The Adoption of Deferred Share Unit Plans for Outside Directors and Shareholder Wealth

• DOI: http://doi.org/10.1111/j.1467-8683.2008.00681.x
• Published date: 01 May 2008
• Author: Paul André,Michel Magnan,Samer Khalil
• Date: 01 May 2008

The Adoption of Deferred Share Unit Plans for

Outside Directors and Shareholder Wealth

Samer Khalil*, Michel Magnan and Paul André

ABSTRACT

Manuscript Type: Empirical

Research Question/Issue: We examine the impact of the adoption of deferred share unit (DSU) plans for directors on a

f‌irm’s stock market value. We also examine the differential response to plan and f‌irm characteristics.

Research Findings/Results: The sample comprises all f‌irms within Canada’s top 1,000 that adopted DSU plans between

1997 (f‌irst one) and 2005. Results show that adopters exhibit positive abnormal returns atthe adoption announcements and

that these vary in accordance with DSU attributes: Investors reward f‌irms that adopt stricter standards. Findings also

indicate a more positive reaction when f‌irms are widely held, have higher levels of related directors, higher free cash f‌lows,

and are not cross-listed in the US.

Theoretical/Implications: The paper adds to the scant literature on directors’ compensation by examining a recent devel-

opment in directors’ pay; DSU plans having many distinguishing features that set them apart from stock options. Second,

it investigates whether investors’ reaction varies with DSU attributes. Third, the specif‌icity of the Canadian settings allows

an analysis of the reaction to DSU adoption given different ownership structures and stock market listing.

Practial Implications: The positive stock market reaction to DSU adoption provides valid economic underpinnings to the

current worldwide trend in director compensation toward the cancellation of stock option plans and their substitution

by DSU. However, the adoption of DSU plans for directors does not add much value in settings where there is alreadygood

monitoring by a large shareholder, by a broader investor base or by the board.

Keywords: Directors, Canada, executive remuneration (compensation), shareholder value

INTRODUCTION

The effectiveness of board monitoring and oversight as

a governance mechanism has been attracting consider-

able attention following recent corporate scandals and

accounting irregularities around the world. Many critics

suggest that outside directors are not suff‌iciently indepen-

dent from top management and do not have the motivation

to monitor management decisions and maximize share-

holder value. They argue that management’s control over

the proxy process and the low equity stake outside directors

typically hold reduce their independence, exacerbate the

incentive problem they face, and create a secondary agency

problem at the board level (e.g., Core, Holthausen and

Larcker, 1999; Bebchuk, Grinstein and Peyer, 2007).

To address these concerns, many f‌irms now offer equity-

based pay to their directors.1Some governance activists

acclaim this move, arguing that equity-based pay resolves

the agency problem at the board level by tying board

members’ wealth to the organization’s long term success

(Elson, 1999). Skeptics, however, question whether equity-

based pay reduces agency costs. Dalton and Daily (2001)

suggest that outside directors should already be motivated

to monitor top management and equity-based pay intro-

duces conf‌licts of interest as directors ultimately set their

own compensation.

This paper investigates the stock market reaction to the

adoption of deferred share unit (DSU) plans for outside

directors. The focus is on Canadian f‌irms that adopted a

DSU plan from 1997 (initial adoption by a f‌irm) to 2005. In

addition, the paper tests whether f‌irm-specif‌ic DSU plan

attributes affect the stock market reaction surrounding its

adoption. Using insights from agency theory, a positive

stock market reaction to the adoption of a DSU plan is

expected, which should be higher for f‌irms that adopt

stricter DSU plans, i.e., plans that theoretically provide a

tighter alignment of directors’ and shareholders’ interests.

Results are consistent with predictions, with adopters

*Address for correspondence: Suliman S. Olayan School of Business. American

University of Beirut, Bliss Street,Beirut, Lebanon, P.O. Box: 11-0236. Tel:961-1-350000

X 3769; Fax: 961-1-750214; E-mail: sk61@aub.edu.lb

210 CORPORATE GOVERNANCE

Volume 16 Number 3 May 2008 © 2008 TheAuthors

Journal compilation © 2008 BlackwellPublishing Ltd

doi:10.1111/j.1467-8683.2008.00681.x