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.
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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.