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The relationship between executive compensation and company's governance of non-international companies.
Abstract:
This study examines the relationship between company's governance and cash compensation paid to the executives of non-international companies. The purpose is to test whether the salary and total cash compensation of the CEOs of such corporations are related to management percentage stock ownership, CEO as chair of the board, and percentage of outside members of the board. Using 591 company-year observations for 217 companies for the years 2007 to 2009, the results show that the management percentage stock ownership is negatively associated with the level of CEO salary and total cash compensation. In addition, the results indicate that companies with boards that have CEO as chair, pay a relatively higher amount of cash compensation to their executives. Finally, the results show that the higher the percentage of outside directors in the corporate board, the lower is the amount of CEO cash compensation.

Keywords: Compensation, Corporate Governance, Executive

Article Type:
Report
Subject:
Executives (Compensation and benefits)
Corporate governance
Wages
Author:
George, Nashwa
Pub Date:
07/01/2011
Publication:
Name: Review of Business Research Publisher: International Academy of Business and Economics Audience: Academic Format: Magazine/Journal Subject: Business, international Copyright: COPYRIGHT 2011 International Academy of Business and Economics ISSN: 1546-2609
Issue:
Date: July, 2011 Source Volume: 11 Source Issue: 4
Topic:
Event Code: 540 Executive changes & profiles; 200 Management dynamics Computer Subject: Company business management; Salary
Product:
Product Code: 9911450 Management Compensation; 9911451 Management Salaries
Accession Number:
272616377
Full Text:
1. INTRODUCTION

This study examines the relationship between company's governance and executive cash compensation of non-international companies. I examine whether management percentage stock ownership, CEO as chair of the board, and percentage of outside board members influence the CEOs' salary and total cash compensation. Previous studies show conflicting results on the association between management stock ownership and executive cash compensation. (Holderness and Sheehan, 1988) and (Mehran, 1995) found a significantly negative association between management ownership and cash compensation of executives. However, (Allen, 1981) and found a positive relationship between top management cash compensation and management stock ownership. This study examines the relationship between the level of executive cash compensation and the percentage of management equity ownership in the company. (Cotter et al., 1997) found that board independence is important as effective governance mechanism to reduce agency problems. When the CEO is not the chair of the board, the board is independent. I expect a negative relationship between board independence and executive compensation; companies having CEO-dependent boards pay greater executive cash compensation compared to companies having CEO-independent board. Board monitoring would improve when companies' boards comprise a larger number of outside directors because outside directors are more likely to monitor managerial performance rigorously and objectively. Therefore, the higher percentage of outside board members, the harder for managers to enter into an unreasonable executive compensation contract. I expect a negative relationship between proportion of outside directors in the board and the level of executive cash compensation. The study controls for company size and growth opportunity that may influence the level of executive compensation.

2. LITERATURE REVIEW

Several prior studies examined the association between various corporate governance variables and the level of cash executive compensation. (Core et al., 1999) argued that executives earn greater cash compensation when corporate governance structure is less effective. (Holderness and Sheehan, 1988) and (Mehran, 1995) found that managers who are major shareholders receive relatively higher compensation. However, (Allen, 1981) showed that as the CEOs' equity holding increases, the level of CEO compensation decreases. Critics of corporate governance argued that companies' boards having greater number of outside directors are more effective monitoring managerial activities since such corporate boards are more CEO-independent and therefore more reasonable cash compensation decisions. However, (Crystal, 1991) argued that since outside directors are essentially placed and removed by the CEO, they remain mostly ineffective in intervening the process of determining appropriate CEO compensation. Board members may be reluctant to take any adversarial actions against CEOs, especially in the matter of setting CEO compensation. Furthermore, corporate boards usually determine the level of CEO compensation based on the compensation consultants hired by the CEO. (Boyd, 1994) found a positive relationship between the percentage of board composed of outside directors and CEO compensation. (Core et al., 1999) found that CEO compensation is higher when the CEO is also the board chair and the greater the percentage of board composed of outside directors the lower is the level of CEO cash compensation.

