At

Berkshire Hathaway's

(BRK.A) - Get Report

annual meetings, the holding company's legendary CEO Warren Buffett has often sounded off on his disapproval of compensation practices in the boardrooms of corporate America.

"I am never asked to sit on compensation committees because of my well-known views on the subject," Buffett reportedly once said. "If you belch too much at the dinner table, you're not invited back."

While the Oracle of Omaha will be stepping down from the high-profile board of directors at

Coca-Cola

(KO) - Get Report

later this month, those who remain will now be subject to a process that he has long advocated: performance-based compensation. The question that looms, though, is to what extent the change will affect board decisions.

The soft drink giant on Wednesday said it set a three-year goal of 8% compounded annual growth in earnings per share, which is the midpoint of its long-term performance target. Starting this year, its directors will receive stock units each year equal to $175,000. After three years, if the performance target is met, the shares will be payable in cash at market prices. If the company's performance falls short, the shares will be forfeited.

The plan, then, is an attempt to hold directors accountable for the company's bottom-line performance and, to a lesser degree, the performance of its stock price. Coca-Cola will use its 2005 earnings of $2.17 a share, after one-time items, as its base. Analysts polled by Thomson First Call have an average estimate for Coke to earn $2.28 a share this year, which would mark a 5% increase.

The new plan will replace Coca-Cola's practice of paying an annual retainer fee of $125,000, of which $50,000 was paid in cash and $75,000 accrued stock grants. It also eliminates additional fees paid for duties like chairing the company's board committees and attending its committee meetings.

Corporate executives are widely criticized on Wall Street for being richly rewarded for poor performance, but the main criticism of directors is their level of independence. Paul Hodgson, a senior research associate with governance-information provider the Corporate Library, found in a recent survey that only around 2% of the 2,000 largest public companies have adopted some sort of bonus or incentive plan for their directors. He doesn't expect that figure to grow anytime soon.

"This isn't a trendsetter," says Hodgson. "Earnings per share strikes me as not really the business of the directors. It's an operational management target, rather than a board-level target. Total stockholder return over three years might be a more appropriate measure than earnings."

He suggests that a plan such as Coke's may end up aligning its directors' interests with those of the company's management, hurting their ability to remain independent and serve the interests of shareholders.

"If you're a director, you're supposed to be focused on long-term strategy," says Hodgson. "Making decisions that grow stockholders' wealth over the long term can often hurt earnings in a particular year. If you're a director, and you're thinking about meeting a profit goal rather than making the best decision for stockholders, then you might

have incentive to make the wrong decision."

Lee Winfield, a Coca-Cola spokeswoman, expressed confidence that the company's board of directors would maintain the proper level of independence from management under the new plan.

"We have the highest faith in the integrity of our directors and that they're among the best and most ethical leaders in corporate America," says Winfield. "We certainly have full confidence that they would do the right thing by the business over the long-term. The board believes that this is an innovative plan that aligns their interests with both shareholders and management. All three should be working together."

Donald Sagolla, a principal with Mercer Human Resources Consulting, says he has found that compensation incentives focused on stock performance make the most sense for a company's directors.

"You want to make sure the board is holding management's feet to the fire on whatever performance metrics are going to increase shareholder value over the long term, whether it is earnings per share increases or something else," Sagolla says. "Putting the emphasis on long-term stock performance puts them in the same foxhole with shareholders."

Beverly Behan, a partner in the corporate governance practice of Mercer Delta Consulting, LLC and co-author of

Building Better Boards: A Blueprint for Effective Governance, says that simply requiring directors to own stock in the company does the trick.

"For a long time, we've said directors should own stock, and many companies have stock ownership guidelines for directors," Behan says.

At first blush, stock ownership appears to have worked in Buffett's case. Through Berkshire, he bought most of his Coca-Cola stake in 1987 for about $1 billion. The roughly 200 million shares are worth about $8.4 billion at current prices, making it Berkshire's most valuable holding.

On the other hand, Coca-Cola has been a sporadic performer in recent years after a number of strategic missteps. Its shares recently traded around $42, down more than 25% from its highs in 2002. Its rivals, including

Pepsi

(PEP) - Get Report

, have shown stronger growth and more innovation in recent years. For the first time in their intense rivalry, Pepsi actually surpassed Coke in market value in December.

Mohnish Pabrai, managing partner with Pabrai Investment Funds, says Coca-Cola is right to use profit metrics as a performance incentive for directors.

"A company's stock price is subject to all kinds of swings on a macro level depending on what the overall equity market is doing at a given period of time," Pabrai says. "If you're going to have a plan, you should have it heavily biased toward internal metrics like profit growth, sales or whatever. Management has no control over the stock price. They should be fixated on the performance measures that are more directly tied to generating cold hard cash by the business."

But while he approves of the plan. Pabrai says it's not a remedy for what ails Coca-Cola. In fact, he says the company's problem may be getting its management to stand up to its board of directors, which includes such luminaries as investment banker Herbert Allen, Internet mogul Barry Diller and former Olympics organizer Peter Ueberroth.

"The board at Coke is so formidable that it's intimidating for any CEO to lead the company," says Pabrai. "It's a very high-powered board, and the problems of the business partially may have something to do with this power. It's very tough to find a CEO who can effectively stand up to that group."

Not only is it hard to stand up to them, but finding a way to provide any real financial incentives for them could be futile.

"This plan might be an improvement, but it really doesn't matter to them," says Pabrai. "These guys have a very high net worth regardless of what happens at Coke, and they're in any case not really the drivers of performance at the company."

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