Master thesis Accountancy & Control, variant Control Faculty
of Economic and Business, University of Amsterdam
The effects of female board members on CEO compensations in the S&P1500 listed companies during 2007-2013
Supervisor: Dr. Bart- Jeroen van Praag
Name: Sanjai Jagesar (10687319) Date: 11 July 2015
Verklaring eigen werk
Hierbij verklaar ik, Sanjai Jagesar, dat ik deze scriptie zelf geschreven heb en dat ik de volledig
verantwoordelijkheid op me neem voor de inhoud ervan. Ik bevestig dat de tekst en het werk dat in deze scriptie gepresenteerd wordt origineel is en dat ik geen gebruik heb gemaakt van andere bronnen dan die welke in de tekst en in de referenties worden genoemd. De Faculteit Economie en Bedrijfskunde is alleen verantwoordelijk voor de begeleiding tot het inleveren van de scriptie, niet voor de inhoud.
Abstract
The objective of this research was to investigate the relationship between CEO compensation (components and total) and presence of female board members in the S&P1500 listed companies during 2007-2013. Various statistical tests are used through SPSS 17. The independent variables are the measures of total board size, chairmanship of CEO, female representativeness, and the number seats occupied by directors. The compensation components of CEO are used as dependent variable and are measured as the sum of base salary, bonus, stock, options and other compensation components. The findings of this study indicated that there is a statistically insignificant relationship between number of female board members and percentage of female boards with first five components of CEO compensation. The results found that number of female board members is only statistically significantly related with Total Compensation. In addition, the study found that there is statistically significant relationship between first three components of CEO compensation and Chairmanship. Besides, the study found that there is statistically significant relationship between first two components of CEO compensation and number of board members. The findings also indicated that there is significant association of total size of the board with the number of female board members. This implies that board with two females on the board is significantly larger than a board that comprised of 1 female director. This also implies that a board with 3 female board members is significantly larger than a board which is comprised of 2 female directors or board members. This therefore conclusively said that board size is an important factor that highly associates with the representation of female director.
Table of Contents
Abstract ... iii
Chapter 1: Introduction ... 1
Background of the Study ... 1
Statement of the Problem ... 3
Research Question ... 4
Significance of the Study ... 4
Theoretical Framework ... 5
Structure of the Research ... 9
Chapter 2: Literature Review ... 10
Compensation Theory... 10
Three Paradigms ... 16
Agency Theory... 17
Expectancy Theory ... 22
Contingency Theory... 24
Human Capital Theory ... 27
Institutional Theory ... 29
Management Theory ... 30
Organizational Theory ... 32
Summary ... 35
Chapter 3: Research Method ... 36
Hypotheses Development ... 36
Test Model ... 41
Research Statistics Layout ... 45
Data Sample ... 46
Selection procedure ... 46
Sample Descriptives... 47
Chapter Summary ... 51
Chapter 4: Data Analysis ... 52
Outcomes statistic tests ... 52
Correlation ... 53
Multiple Regression Model 1... 55
Multiple Regression Model 2... 57
ANOVA Relationship between female directorship and board size ... 59
ANOVA Relationship between female directorship and CEO chairmanship ... 61
ANOVA Relationship between female directorship and occupancy of directors ... 62
Hypothesis Validation ... 63
Chapter 5: Discussions, Conclusions and Recommendations ... 65
Discussions ... 65
Conclusions ... 67
Recommendations ... 69
Chapter 1: Introduction
Background of the Study
CEO compensation packages have come under increased scrutiny (Reingold, 2003). “Executive perks, those not-so-little extras that chief executives get as fringe benefits, are back in the limelight” (Potkewitz, 2005, p. 17). Scrutiny of CEO compensation increased because of significant increases in CEO compensation, major company fiduciary failures, and a perceived separation of stakeholder goals from management goals and risk preferences.