3. HYPOTHESIS DEVELOPMENT

3.1 Ownership Structure

(Jensen and Meckling, 1978) and (Warfield et al., 1995) argued that managerial ownership is an effective mechanism, which lowers the principal-agent conflict. (Gul and Tsui, 2001) found that increase in managerial ownership leads to a greater alignment of manager-shareholder interests, which in turn, lowers agency problems. (Holderness and Sheehan, 1988) and (Mehran, 1995) found that managerial stock ownership negatively impacts the level of executive compensation. (Allen, 1981) found a positive relationship between the percentage of managerial stock ownership and executive compensation. The first hypothesis in the null form is as follows:

H1: Ceteris paribus, there is no relationship between the percentage of common stock held by managers and the level of cash compensation paid to executives.

3.2 Board Structure

(Mehran, 1995) suggested that board structure is an essential element of corporate governance. (Conger et al., 1998) argued that board independence is important for board effectiveness and corporate governance. (Monks and Minow, 2005) found a direct link between board effectiveness and executive compensation. So, board structure can be used as a proxy for effectiveness in monitoring corporate affairs. Shareholders demand the separation of board chairmanship from CEO.

The second hypothesis is as follows:

H2: Ceteris paribus, there is no relationship between a CEO as chair of the board and the executive cash compensation.

It is the board's responsibility to determine the level of executive compensation and ensure that shareholders' interests are protected. Inside directors are most likely to be dominated by the CEO. Therefore, board monitoring may improve with the increase in the number of outside directors (Fama, 1980; Kren and Karr 1997). Corporate boards with relatively more inside directors are less independent from the CEO, which might allow the CEO to take undeserved cash compensation (Mizruchi, 1983; Mangel and Singh, 1993). Therefore, the higher the percentage of outside directors in the board the lower is the level of executive cash compensation. The third hypothesis is as follows:

H3: Ceteris paribus, there is no relationship between the percentage of outside directors in the board and the level of executive cash compensation.

4. RESEARCH DESIGN

4.1 Variables

Using EXECUCOMP data base cash salary (CS) and total cash compensation (TCC) paid to the executives were collected and used as the two dependent variables. Three independent variables were collected from Compact Disclosure LEXIS/NEXIS database. 1. CSM is the percentage of common stock owned by the executives. 2. CHCEO is 1 if the CEO is the chair of the board, 0 otherwise. 3. OUTDIR refers to the percentage of outside directors in the board. The analysis also includes two control variables, which could potentially affect the level of CEO cash compensation. Company size (SIZE) is measured by the natural log of total assets. The larger the size of the company, the greater would be the manager's responsibility and task complexity, which in turn affect the overall cash compensation. Future growth opportunity (GROW) can potentially influence the level of CEO compensation. The higher the growth opportunity of a company, the greater is the role of the managers and the higher managerial compensation requirement. Growth is measured as the ratio of market to book values.

4.2 Research Model

The following multiple regression model is used:

[CT.sub.i,t] or [TCC.sub.i,t] = [CSM.sub.i,t] + [CHCEO.sub.it] + [OUTDIR.sub.i,t] + [SIZE.sub.i,t] + [GROW.sub.i,t] + [epsilon]

Where,

[CT.sub.i,t] = Natural log of cash salary paid to the executive of company i in year t;

[TCC.sub.i,t] = Natural log of total cash compensation paid to the executive of company i in year t;

[CSM.sub.i,t] = Percentage of common stock owned by executives of company i in year t;

[CHCEO.sub.i,t] = 1 if CEO is the chair of the board, 0 otherwise for company i in year t;

[OUTDIR.sub.i,t] = Percentage of the outside directors in the company board;

[SIZE.sub.i,t] = Log natural of the total assets of company i in year t;

[GROW.sub.i,t] = The ratio of market to book value of company i in year t.

5. SAMPLE SELECTION, DESCRIPTIVE DATA and CORRELATION STATISTICS

A sample of 250 non-international companies was taken from COMPUSTAT for the fiscal years from 2007 to 2009. Out of these 250 companies, salary and/or cash compensation data for 10 companies were not available from the EXECUCOMP database. The data for another 23 companies were not available to run regression analysis, leaving 217 companies. The total number of company-year observations for the 217 companies for the period from 2007 to 2009 is 651. For 60 companies- years, data from either EXECUCOMP or COMPUSTAT annual file were not available. Table 1 has the final sample.

