Cash versus incentive compensation: Lawsuits and director pay

The role of the board of directors is to oversee managerial decisions and to protect the interests of shareholders. While director pay historically is a small cash fee, many corporations now use both stock and option grants as a part of a director's compensation. This paper examines whether this incentive pay aligns the interests of directors with those of the shareholders. We study the special case of shareholder lawsuits that specifically name the board of directors. These lawsuits indicate a breakdown in the trust and therefore the relationship between shareholders and directors. We find that when directors are paid with high incentive pay (designed to align their interests with shareholders) there is a greater incidence of lawsuits. Interestingly, greater cash compensation actually reduces the likelihood of a lawsuit.