Board Members and CEOs: How Close Is Too Close?

Jake VanKersen: Imagine being able to hire the people that were responsible for putting your compensation package together. A company's board of directors is meant to represent the shareholder's interest, but when the CEO is often the one that hires them, can they really be objective?

Kristoffer Inton: Based on our research, we're skeptical that board members are as independent as they're supposed to be. CEOs tend to play a heavy role in the selection of the board, which can lead to them selecting the candidates most sympathetic to their cause. Disagreeing with that same CEO might mean you won't get invited to a board again.

VanKersen: And it's just not the CEO's compensation to consider here. Often board members are paid anywhere between $250,000 to $300,000 for what can amount to a few days of work a year.

Inton: That's a lot of money for just a few days of work, and it potentially becomes a large part of a person's annual earnings. With that kind of cushy arrangement, directors are incentivized not to be as independent--as potentially rocking the boat could threaten their seat.

In addition, board members often get equity as part of their compensation to have skin in the game. But directors don’t put up their own money. They basically are given house money, which can incentivize more risk-taking since it’s all upside to them.

VanKersen: All this is to say that we end up with a situation in which a CEO gets to hire their own bosses, and those bosses are paid by the company the CEO leads. It's possible that they aren't 100% independent. So, what could be done about it?

Inton: We think there's two things that companies could do.

First, we look at the board structure itself. The nominating and compensation committee needs to be completely independent and free of the CEO’s influence, especially when the CEO is also the chairperson. Additionally, board members should have equity in the company, but they should be obligated to purchase their stakes, not just get them for free, and at a level that matters to their wealth. This would tie their fates to those of the shareholders they represent.

Second, we think board members should have a thorough understanding of business and accounting and the time and interest to carry out their duties. It’s important to have capable and motivated board members overseeing management.

VanKersen: Putting some distance between CEOs and board member investors, as well aligning compensation with shareholder benefits, could be a way to go.