Table 2 has the descriptive data. The mean (median) natural log of total salary and cash compensation are 6.256 (5.686) and 8.485 (6.096) respectively. The mean (median) of management percentage stockholding are 0.175 (0.135) respectively. The mean (median) of CEO chair of the board is 0.425 (0.125) respectively. The mean (median) percentage of outside directors in the board is 25% (16%). The mean (median) natural log of total assets is 3.176 (3.018) respectively. The mean (median) market to book ratio (GROW) is 3.941 (2.245) respectively.

Variable definitions

CS = Natural log of cash salary paid to the executive;

TCC= Natural log of total cash compensation paid to the executive;

CSM = Percentage of the outstanding common stock held by managers;

CHCEO = 1 if CEO is the chair of the board, 0 otherwise;

OUTDIR = Percentage of the outside directors in the board;

SIZE = Log natural of total assets;

GROW = The ratio of market value to book value;

Table 3 provides the Pearson Correlation Coefficients among different groups of variables. The results show that both cash salary and total cash compensation are significantly correlated with all variables except GROW. Table 3 is available upon request.

6. THE RESULTS AND DISCUSSION

Table 4 has the results of test the relationship between few corporate governance factors and cash salary and total cash compensation paid to company executives. Columns 1 and 2 show the results of the reduced model 1. Model 1 tests the relationship between cash compensation (salary and total cash compensation) and management stock ownership. The results show that CSM (salary: coefficient -4.67, p-value 0.02; total cash compensation: coefficient -3.52, p-value 0.03) are significantly negatively related to both the CEO salary and total cash compensation. Columns 3 and 4 show the results of the reduced model 2 testing the relationship between two board characteristic variables and the level of CEO salary and total cash compensation. CHCEO has a positive and significant relationship with both salary and total cash compensation (salary: coefficient 2.53, p-value 0.03; total cash compensation: coefficient 2.34; p-value 0.03). OUTDIR is significantly negatively related with salary and total cash compensation (salary: coefficient -5.19, p-value 0.00; total cash compensation: coefficient -5.65; p-value 0.00). The results indicate that when CEO is the chair of board that positively affects the level of cash compensation. A significant negative relationship exists between percentage of outside directors and the level of total cash compensation. Columns 5 and 6 provide the results of whole model. This examines the relationship between management ownership and board variables and the level of salary and total cash compensation after controlling for size and growth. The results do not materially change even after including the firm specific control variables in the analysis.

7. CONCLUSION

This study examines the relationship between salary and total cash compensation of the executives and management shareholdings, CEO dependent board (whether CEO is also the chair of corporate board or not), and percentage of outside board members. The study includes two variables (size and growth) as controls that could potentially affect the level of executive cash compensation. In addition, two reduced models by which the relationships between executive cash compensation and ownership and board variables could be tested separately. A multivariate regression model using 591 company-year observations for the years from 2007 to 2009 was run. The results show management stock ownership has negative relationship with the level of executive cash salary and total cash compensation. In addition, the results indicate that the board that has CEO as chair, positively impacts while the percentage of outside board members negatively affects the level of cash salary and total cash compensation paid to executives.

REFERENCES:

Allen, M. "Power and privilege in the large corporations: corporate control and managerial compensation", American Journal of Sociology, Vol. 86, pp.1112-1123, 1981.

Boyd, B. K. "Board composition and CEO compensation", Strategic Management Journal, Vol 15, pp 335-344, 1994.

Core, J.E. Holthausen, R. W. and Larcker, D. F, "Corporate governance, chief executive office compensation and firm performance", Journal of Financial Economics, Vol. 51, pp. 371-406, 1999.

Cotter, J. F. Shivdasani, A. and Zenner, M. "Do independent directors enhance target shareholder wealth during tender offers?", Journal of Financial Economics, Vol. 43, pp. 195-218, 1997.

Crystal G., In search of excess: the overcompensation of American Executives, W.W. Norton and Company, New York, 1991.

Fama, E. F. "Agency problems and the theory of the firm", Journal of Political Economy, Vol. 88, pp. 288-397, 1980.

Gul, F.A., and J.S.L. Tsui. "Free cash flow, debt monitoring, and audit pricing: Further evidence on the role of director equity ownership", Auditing: A Journal of Practice and Theory, Vol. 20, pp.73-84, 2001.