In 2002, Fortune Magazine examined the CEO compensation structures of 100 Fortune 500 companies and found a 14% average compensation increase (Reingold, 2003). Ratings of the Standard and Poor’s 500 dropped 13% in 2001 and another 23% in 2002 (Reingold, 2003). John H. Briggs, a 2009 director at Boeing and JP Morgan Chase and former CEO of the Teachers Insurance and Annuity Association – College Retirement Equities Fund (TIAA-CREF), stated that shareholder and stakeholder interests are not supported when CEOs and management leverage the company to reflect better performance by restricting dividends paid to shareholders and by restricting stakeholder participations (Reingold, 2003). Reingold stated, “CEOs, such as Tyco's Dennis Kozlowski and HealthSouth's Richard Scrushy, cashed in consistently over the past few years and then found themselves under criminal indictment” (p. 37).
A compensation system should be internally equitable and externally competitive to attract and retain qualified employees (Wolf, 2000) and to reinforce the overall strategy of the organization (Balkin & Gomez-Mejia, 1984; Mazer & Larre, 2000). Kraus (1980) identified the importance bonus and incentive payment alignment with organizational strategies and not
patterned on a survey or competitor. Three general problems and one specific problem, the focus of this study, follow.
Weak corporate governance (Nyberg, Fulmer, Gerhart, & Carpenter, 2010) allowed backdating (Narayanan & Seyhun, 2008) and re-pricing (Chance, Kumar, & Todd, 2000) of CEO stock options in the face of mounting investor losses, and resulted in investor lawsuits (Raiborn, Massoud, Morris, & Pier, 2007). For example, Citigroup CEO and CFO received $6.1 million and $19.4 million in compensation the same year the company received a $45 billion bailout from the US government. Morgan Stanley’s Blankfein and Cohen received $70.3 million and $72.5 million in compensation while receiving $10 billion in Federal bailout funds. Both were examples of weak corporate governance. The United States (US) federal government attempted to restrain executive compensation by enacting legislation, most recently the Sarbanes-Oxley Act (SOX) in 2002 (Malsch, Tremblay, & Gendron, 2012) and the Dodd-Frank Act (DF) in 2010 (Sepe, 2011). Even with (1) increased public concern, (2) research on executive compensation, and (3) legislation, the ratio between executive and average worker compensation increased from 195 times in 1993 to 331 times in 2013 (AFL-CIO, 2014).
As stock prices fall and CEOs receive existing stock options or benefit packages based upon stock prices, CEO compensation in this venue will be challenged. Todd (as cited in Reingold, 2003) stated, “because options make up as much as two-thirds of the value of total [CEO] compensation packages, this fact alone has reduced CEO pay considerably” (p. 35). Todd suggested, “the actual number of shares granted [CEOs as compensation] hasn't risen--so the value of option grants has dropped in this terrible market” (p. 35). Dorata (2008) found that CEOs were likely to receive favorable treatment in reorganization scenarios and with regard to stock options because of dropping stock values. Dorata suggested that CEO compensation, in
retention or at severance, was a board decision, and internal and public scrutiny of CEO compensation decisions were increasing.
“There are major changes afoot in the way executives are paid” (Reingold, 2003, p. 36). Laurence E. Hirsch, CEO of Centrex stated, "compensation committees are going to be much more intense about reviewing pay-for-performance-based systems" (as cited in Reingold, p. 36). “The Sarbanes-Oxley Act of 2002 required independent directors to determine CEO
compensation and new accounting rules have cut back on the number of options being granted” (Potkewitz, 2005, p. 17). Increased governmental and other external examinations by state and public bodies can be expected as CEO performance is linked to company performance and as company performance is defined by profitability and stability (Nouraji & Mintz, 2008; Reingold, 2003).
