Author Topic: Ownership Structure and CEO Compensation in North America: A Combined Study Ap-p  (Read 4102 times)

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Author : Nulla, Yusuf Mohammed
International Journal of Scientific & Engineering Research Volume 4, Issue 10, October-2013
ISSN 2229-5518
Download Full Paper : PDF

Abstract—This research had investigated ownership structure and its impact on CEO compensation system in TSX/S&P and NYSE indexes companies from the period 2005 to 2010. The totaled of two hundred and forty companies were selected through random sample method. The research question for this study was: is there a relationship between CEO compensation, firm size, accounting firm performance, and corporate governance, among owner-managed and management-controlled companies?. To answer this question, thirty six statistical models were creat-ed. It was found that, there was a relationship between CEO compensation, firm size, accounting performance, and corporate governance, both in the owner-managed and management-controlled companies, except for the relationship between CEO bonus and firm size of owner-managed companies.

Keywords: Accounting Performance, Corporate Governance, Corporate Ownership, Accounting Earnings, TSX/S&P CEO compensation, and NYSE CEO compensation.

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he purpose of this research is to understand the influence of firm ownership on CEO compensation as a combined study of TSX/S&P and NYSE indexes companies, from e period 2005 to 2010. That is, extent of influence of owner-controlled and management-controlled companies in CEO compensation system. This interesting and important study in the executive compensation area will reveal some scientific methodologies or trends to understand the nature of CEO con-tract under respective ownerships. This study was conducted also in the influence of, over the past decade, Canadian and United States public had raised concerns over large bonuses declared to CEOs by their board of directors. The failure to understand the determinants of CEO compensation by public had led to blaming CEOs of rent grabbing; misused of its power towards board; and its monopolization of the compen-sation system. Thus, these ever growing concerns bring to foreground conclusion the need to further study CEO com-pensation system especially the effect of type of ownership on CEO compensation, as one important variable of executive compensation study.
The CEOs and other executives would like to elimi-nate the risk exposure in their compensation packages by de-coupling their pay from performance and linking it to a more stable factor, firm size. This strategy indeed deviates from ob-taining the optimum results from principal-agent contracting. In general, previous studies had found a strong relationship between CEO compensation and firm size but the correlation results were ranged from nil to strong positive ratios. The var-iables used in previous studies as a proxy for firm size were either total sales, total number of employees, or total assets. Therefore, firm size needs to be studied with CEO cash com-pensation in greater detail such as using both total sales and total number of employees.
The most researched topics in the executive compen-sation are between CEO compensation and firm performance. Although executive compensation and firm performance had been the subject of debate amongst academic, but there was little consensus on the precise nature of the relationship as such, further researched in greater detail need to be conducted to understand in finer terms the true extent of the relationship between them. As such, this research had unprecedentedly used eight variables to attest with CEO compensation, that is, return on assets (ROA), return on Equity (ROE), earnings per share (EPS), cash flow per share (CFPS), net profit margin (NPM), book value per common stock outstanding (BVCSO), and market value per common stock outstanding (MVCSO).

The relationship between CEO compensation and corporate governance (CEO Power) was not attested exten-sively in the past, especially in Canada. In fact, only few credi-ble researched papers were written. That is, CEO power only had been the subject of recent focus among researchers, pri-marily due to the effect of researchers had failed to find the strong relationship between CEO compensation, firm size, and firm performance. The variables used in previous studies as a proxy for corporate governance such as, CEO age; CEO ten-ure; and CEO turnover, were found to have negligible to weak relationship with CEO compensation. In addition, third party data collection, different population samples such as industry and market, and use of different statistical methods, all had led to a divergence in results. Therefore, corporate governance needs to be studied with CEO compensation on an extensive basis such as using, CEO age, CEO stocks outstanding, CEO stock value, CEO tenure, CEO turnover, management 5 per-cent ownership, and individuals/institutional 5 percent own-ership.

Prasad (1974) believed that executive salaries appear to be far more closely correlated with the scale of operations than its profitability. He also believed that executive compensation is primarily a reward for previous sales performance and is not necessarily an incentive for future sales efforts. McEachern (1975) believed that executives are risk averse. They can reduce or eliminate risk exposure in their compensation package by linking it to a more stable factor, firm size. Gomez-Mejia, Tosi, and Hinkin (1987) believed that firm size is a less risky basis for setting executives’ pay than performance, which was subject to many uncontrollable forces outside the managerial sphere of influence. Deckop (1988) believed that a strong sales compensation relationship would suggest that CEOs are given an incentive to maximize size rather than profitability. Tosi and Gomez-Mejia (1994) believed that measurement of firm size is the composite score of standardized values of reported total sales and number of employees. Gomez- Mejia and Barkema (1998) defined the relationship between CEO compensation and firm size as “positive”. That is, CEOs in large companies make higher income than CEOs in small companies. This is supported by Finkelstein and Hambrick (1996), who believed that firm size is related to the level of executive compensation. This is further supported by Murphy (1985), who find that holding value of a firm constant, firm whose sales grow by 10% will increase CEO salary or bonus between 2% and 3% Therefore, it shows that size pay relation is causal, and CEOs can increase their pay by increasing firm size, even when increase in size reduces the firm’s market value. Shafer (1998) shown that pay sensitivity, which measured as change in CEO wealth per dollar and change in firm value, falls with the square root of firm size. That is, CEO incentives are 10 times higher for a $10 billion firm than for a $100 million firm.

According to previous studies conducted in the United States and the United Kingdom, CEO compensation is believed to be weakly related to firm performance. Loomis (1982) argued that pay is unrelated to performance. Henderson and Fredrickson (1996), and Sanders and Carpenter (1998, 2002) argued that CEO total pay may be unrelated to performance but it related to organizational
complexity they manage. Likewise, studies conducted by Murphy (1985), Jensen and Murphy (1990), and Joskow and Rose (1994) find similar conclusions. Jensen and Murphy (1990) argued that incentive alignment as an explanatory agency construct for CEO pay is weakly supported at best. That is, objective provisions of principal agent contract are not comprehensive enough to effectively create a direct link between CEO pay and performance. They find that pay performance sensitivity for executives is approximately $3.25 per $1000 change in shareholder wealth, small for an occupation in which incentive pay is expected to play an important role. This is supported by Tosi, Werner, Katz, and Gomez-Mejia (2000), who find that overall ratio of change in CEO pay and change in financial performance is 0.203, an accounting for about 4% of the variance. This weak relationship is explained by Borman & Motowidlo (1993) and Rosen (1990), who stated that archival performance data focuses only on a small portion of a CEO’s job performance requirements as such, it is difficult to achieve a robust conclusion. According to Jensen and Murphy (1990) who believed that CEO bonuses are strongly tied to an unobservable performance measure. They believed that if bonuses depend on performance measures observable only to the board of directors,
they could have provided a significant incentive. They believed that one way to detect the existence of such phantom performance measures are to examine the magnitude of year to year fluctuations in CEO compensation. They believed that such fluctuations signifies CEO pay is unrelated to accounting performance. In addition, they argued that although bonuses represent 50% of CEO salary, such bonuses are awarded in ways that are not highly sensitive to performance. And the variation in CEO pay can be explained by changes in accounting profits than stock market value. Overall, they believed that pay performance sensitivity remains insignificant.

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