Holderness, D. and Sheehan, D. "The role of majority shareholders in publicly-held corporations: an exploratory analysis", Journal of Financial Economics, Vol. 20, pp. 317-346, 1988.

Jensen, M., and Meckling, W. "Theory of the firm: managerial behavior, agency costs, and capital structure", Journal of Financial Economics Vol. 3, pp. 305-360, 1978.

Kren, L. and Kerr, J. L. "The effects of outside directors and board shareholdings on the relationship between chief executive compensation and firm performance", Accounting and Business Research, Vol. 27, pp. 297-309, 1997.

Mangel, R. and Singh, H. "Ownership structure, board relationships and CEO compensation in large US corporations", Accounting and Business Research, Vol. 23, pp. 339-350, 1993.

Mehran, H. "Executive compensation, ownership and firm performance", Journal of Financial Economics, Vol. 38, pp.163-184, 1995.

Mizruchi, M. S. "Who controls whom? An examination of the relation between management and boards of directors in large American corporations", Academy of Management Review, Vol. 3, pp. 426-435, 1983.

Monks, R. A. G. and Minow, N., Corporate Governance, Blackwell Publishing, 108 Cowley Road Oxford OX4 1JF, UK, 2005.

Warfield, T.D., Wild, J.J. and Kenneth. W.L. "Managerial ownership, accounting choices and informativeness of earnings" Journal of Accounting and Economics, Vol. 2, pp. 61-91, 1995.

Nashwa George, Berkeley College, Woodland Park, New Jersey, USA

Dr. Nashwa George earned her Ph.D. at Baruch College, CUNY, New York City in 1988. She is a professor of Accounting at Berkeley College, New Jersey, USA.
Table 1: Sample

Total number of companies taken from COMPUSTAT for the years      250
2007 to 2009

Companies not reporting salary and/or cash compensation data      (10)
in EXECUCOMP database

Companies did not have data needed in COMPUSTAT annual tape       (23)

Number of companies available                                     217

Number of company-year observations for 217 companies for the     651
years 2007 to 2009 (217 x 3)

Data not available for regression analysis.                       (60)

Company - year observations used                                  591

Table 2: Descriptive Statistics

Variable   N     Mean    Median   Std Dev   Minimum   Maximum

CS         591   6.256   5.686     2.263     4.568    11.4x24
TCC        591   8.485   6.096     2.201     5.253    12.512
CSM        591   0.175   0.135     0.194     0.005     0.597
CHCEO      591   0.425   0.125     0.537     0.004     0.986
OUTDIR     591   0.253   0.164     0.143     0.003     0.451
SIZE       591   3.176   3.018     1.834     0.309    10.605
GROW       591   3.947   2.245     7.746    -50.089   90.174

Variable definitions

CS = Natural log of cash salary paid to the executive;

TCC = Natural log of total cash compensation paid to the executive;

CSM = Percentage of the outstanding common stock held by managers;

CHCEO = 1 if CEO is the chair of the board, 0 otherwise;

OUTDIR = Percentage of the outside directors in the board;

SIZE = Log natural of total assets;

GROW = The ratio of market value to book value;

Table 4 Regression Results

VARIABLES     REDUCED       MODEL 1       REDUCED       MODEL 2

                             TOTAL                       TOTAL
              SALARY         CASH         SALARY         CASH

Intercept     11.791        11.936        12.134        12.750
            (0.000) ***   (0.000) ***   (0.000) ***   (0.000) ***

CSM            -4.67         -3.52
               -0.02         -0.03

CHCEO                                      2.53          2.34
                                           -0.03         -0.03

OUTDIR                                     -5.19         -5.65
                                          (0.000)       (0.000)

SIZE

GROW

VARIABLES      FULL          MODEL

                             TOTAL
              SALARY         CASH

Intercept     11.132        12.253
            (0.000) ***   (0.000) ***

CSM            3.47          2.58
               -0.05         -0.06

CHCEO          1.533         1.721
               -0.04         -0.02

OUTDIR        -3.064        -3.350
             (0.01) *      (0.01) *

SIZE           0.066         0.023
              (0.000)       (0.000)

GROW           0.003         0.001
              (0.05)        (0.76)

note: The numbers in the parentheses represent p-values (two-tailed).
The variables are all defined in previous sections. ***, ** and *
denote statistical significance at 1%, 5% and 10% level respectively.
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