will sit. independence reflects qualities of objectivity, experience, insight, and force of character. the need for directors to possess this blend of knowledge plus independence is critical, given the increased technical complexity of most business activities and the rapid pace of change in financial markets and practices. finding such outside directors can involve a tough balancing act. directors who are paid too little or who are kept at the perimeter of the corporate structure may be truly independent but have little incentive or insufficient knowledge about the organization to govern effectively. by contrast, directors who are paid well or who are fully integrated into the corporate structure may have the incentive and the knowledge to govern effectively but lack the desired independence to discipline incompetent or dishonest management. the risk is that as outside directors ’ compensation increases, their independence may wane and, instead of functioning as watchdogs for shareholders, they may increasingly function as lapdogs for management. getting the right balance of expertise and independence so that the board does not rubberstamp the decisions of top management is a major challenge. another challenge in selecting outside directors is how to balance general business knowledge with specific industry knowledge and technical expertise in areas such as accounting, finance, and labor markets. boards of directors clearly need individuals with a broad range of expertise. but as business problems evolve - and in large multinational corporations business inevitably changes - the range of expertise needed similarly evolves. developing a well - rounded, appropriately balanced board of directors is a tough assignment. it is especially so considering that the shareholders who elect the board are generally a diffuse group with little economic incentive or capability to monitor the corporation closely - until, of course, something goes terribly wrong. added to these challenges is the difficulty of finding qualified directors who have the time to devote to the affairs of the company and who are willing to face the risk of shareholder lawsuits. some qualified directors may be reluctant to serve for fear that the potential bad performance of the firm will damage their reputations. the irony is that directors who are most qualified may be the least willing to serve because of the opportunity costs of the time they must spend and the potential threat to their reputations. given what has transpired over this past year, there may in fact be a need to reconceive the role of directors. some firms reportedly are already moving away from the tradition of choosing the ceo of another company as a director to choosing people who are equipped with more specialized and technical knowledge. still open, however, are questions concerning how much

time directors should devote to their duties and what the appropriate remuneration should be. 2. executive compensation i have already publicly expressed my views on the trend toward excessive executive compensation. as i argued earlier this month, i can find nothing in economic theory to justify the levels of executive compensation that are widely prevalent today. i believe that corrective action - taken voluntarily - is not only overdue but also morally sound. this evening, i would like to focus on the effects of public policy on executive compensation. as you know, in 1993, the irs ruled that the maximum tax - deductible salary a company can pay an employee is $ 1 million per year. compensation above $ 1 million has to be “ performance - related ” to be considered a tax - deductible expense. this change in public policy gave firms that wanted to minimize taxes the incentive to introduce performance - related pay structures for executives earning above $ 1 million a year. the policy change is a key reason that stock options have become the most prevalent performance - related structure for executive compensation. option - based executive compensation raises a number of issues. for example, one feature of the 1993 irs ruling is that the $ 1 million salary cap for tax deductibility is nominal and not indexed. this means that as the average total compensation for executives rises over time, the incentive to use stock options increases. another issue stems from the fact that stock options are non - transferable. therefore, an increasingly large fraction of an executive's compensation in the form of stock options represents a non - diversified risk. moreover, if the firm goes bankrupt, the options become worthless at the same time that the executive ’ s job is lost. as a result, firms may have to increase the amount of options they offer an executive to offset the increased riskiness of this form of compensation. from my perspective, a more neutral tax policy toward executive compensation would reduce the reliance on stock options and not penalize firms if they opted instead to use other forms of contingentpay mechanisms. a reconsideration of stock options is already under way. clearly, there is room for changing the incentives that have been driven by tax policy. for me, what is key is that firms have the flexibility to structure new types of incentive compensation and that public policy be responsive to these initiatives. a deeper issue, in my view, relates to dividends. it is true that dividend payout ratios - dividends divided by earnings - have fallen over time