stock or increasing current total board remuneration by adding extra cash to provide needed liquidity.

There is a better route to ensuring stock ownership and eliminating suspicion of inappropriate or opportunistic (although legal) selling or buying of company stock. In reality few, if any, non-affiliated directors of major corporations engage in such trading or, for that matter, hedging of their positions. What's really needed is the widespread adoption of meaningful share ownership guidelines with teeth.

Only a quarter of the Top 200 currently disclose any sort of current stock ownership guidelines, although prevalence may be far higher, since such disclosure is voluntary. Only a handful of these companies have penalties for noncompliance, such as restricting additional awards or paying further compensation in shares until the standard is met. In most cases, board members are required to own stock valued at a multiple of the annual retainer, which introduces an element of market volatility. Better alternatives would be expressing required ownership as a number of shares, or as a percentage of compensation delivered in equity, to avoid the problem of directors having to buy more shares when prices fall and encouraging sales when prices rise. Regardless of the ownership parameters used, board members in compliance with meaningful guidelines should be free to sell any excess shares, whether earned through service or purchased on their own.

Overall, straight-jacketing sitting directors by prohibiting any sale of shares simply adds to the risk that board members will end up putting "too much stock in stock." Ideally, directors should be mindful of share value -- but not at the expense of neglecting their core responsibility to oversee longterm corporate performance.

Pearl Meyer is president of Pearl Meyer & Partners, a leading consulting firm dedicated to executive and board compensation strategy and programs. She has been an adviser to top management and boards of directors on designing and implementing compensation plans for over 20 years.

Directors should hold for the long term

By Donald J. Gogel

THE PRIMARY MOTIVATION in the drive to increase equity ownership by directors is to ensure alignment of director and shareholder interests. With few exceptions, the sale of shares by directors undercuts that rationale and inevitably creates a perception -- and often a reality -- that directors and shareholder interests diverge.

By necessity, the private equity model of director equity ownership forces the alignment of directors and shareholder interests. Directors typically buy shares (and receive some or all of their compensation in shares) at the same time and at the same price as the private equity firm. Starting together, directors, management, and the private equity shareholder begin in the same place. They all are investing with an agreed-upon strategy and plan and with expectations that strong execution of that strategy and plan will create shareholder value. There is no public or private market for the sale of shares. All the parties look ahead to liquidity only when there is a common exit event -- an IPO or sale of the company.

Of course, a public company does not offer directors the same opportunity for perfect alignment. Other directors, management, and shareholders may have owned the stock for different periods of time and have different cost bases. However, these differences do not justify director sales of stock in an unfettered manner. Such sales create a number of problems since they:

* Create the perception that the sale is motivated by superior insight into the company's forecast. Even when the sale is made within the proper disclosure window after a public filing, there is a lurking sense that the director may have superior knowledge.

* Foster a short-term trading mentality in which interim results may move the stock price but may not be indicative of longer-term trends.

* Dilute the directors' economic interest in future stock performance since they now own less stock.

* Allow directors an unfair advantage over the managers, many of whom face greater restrictions on their ability to sell stock.

Of course, a blanket prohibition on director sales of stock solves these problems, but places a director at too much of a financial disadvantage, and, over time, could make it more difficult to attract and retain talented directors. More appropriately, directors should be able to sell stock in limited circumstances that alleviate concerns about alignment with shareholder interests. Such circumstances might include:

* A scheduled plan of sales in which a director discloses that he or she will sell a fixed percentage of shares at the end of each fiscal year for the next three years. (This would give before-the-fact specificity to the "personal financial planning" tag line that usually is announced after a director sale. It could also be linked to the end of a director's term of service.)

* The achievement of corporate goals like financial targets or successful integration of a major acquisition. Directors could disclose that they plan to sell a certain percentage of their holdings at the target date if the goals have been achieved. (This will help to ensure that a director will benefit from the long-term value at a merger, not from the...