322 Part 3: Strategic Actions: Strategy Implementation
An increase in the board’s involvement with a firm’s strategic decision-making pro-
cesses creates the need for effective collaboration between board members and top-level
managers. Some argue that improving the processes used by boards to make decisions and
monitor managers and firm outcomes is important for board effectiveness.^81 Moreover,
because of the increased pressure from owners and the potential conflict among board
members, procedures are necessary to help boards function effectively while seeking to
discharge their responsibilities.
Increasingly, outside directors are being required to own significant equity stakes as
a prerequisite to holding a board seat. In fact, some research suggests that firms perform
better if outside directors have such a stake; the trend is toward higher pay for directors
with more stock ownership, but with fewer stock options.^82 However, other research sug-
gests that too much ownership can lead to lower independence for board members.^83
In addition, other research suggests that diverse boards help firms make more effective stra-
tegic decisions and perform better over time.^84 Although questions remain about whether
more independent and diverse boards enhance board effectiveness, the trends for greater
independence and increasing diversity among board members are likely to continue.10-3b Executive Compensation
The compensation of top-level managers, and especially of CEOs, generates a great deal
of interest and strongly held opinions. Some believe that top-management team members,
and certainly CEOs, have a great deal of responsibility for a firm’s performance and that
they should be rewarded accordingly.^85 Others conclude that these individuals (and again,
especially CEOs) are greatly overpaid and that their compensation is not as strongly
related to firm performance as should be the case.^86 One of the three internal governance
mechanisms attempts to deal with these issues. Specifically, executive compensation is
a governance mechanism that seeks to align the interests of managers and owners through
salaries, bonuses, and long-term incentives such as stock awards and options.^87
Long-term incentive plans (typically involving stock options and stock awards) are an
increasingly important part of compensation packages for top-level managers, especially
those leading U.S. firms. Theoretically, using long-term incentives facilitates the firm’s
efforts (through the board of directors’ pay-related decisions) to avoid potential agency
problems by linking managerial compensation to the wealth of common shareholders.^88
Effectively designed long-term incentive plans have the potential to prevent large-block
stockholders (e.g., institutional investors) from pressing for changes in the composition
of the board of directors and the top-management team because they assume that, when
exercised, the plans will ensure that top-level managers will act in shareholders’ best
interests. Additionally, shareholders typically assume that top-level managers’ pay and
the firm’s performance are more properly aligned when outsiders are the dominant block
of a board’s membership. Research results suggesting that fraudulent behavior can be
associated with stock option incentives, such as earnings manipulation,^89 demonstrate
the importance of the firm’s board of directors (as a governance mechanism) actively
monitoring the use of executive compensation as a governance mechanism.
Effectively using executive compensation as a governance mechanism is particularly
challenging for firms implementing international strategies. For example, the interests of
the owners of multinational corporations may be best served by less uniformity in the
firm’s foreign subsidiaries’ compensation plans.^90 Developing an array of unique com-
pensation plans requires additional monitoring, potentially increasing the firm’s agency
costs. Importantly, pay levels vary by regions of the world. For example, managerial pay
is highest in the U.S. and much lower in Asia. Historically, compensation for top-level
managers has been lower in India partly because many of the largest firms have strong
family ownership and control.^91 Also, acquiring firms and participating in joint venturesExecutive compensation
is a governance mechanism
that seeks to align the
interests of managers and
owners through salaries,
bonuses, and long-term
incentives such as stock
awards and options.