The essay about agency theory and BoDs prompted us to look into BoD compensation. In the essay, we assert that BoDs basically compensate themselves, imposing a significant agency cost on the investors they represent.

We wonder about how BoDs actually accomplish this, what investors can do about it, and how changing BoD comp might address this agency problem and potentially increase company value. We’ve come down on the side of increasing shareholder authority over BoD comp, through a bylaw requiring a shareholder vote on director comp packages.

We investors might use this tactic in some instances, say where we need additional leverage over a stubborn BoD. However, similar to other good corp gov efforts, we have no evidence that it systematically increases shareholder value. We refrain from suggesting all companies adopt it routinely.

The Structure of BoD Comp

In general, CEOs and other company employees do not receive comp for their BoD service. One hopes their typically generous exec comp will suffice.

Companies do pay non-executive directors for their service. Directors usually receive cash, and frequently shares. Cash payments take all sorts of forms:

1. ❖stipend per meeting attended
   

2. ❖monthly or quarterly retainer
   

3. ❖payment for BoD and committee chair service.
   

Companies also grant equity (usually options and restricted shares) to directors. Shares usually vest over time. Otherwise, the number of shares, and the cash payment, rarely depends on company performance. Directors sometimes can choose to accept a number of shares instead of cash, and a few even do that.

As investors have long-known, BoD service is a good gig. One annual review annual review estimates that the average BoD comp for a director of an S&P 1500 company is almost $170,000.

Paying Themselves

Beyond the structure and size of these comp packages, the design process illustrates almost perfectly the agency problems of a BoD. The essay asserts that BoDs have their own identity, separate from that of investors, that draws them closer to the executives they oversee. BoD interests thus diverge from investors’. Investors must manage the BoD, and incur cost to monitor and incent it. BoD comp falls into the incentive side of agency cost to investors.

Directors have a specific interest in preserving their cash and equity comp, separate from investor interest in increasing company value. That BoD comp rarely varies with company performance reinforces that separation. And, directors typically own a much smaller stake than the CEO, and than the top outside shareholders.

Officially, the Comp Committee of a BoD designs and recommends BoD comp, and the full BoD approves it. We do not know of any US corporation that asks shareholders to approve annual BoD comp plans or amounts. Every few years, shareholders do vote on the broad share issuance plan pursuant to which a BoD grant itself stock.

Worse, executives can end up with a role in designing BoD comp. Some Comp Committees retain an external consultant for this purpose. Many Comp Committees rely on company executives for information and advice. In this way, executives help design the comp for the directors that hire and supervise them.

The BoD Comp Bylaw Amendment

This is madness. Under current practice, BoDs can pay themselves however much they wish, subject only to election challenges, and we know how those usually go.

Delaware law (of course) allows this:

1. Unless otherwise restricted by the certificate of incorporation or bylaws, the board of directors shall have the authority to fix the compensation of directors.
   

It seems we investors can indeed restrict this authority through company bylaws. We don’t know, exactly, how this might look. We think investors can require a vote on prospective compensation level, say as disclosed in the proxy materials for the annual meeting.

How about requiring approval from a majority of shares voting at the meeting? Without that approval, directors receive nothing. This does happens sometimes with equity comp plans. If shareholders don’t approve one, then the company can’t issue shares, and the executives (and directors, if included) go without.

Formally, in the language of agency theory, shareholder approval of BoD comp represents a form of monitoring by the principal (investors) of the agents (BoD). It’s direct, and relatively low-cost. It also elevates shareholder monitoring of the BoD over executive monitoring.

We like a bylaw amendment, too. We’re tired of shareholder resolutions that companies routinely ignore, or that they implement in ways that hardly reflect the intent and will of the shareholders.

A Tool, Not a Policy

In principle, every public company should do this. Of course, in principle every company should also implement strong majority voting for the BoD and a dozen other corp gov reforms. As we’ve noted elsewhere, we can’t find persuasive evidence that corp gov changes for their own sake add shareholder value. We advocate other, more critical corp gov reforms before we push hard for shareholder approval of BoD comp at every company.

It strikes us that at the right company, an activist investor  could use a BoD comp bylaw as part of a broader activist project. It could work well at a company where the BoD has especially high comp, or where the BoD is especially stubborn.  At a company that fails to win a majority for BoD comp, directors either serve without pay or resign. Either way, it hits directors right where it matters, and sends a strong message.

Who wants to try this?