Incentive Compensation for Outside Directors and CEO Turnover

Abstract

As monitors of management, independent outside directors play an important oversight and monitoring role in corporate governance. By providing directors with a financial stake in the performance of the firm through incentive-based compensation, firms can align the interests of directors and shareholders. In this paper, I examine whether the structure of director compensation affects CEO turnover, a specific corporate event where directors play a crucial role. I document a substantial increase in the use of incentive-based compensation for directors. I also find that incentive compensation for directors influences the level of monitoring by the board. When directors of independent boards receive incentive compensation, the like lihood of CEO turnover following poor performance increases. I also find that the likelihood of a firm adopting a stock-based incentive plan for directors is positively related to the fraction of independent directors on the board and institutional ownership of the firm, which is consistent with firms adopting option and stock plans for directors to provide financial incentives for directors to monitor management.