COMMENTARY : Paying Directors in Company Stock Doesn’t Boost Performance : Compensation: Stocks don’t move in relation to directors’ ownership of shares, study shows.

It never ceases to amaze me that so many people are such ardent believers in the motivational value of money.

Perhaps the most credulous of all are newspaper editors and reporters. They will dutifully report any evidence that suggests that Economic Man is alive and well in America--or, to put it more graphically, that any red-blooded American would gladly kill his mother for a quarter.

Ironically, these editors and reporters never observe that they themselves are among the most motivated of workers, hustling from one deadline to another, and yet are paid a pittance and generally are given no monetary incentives whatsoever. Go figure!

Recently, the New York Times opened its pages to an article by Robert B. Stobaugh, a professor at the Harvard Business School. For some time, Prof. Stobaugh has been extolling the virtues of company stock in motivating not only senior executives but also outside directors.

In his article, Stobaugh asserted that if outside directors own lots of company stock, they will mind the store better, with the result that the company’s performance will also be better. He cited approvingly the decision of Scott Paper to require all outside directors to take their compensation not in cash, but in shares of Scott Paper, and he also gave the nod to innovative outside director pay practices at such companies as Travelers, Hartford Steam Boiler, Ashland Oil, Hannaford Bros. and Johnson & Johnson.

“As with executives’ stock options, the theory behind these various approaches is the same: Significant equity ownership insures high motivation to safeguard company interests,” Stobaugh noted. His conclusion: “Directors, like executives, are usually highly qualified. So much the better if, like more and more executives, they are highly motivated too.”

Is he right? Will outside directors really change their behavior if they are paid in company shares and/or if they own lots of company shares already?

As a test of his theory, I rummaged through my files of company proxy statements dating back to 1987 and selected 30 major companies, 15 of which performed exceedingly well for their shareholders from mid-1987 to the end of 1994 and 15 of which performed exceedingly poorly. Except for the fact that a company selected for the study had to be a high performer or a low performer, the companies were picked at random. I figured that if I was going to find a relationship between outside director share ownership and company performance, that relationship would emerge in spades if I concentrated on the extremes of the shareholder return distribution.

*

On the high end of the performance spectrum was Coca-Cola. Had you invested $100 in Coca-Cola stock in 1987 and reinvested any dividends in more Coke stock, you would have been sitting on an investment worth $610.80 at the end of 1994. At the other extreme of performance was Digital Equipment: A $100 investment in DEC would have been worth only $31.70 seven years later.

(For further contrast, had you invested your $100 in the stocks forming the S&P; 500 index, your investment would have been worth $227.80.)

Having chosen the 30 companies and measured their shareholder return performance, I looked at the aggregate shareholdings of the outside directors of each company in 1987. Shareholdings were measured by their dollar value at the time and also by the percentage of outstanding shares owned by the outside directors.

By both measures, Procter & Gamble was on the low end. In total value of shares owned, Coca-Cola was on the high end; measured by percentage of shares outstanding, Campbell Soup was at the top.

So much for the raw statistics. Now for the crucial question: Is there any evidence to suggest that companies in which outside directors own lots of stock outperform companies in which outside directors own little stock?

The answer is an unequivocal “no.”

For proof, consult the chart that accompanies this article and see if you can discern any relationship between the shareholdings of the outside directors and the performance of the companies they oversaw.

Further tests showed that finding was no fluke. No matter what the time period chosen--whether 1987-93 or 1987-92 or even 1987-88--there was simply no significant statistical association between outside director shareholdings and subsequent company performance. Nor was there any association when the analyses were totally re-run, this time substituting the percentage of total shares owned by the outside directors for the dollar value of such shares.

*

On reflection, can we honestly believe that outside directors--who are selected at least partially for their integrity and who are, as a group, already independently wealthy and highly paid--will utterly change their behavior just because they are paid in shares instead of cash, or just because they are given a small stock-option grant?

Paradoxically, the lack of a relationship between outside director share ownership and company performance can be seen as reassuring. Because if the behavior of outside directors can be swayed by a few shares of company stock, might not those same outside directors conspire with the CEO, consciously or unconsciously, to gloss over current problems so as not to disturb the value of their now-larger shareholdings? And might not those same outside directors become so devoted to maximizing company profits that little or no attention is given to the company’s relationships with its employees, its suppliers and the communities in which it operates?

