Determinants of the Adoption of Director Incentive Plans

Abstract

This study investigates the determinants of the adoption of director incentive plans. The tests compare the financial and governance characteristics of 122 firms adopting director incentive plans between 1989 and 1995 to a sample of control firms matched on industry affiliation and sales. The multivariate test results suggest that the likelihood of plan adoption increases with the fraction of outside directors serving on the board and a certain form of director cash compensation. Three years after plan adoption there is a significant increase in the share and option holdings of the outside directors of adopting firms, a relative decline in their cash compensation, and a reduction in the adopting firm?s inside ownership and board size. In general, these results suggest the plans are adopted by firms that rely more on the board as a monitoring device and that related governance improvements bring the adopting firm?s director compensation structure closer to that of control firms.

JEL Classification: G34, J33