The Trouble With Stock Compensation

Paying outside board members with equity grants is becoming increasingly popular. Unfortunately, new research suggests that it leads to companies with less socially responsible behavior.

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Using equity to compensate outside board members has become a popular practice. The theory goes that if directors are paid with stock, they will have a stronger incentive to protect the interests of shareholders. But does investor advocacy for a compensation scheme that aligns the interests of the board with those of shareholders usurp the interests of other constituencies — such as the environment or society at large — that may not have an obvious connection to shareholder value creation?

This question comes amid recent public outcry over business actions that have had a negative impact on societal and environmental interests — such as BP’s oil spill in the Gulf of Mexico in 2010 or the 2008 financial crisis. Surprisingly, despite the growing prevalence of corporate social responsibility (CSR) in business over the past decade, the question of whether compensating the board with stock has any adverse impact on such responsibility remains largely unanswered.

Our research set out to investigate the relationship between outside director compensation and corporate social performance. We looked at both social performance ratings and director compensation data for more than 1,100 U.S. public companies between the years 1998 and 2006. (A full description of the study was published online in August by the Journal of Business Ethics in an article titled “Compensating Outside Directors With Stock: The Impact on Non-Primary Stakeholders.”)

Our analysis produced some intriguing results. While companies in our sample with high levels of outside director stock compensation in a given year exhibited higher financial performance in later years, they also showed lower levels of responsibility to communities as measured by their charitable giving, relations with indigenous peoples, community employment and economic development, and support for basic public services. A similar effect was evident with environmental performance, where companies with higher rates of outside director stock compensation later exhibited higher pollution levels, higher use of toxic and ozone-depleting chemicals, higher instances of environmental fines, lower use of recycled materials and alternative fuels, and higher revenues from products with environmentally destructive outcomes. Finally, companies with higher outside director stock compensation tended to perform less well on human rights measures in subsequent years and demonstrated greater involvement in “sin” industries — alcohol, tobacco, gambling, nuclear power and firearms.


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