Moreover, what about female directors and minority directors? Not all outside directors are independently wealthy and highly paid; of those who are not, a large proportion are women or minorities. So if the company decides to pay outside directors in shares of stock that may not be convertible into cash for many years, will that same company experience difficulty in persuading talented women or minorities to join its board of directors?

At the end of the day, the bellwether decision of Scott Paper to require that its directors take all their pay in company shares probably won’t do much harm, but it almost assuredly won’t do much good, either.

So long as Prof. Stobaugh and others of his view continue to maintain that outside directors--and, indeed, almost everyone else in the business world--will gladly kill their mothers for a quarter, we will be prevented from exploring more significant wellsprings of motivation.

(BEGIN TEXT OF INFOBOX / INFOGRAPHIC)

Do Directors Respond to Stock Incentives?

Some experts contend that busineses perform better when corporate directors are paid in company stock. To test the hypothesis, Graef Crystal studied 15 companies that have performed very well over the last 7 1/2 years and 15 that have performed very poorly. He then ranked the firms on two measures: the dollar value of the stock owned by their outside directors and the percentage of the each company’s stock owned by those directors. By either measure, Crystal found there was no relationship between director stock ownership and corporate performance. High-performing firms are in boldface type; low-performing companies are in regular type.

Outside Company Directors’ Shares Value of $100 Invested As Percentage of Shares mid-1987, as of Outstanding Dec. 31, 1994 Campbell Soup 6.734% $387.50 Coca-Cola 4.624% $610.80 Dun & Bradstreet 3.045% $153.10 Walt Disney Co. 1.704% $332.10 Morrison-Knudson 1.303% $ 90.20 Delta Airlines 1.189% $116.00 Dow 0.798% $165.20 Digital Equipment 0.675% $ 31.70 Aetna 0.527% $163.60 Pepsico 0.243% $350.80 Borden 0.199% $ 55.80 Colgate-Palmolive 0.183% $343.10 Loews 0.132% $134.80 Bankamerica 0.103% $459.90 Occidental Petroleum 0.083% $114.90 Motorola 0.048% $524.10 IBM 0.022% $ 84.60 AMR 0.019% $123.50 Philip Morris 0.018% $335.20 Champion Int’l 0.017% $122.60 CSX 0.014% $312.60 Southwestern Bell 0.013% $310.20 Southern 0.010% $292.90 Westinghouse 0.009% $ 60.60 Goodyear 0.009% $129.60 Merrill Lynch 0.008% $368.00 Pfizer 0.004% $340.60 General Motors 0.004% $151.90 Johnson & Johnson 0.004% $333.90 Proctor & Gamble 0.001% $378.80

*

Company Value of Shares Held Value of $100 Invested by Outside Directors Mid-1987, as of (in millions of dollars) Dec. 31, 1994 Coca-Cola $657.5 $610.80 Dun & Bradstreet 220.5 $153.10 Walt Disney Co. 128.6 $332.10 Dow 123.7 $165.20 Campbell Soup 116.0 $387.50 Digital Equipment 89.7 $ 31.70 Delta Airlines 28.0 $116.60 Aetna 25.1 $163.60 Pepsico 22.0 $350.80 IBM 14.6 $ 84.60 Borden 8.0 $ 55.80 Loews 7.0 $134.80 Colgate-Palmolive 5.5 $343.10 Morrison-Knudson 5.0 $ 90.20 Occidental Petroleum 4.8 $114.90 Philip Morris 3.9 $335.20 Motorola 2.9 $524.10 Bankamerica 1.8 $459.90 Southwestern Bell 1.4 $310.20 General Motors 1.0 $151.90 Westinghouse 0.7 $ 60.60 Southern 0.7 $292.90 CSX 0.6 $312.60 Champion Int’l 0.5 $122.60 Johnson & Johnson 0.5 $333.90 AMR 0.5 $123.50 Pfizer 0.4 $340.60 Goodyear 0.3 $129.60 Merrill Lynch 0.2 $368.00 Proctor & Gamble 0.2 $378.80