Finance Essay

14391 Words Sep 14th, 2014 58 Pages

Journal of Financial Economics 73 (2004) 497–524

Who is in whose pocket? Director compensation, board independence, and barriers to effective monitoring$
Harley E. Ryan Jr.a,*, Roy A. Wiggins IIIb a Department of Finance, E. J. Ourso College of Business Administration, Louisiana State University, Baton Rouge, LA 70803, USA b Department of Finance, Bentley College, Waltham, MA 02452, USA Received 8 October 2003; accepted 18 November 2003 Available online 9 June 2004

Abstract We use a bargaining framework to examine empirically the relations between director compensation and board-of-director independence. Our evidence suggests that independent directors have a bargaining advantage over the CEO that results in
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The authors assume responsibility for any errors. *Corresponding author. Tel.: +1-225-578-6258; fax: +1-225-578-6366. E-mail address: (H.E. Ryan Jr.).

0304-405X/$ - see front matter r 2004 Elsevier B.V. All rights reserved. doi:10.1016/j.jfineco.2003.11.002

498 H.E. Ryan Jr., R.A. Wiggins III / Journal of Financial Economics 73 (2004) 497–524

1. Introduction The general consensus in both the popular press and the academic literature is that an independent board of directors results in more effective corporate governance. Researchers and practitioners suggest that inside board members, large boards, CEOs who also chair the board, and entrenched CEOs result in less independent and less effective boards of directors. Although such characteristics constitute barriers to effective governance, contracting theory suggests that they could be counteracted by the incentive compensation contracts that directors receive. In this paper, we examine the relations between the structure of outside-director compensation and board-of-director independence. We seek to shed light on the following question: Does the structure of director compensation mitigate or reinforce barriers to effective governance? The extant financial literature has typically examined compensation decisions from the perspective of a board of directors that wishes to establish an optimal contract in order to mitigate agency conflicts. Recent research, however, suggests

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