CEO REMUNERATION: AUSTRALIAN EVIDENCE OF THE INFLUENCE OF REPUTATION, PERFORMANCE AND GOVERNANCE A thesis submitted in fulfilment of the requirement of the Degree of Doctor of Philosophy Damian Tien Foo Niap Master of Business Bachelor of Accounting School of Accounting College of Business RMIT University June 2013 DECLARATION I, Damian Tien Foo Niap, declare that: a) except where due acknowledgement has been made, the work completed is mine alone; b) the work has not been submitted previously, in whole or in part, to qualify for any other academic award; c) the content of the thesis is the results of work which has been carried out since the official commencement date of the approved research program; d) any editorial work, paid or unpaid, carried out by a third party is acknowledged; and e) relevant ethics procedures and guidelines have been followed. Signature Name June 2013 ii ACKNOWLEDGEMENTS I would like to thank my family, especially my brother Christopher Niap for the encouragement given to me to complete this thesis. It is certainly not easy juggling a full-time job and other commitments while doing this PhD on a part-time basis for approximately six years. In addition, I would like to thank RMIT University for granting me a tuition-fee exemption scholarship as well as funding to attend conferences and to learn how to use Stata econometrics software et cetera.
I would also like to thank Peter Keet for the discussion in regard to the change of CEOs during the year. Last but not least, I would like to thank my supervisors Professors Dennis Taylor and Clive Morley for their guidance. iii TABLE OF CONTENTS DECLARATION. iii TABLE OF CONTENTS.
iv LIST OF TABLES. viii LIST OF FIGURES .2 Multiple drivers of CEO remuneration .3 Objectives and research questions .4 Motivation and the literature gap .5 Regulatory context in Australia .1 Recent regulatory history of directors’ and executives’ remuneration .2 Components of CEO remuneration packages .3 ASX principles of good corporate governance .6 Structure of the thesis.2 Debate about KMP remuneration packages .3 The link between corporate reputation and personal reputation .4 Professional reputation as a sub-set of personal reputation of CEOs .5 The measurement of CEO professional reputation .1 Corporate governance definitions and reforms .2 The agency theory perspective on monitoring .3 Agency theory and the relationship between CEO remuneration and corporate performance .4 The stewardship and resource dependency theoretical perspectives on corporate governance .5 Research on corporate governance mechanisms and factors that mitigate agency problems .6 The roles, functions and duties of ‘officers’ (that is, directors and executives) of the company .1 Monitoring role of the remuneration committee within the board structure .2 Remuneration committee independence .4 Background and experience of members of the remuneration committee .8 Other relevant governance factors .2 Substantial shareholders and their activism .9 Weaknesses in corporate governance reflected in KMP remuneration practices .1 Corporate versus managerial performance .2 Corporate financial performance: accounting and market-based .3 Corporate productivity performance and the stakeholder perspective.4 Measures of productivity .1 Partial productivity (physical, labour and structural) and multifactor (or total) productivity .2 Gross versus net value-added productivity measures .3 Productivity measures chosen for this study. FRAMEWORK AND HYPOTHESES DEVELOPMENT .2 Conceptual framework for this study .3 Development of hypotheses .3 Volatility of company earnings or returns: risk .4 Market-to-book value ratio. RESEARCH DESIGN AND METHODS .3 Specification of models and definitions of variables .4 Construction of CEO professional reputation index .5 Sample selection and justification of sample size.1 Use of annual reports .2 Use of Databases .3 Confidentiality and ethical considerations .7 Screening and preparing the data .1 Checking for outliers.2 Change in CEO during the year .3 Dealing with missing data .4 Dealing with different monetary amounts .5 Dealing with termination payments .6 One-year lag company performance measures .11 Methods of data analysis .1 Pooled versus panel regression analysis .2 Fixed effects versus random effects panel data analysis (Hausman and Likehood Ratio tests).
RESULTS AND ANALYSIS .1 Descriptives for the key variables .2 Industry comparisons for CEO remuneration .3 Bi-variate correlation .4 Panel regression analysis results .2 Results for Model A – financial performance, reputation and governance effects on CEO remuneration .3 Results for Model B – productivity, reputation and governance effects on CEO remuneration .5 Discussion of results of hypotheses tests .1 CEO professional reputation – hypothesis 1 (H1) .2 Remuneration committee’s independence – hypothesis 2 (H2) .3 Remuneration committee’s diligence – hypothesis 3 (H3) .4 Company’s financial performance – hypothesis 4 (H4) .5 Company’s productivity performance – hypothesis 5 (H5) .6 Company’s ownership concentration – hypothesis 6 (H6) .6 Discussion of results for control variables .2 Summary of results of hypotheses tests and control variables .3 Implications of the findings and contribution to the literature .4 Limitations of this study .5 Suggestions for future research. 183 Appendix: Example of normal P-P plot of regression standardised residual. 216 vii LIST OF TABLES Table 1.1 Annual GDP change in Australia from 2005 to 2011 (ABS 2013) .1 Percentage of a company’s reputation that was attributed by groups of stakeholders to the reputation of the CEO (Burson-Marsteller 2001 as cited in Gaines-Ross 2003) .2 List of high-technology and traditional industries (selected only) .1 Variability of the variables that make up the CEO reputation index .2 Types of data collected and the sources.3 Details in regard to outlier .4 Skewness and kurtosis of CEO remuneration: pre and post transformation to log137 Table 4.5 Collinearity statistics for Model A (financial performance measures) .6 Collinearity statistics for Model B (using partial productivity measures) .7 Collinearity statistics for Model B (using total productivity measures) .1 Descriptive statistics of dependent and independent variables .2 CEO fixed remuneration as a percentage of total remuneration .3 Number of observations by industry sector .4 Comparison of CEO remuneration by industry (Scheffe): significance levels .8 Panel regression results for Model A – financial performance, reputation and governance effects on CEO remuneration .9 Panel regression results for Model B – productivity, reputation and governance effects on CEO total remuneration .10 Panel regression results for Model B – productivity, reputation and governance effects on CEO fixed remuneration .11 Panel regression results for Model B – productivity, reputation and governance effects on CEO performance-based remuneration .1 Summary of the regression results in terms of the significance of the relationships between the dependent variable CEOREM and the independent variables. 174 viii LIST OF FIGURES Figure 2.1: Factors that mitigate agency problems 59 Figure 3.
