Correspondence: M Magnan, Professor and Lawrence Bloomberg Chair in Accountancy, John Molson School of Business, Concordia University, 1455, de Maisonneuve West, Montreal, Quebec, CANADA H3G 1M8, Canada. E-mail: mmagnan@jmsb.concordia.ca

¹is the Lawrence Bloomberg Chair at the John Molson School of Business (Concordia University). He holds a PhD in business administration from the University of Washington and is Fellow Chartered Accountant. His areas of expertise encompass financial statement analysis, governance, environmental disclosure, executive compensation and professional ethics. He has coauthored more than 80 papers on these issues, which have been published in academic and professional journals. He is currently the Editor-in-Chief of Contemporary Accounting Research. He serves on several not-for-profit boards and is actively involved in the activities of the Canadian Institute of Chartered Accountants.

²is a Professor at HEC Montréal. She holds a PhD in Organizational Behaviour and Industrial Relations from the Schulich School of Business (York University). Her areas of expertise encompass compensation and performance management, governance and work–family balance practices. She is a coauthor of three books in Human Resources Management, Compensation Management and Supervision. She is also a coeditor of two recent handbooks on performance management. She currently serves as the editor and director of Gestion, a referred professional journal.

³is an Associate Professor of accounting at the School of Administrative Studies at York University. He holds a PhD in accounting from HEC Montréal. His research and professional interests include executive and board compensation, the value of job security, corporate governance, disclosure regulation and business history.

Received 10 August 2009; Revised 10 August 2009; Published online 10 September 2009.

Abstract

This article provides a synthesis of academic research on director compensation, the ultimate purpose being the identification of practices that are measurably linked with value creation. From a methodological perspective, mapping director compensation into firm performance is extremely difficult as there are many other aspects of governance and management that ultimately affect firm performance. The article focuses on specific components or aspects of director compensation. What is deemed to be the 'Best' practice in director compensation evolves over time. In parallel, the popularity of stock options as a compensation strategy for corporate directors has waned, with full-value equity unit grants (typically with vesting and ownership conditions) emerging as the preferred approach. Similarly, while earlier findings show stock option grants as a director compensation tool to be value enhancing, more recent findings revisit the issue and mostly support the use of full-value unit equity-based compensation. Overall, it appears that equity-based compensation for directors translates into value creation by enhancing directors' monitoring focus. However, its effectiveness is conditional upon a firm's context, with greater improvements in performance being observed when firms start from a weak governance base. Moreover, there are several ethical dimensions, which must be addressed in the elaboration of any director compensation strategy. The article concludes with some additional observations and some recommendations useful to practitioners and that may guide academic research as well:

1. Director compensation must be high enough to attract high-caliber individuals and to reward them for their responsibilities, but not so high as to potentially impair their objectivity, judgment and independence.
2. Director compensation must be set in a transparent and objective way, with clear benchmarks that reflect the most plausible talent markets.
3. A significant proportion of director compensation must be 'locked in' for the long term (5–10 years).
4. Director compensation must not be based upon the attainment of short-term objectives or goals, but rather based on the long-term success of the organisation predominantly while not encouraging excessive risk taking.