Do Motivation and Equity Ownership Matter in Board of Directors' Evaluation of CEO Performance

The role of the board of directors has received much attention in the last several years due to the increasing salaries of Chief Executive Officers (CEO) and board scandals like the New York Stock Exchange (NYSE) debacle. Specifically the effectiveness of the board has been questioned as a useful governance device for shareholders. The public indignation about the questionable practices of CEOs has increased attention on the corporate boardroom, making the study of board member decision making a fruitful area for research. Perhaps by understanding the perception of board members of their job duties and their perceived significance to the firm, we can understand the resulting decisions. In this study, this issue is explored through the examination of the motivation of board members. How board members feel about their decisions and participation in boardroom discussions should give us some answers to why board members make the decisions they make. It should be pointed out, that at this time, no other study has attempted to address this issue which adds to the impact of this research. In addition, the type of compensation board members receive for their position is examined to determine whether decision making differs according to the type of compensation received by board members. This study examines the relationship between board of directors' motivation and pay in the evaluation of CEO performance. Specifically, board decision making is examined through the boards' evaluation of CEO performance. The decision as to whether boards use quantitative or qualitative criteria in the evaluation of CEO performance is related to board compensation and motivation. While an abundance of literature examines subordinate performance appraisals (Harris et al., 1995; Landy and Farr, 1980), few studies examine CEO performance appraisals (Young et al., 2000; Bushman et al., 1996). Young, Steham and Beekun (2000) researched factors relating to the board's adoption of a formal CEO evaluation process. The authors found that institutional pressure and the independence of the board affected whether or not boards adopted a formal evaluation process. Other researchers have investigated the utility of evaluating CEOs relative to the performance of CEOs in comparable industries (Antle and Smith, 1986; Gibbons and Murphy, 1990; Janakiraman et al., 1992). Janakiraman, Lambert and Larcker (1992) discussed the merits of organizations making a CEO compensation decision by comparing CEO performance relative to CEOs in comparable industries. Research more pertinent to this study has shown the use of non-financial or subjective criteria to be important in the determination of CEO bonuses (Bushman et al., 1996; Ittner et al., 1997). Bushman, Injejikian and Smith (1996) show that in the determination of CEO bonuses, the board's use of non-financial criteria is greater in firms where the CEO has held his/her position longer. These authors posit that CEOs with more power are able to influence the board to assess them by more subjective criteria that can be more prone to manipulation. Their argument is that subjective criteria can be manipulated by powerful CEOs, especially in situations in which they hold more influence over board members. Independent boards, not strongly influenced by the wishes of a CEO, would be expected to use objective, financial criteria in the evaluation of the CEO since these most closely align the CEO performance with firm performance. It should be pointed out that other research suggests that the use of financial measures can also be manipulated by top management (Cochran and Wood, 1984). While there is certainly evidence of this, the argument here is that qualitative criteria inherently poses more problems in that verification is difficult to assess. Thus, it is expected that board of directors would consider the use of quantitative criteria to better represent the firm's interests. The board of directors represent the interests of the owners and are stewards of the company's resources. …