100 ix ABSTRACT The issue of remuneration of executives, especially chief executive officers (CEOs), tends to attract attention from the media, regulators and the public in general. This is especially true in times of financial crisis such as the recent global financial crisis (GFC). There is a perception that CEOs may be paid excessively despite performing poorly (Clarke 2007). This concern therefore provides the impetus for this study: Is there a common basis for the justification of CEO remuneration? There have been numerous studies undertaken in the past to understand what affects CEO remuneration.
The most commonly researched drivers of CEO remuneration are those related to conventional corporate financial performance measures such as return on equity; as well as the influence from corporate governance mechanisms and ownership structures. These studies have produced mixed results (for example Merhebi, Pattenden, Swan and Zhou 2006; Productivity Commission 2009). A review of the literature suggests that there are other factors which drive CEO remuneration especially if viewed from a broader stakeholders’ perspective (Kim, Joo and Choi 1996; Niap, Taylor, Morley and Kim 2012). Therefore, this study seeks to add two new drivers to the traditional models, namely CEO personal professional reputation and company productivity as an alternate to conventional company financial performance measures.
The literature also criticises previous studies that concentrate on only one (corporate governance) perspective to study the agency problem which is the conflict between shareholders and management interests (for example Shivdasani 1993). Rather, the literature contends that studying the agency problem depends on the efficiency of a bundle of monitoring mechanisms (Agrawal and Knoeber 1996). Furthermore, certain authors have questioned the effectiveness of the Anglo-American corporate governance structure (Clarke 2010). Accordingly, this study revisits the monitoring effects that ownership structure and the quality of the remuneration committee may have on CEO remuneration.
Ownership structure is measured by the percentage of shares owned by external substantial shareholders while the quality of the remuneration committee is measured by its independence and diligence. The possible influences of company size, industry, volatility of company returns and company growth are controlled for in this study. In addition, this study seeks to provide evidence on the comparative effects that these drivers may have on not just total CEO remuneration, but also on the two major components of fixed and performance-based remuneration that make up x total CEO remuneration. Consequently, this study seeks to address the following five research questions: RQ1 is there a relationship between CEO professional reputation and CEO remuneration? RQ2 is there a relationship between the independence of the company’s remuneration committee and CEO remuneration? RQ3 is there a relationship between the diligence of the company’s remuneration committee and CEO remuneration? RQ4 is there a relationship between company performances, in terms of the following, and CEO remuneration: RQ4.1 conventional company financial performance; and or RQ4.2 productivity? and RQ5 is there a relationship between the concentration of the company’s shareholders and CEO remuneration? The method entails a quantitative approach using panel regression analysis of data from companies sampled from the Top 200 ASX listed companies (based on their market capitalisation in 2009) over three years from 2007 to 2009.
This study spans the period from 2007 to 2009 due to the intense public attention that excessive executive remuneration garnered due to the GFC. Data are obtained from secondary sources, namely companies’ annual reports and the FinAnalysis, Connect4 and DatAnalysis databases. A total of 18 regressions are run. Measuring reputation is difficult because it is an intangible.
Therefore, it is contended that constructing a reputation index based on objective measures from annual reports provides a more reliable indicator of reputation which is the approach taken in this study. For the purpose of this study, CEO professional reputation, which is a component of CEO personal reputation, is used because this can be measured objectively from data obtained from annual reports. The CEO professional reputation index is constructed using the following four proxies as based on the literature and face validity: • CEO education level; • CEO professional memberships: • CEO prior working experience; and • CEO tenure with the company. xi In assessing the relationship between CEO remuneration and company productivity, both partial productivity, and multifactor or total productivity measures are used.
Partial productivity measures comprise of labour productivity, structural productivity and physical capital productivity. In regard to research question one, the results clearly show a positive association between CEO fixed remuneration and CEO professional reputation. For research questions two and three, the results indicate that the internal governance factor, the quality of the remuneration committee in terms of its independence and diligence, has not had a significant impact on the determination of CEO remuneration. The results for research question 4.
There does not appear to be any significant effect of ROE or total shareholders return on CEO remuneration, although there is a positive relationship between net operating cash flow and CEO remuneration. For research question 4.2, the results indicate a positive relationship between CEO remuneration and company total productivity. Finally, the results indicate that the external governance factor, concentration of substantial shareholders (research question five), has not had a significant impact on the determination of CEO remuneration during the period of the GFC. The contributions of this study to the literature are threefold.
Firstly, this is the first known attempt to construct a CEO professional reputation index which provides a starting point for future research to further improve on this index.