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Outside Directors with a Stake: The Linchpin in Improving Governance

In recent years, numerous governance experts and activist investors have argued that outside directors should hold significant stakes in the companies they oversee. So far, however, systematic evidence that outside directors' holdings are actually associated with subsequent corporate performance has been scarce. This article provides such evidence. It examines a sample of companies that significantly outperformed their business sectors (in shareholder returns) over a 10-year period (Stars) and a matched sample of companies that underperformed their sectors during the same period (Laggards). At the outset of the 10-year period—before their performance diverged—the outside directors of the Star companies held substantially more equity (about four to five times more) than did the directors of the Laggard companies. Then, as the Stars outpaced the Laggards in performance, the disparity in director holdings grew even wider. The results strongly suggest that directors with a meaningful stake are a pivotal factor in improved governance. The article concludes with a proposal for a new approach for getting equity into directors' hands—a stock purchase matching fund for each director—that overcomes the drawbacks of currently prevailing approaches.