Statement of the Problem
One of the recent issue that has gained wide attention in CEO literature, because of huge amount of earnings of CEO’s during times of economic crises, is the participation of females in top executive positions in board of directors. In an effort to address the political and ethical issues surrounding the discrimination and inequality in pay of men and women executives, Norway and Spain have implemented laws and procedures that dictates a quota of minimum number of female board members especially in publicly traded firms. Apart from the ethical issue, economic perspective is also considered where diversity in board members might affect continuity and performance of firms (Erhardt et al., 2003). Also, as women are prone to more risks compared to men (Harris and Jenkins, 2006), they are also able to assess risks better than males (Ertac and Szentes, 2011) and evaluate success effectively unlike men (Gill and Prowse,
2010) which eventually enable them to influence better decisions in board as compared to men. However, economic argument for gender diversity in CEO compensation is still not conclusive and therefore additional research is required in this domain that can contribute to this issue.
Research Question
What is relationship between CEO compensation (components and total) and presence of female board members in the S&P1500 listed companies during 2007-2013?
Significance of the Study
The compensation of executives has attracted the attention of managers (Westervelt, 2012), compensation experts (Grant Thornton, LLP, 2012; McGovern & Williams, 2012), organizational theorists (Davis & Greve, 1997; DiPrete, Eirich, & Pittinsky, 2010), accountants (Armstrong, Jagolinzer, & Larcker, 2010; Balachandran, Dossi, & Van Der Stede, 2010; Cheng, Warfield, & Ye, 2011; Core, 2010; Dossi, Patelli, & Zoni, 2010; Gong, 2011; Henderson, Masli, Richardson, & Sanchez, 2010; Weiss, 2011), economists (Carroll & Ciscel, 1982; Ciscel & Carroll, 1980; Lerner & Wulf, 2007; Schaefer, 1998), government (Security and Exchange Commission (SEC), 2012), and non-governmental organizations (AFL-CIO, 2011; Equilar, 2012). The self-serving nature of agents (Jensen & Meckling, 1976) implies CEOs perform in a manner that maximizes their compensation. Incentives that do not properly align the CEO and the principal’s objectives for the organization, bias performance towards the true nature of the incentive provided to the CEO (Kerr, 1975). This study is important in considering an aspect not addressed by agency theory, the effects of institutionalization on compensation structures and the
potential decoupling of the alignment of EI and NEI compensation with operational and investment goals.
The contingency theory framework predicts that the better the fit between compensation and organizational strategies, the more effective the organization will be (Milkovich & Newman, 2004). By assessing use of EI and NEI, organizations can better align CEO compensation
packages with shareholder’s focus on operating efficiency or product development, innovation, and risk tolerances (Balkin & Gomez-Mejia, 1990; Schuler & MacMillan, 1984). Properly structuring a CEO compensation package reduces total agency costs by aligning goals and risk tolerances of agents and principals (Jensen & Meckling, 1976). Improperly designed
compensation packages may incentivize short-term gains over long-term value creation (Bebchuk & Spamann, 2010). Institutionalized pay practices decouple pay from strategy and may not incentivize desired agent behaviors or actions.
Theoretical Framework
The theoretical framework of this research drew on compensation theory, agency theory, expectancy theory, contingency theory, and institutional theory to understand the construction of compensation contracts between organizations and their CEOs and the equivocal
payperformance findings of prior research. The theoretical framework of this research
incorporated the work of Baeten et al. (2011), which examined and categorized theories used in compensation research into three paradigms: (a) control, (b) social-psychological, and (c) fit. The focus of the control paradigm is firm governance and includes agency, prospect, managerialism, and stakeholder theories. The social-psychological paradigm focuses on judgment regarding resource decisions and includes equity, expectancy, social comparison, and tournament theories.
The fit paradigm focuses on institutional and environmental influence on BoD’s executive pay decisions and includes human capital, institutional, and contingency theories. The fit paradigm incorporates “national institutional contexts at a macro level as well as sector- and firm-specific characteristics” (p. 9). Baeten et al. posited executive compensation theory would benefit by adding behavioral, institutional, and contingency factors to the control perspective.
Compensation systems attract, retain, motivate, and reward employees (Berger & Berger, 2000; Lawler, 1990), and consist of salary, bonus, and long-term incentives (Balkin &
GomezMejia, 1987a). Salary is a fixed annual compensation component for doing a job. Bonus payments may supplement base salary, attract an employee, or reward achieving specified profitability levels (Balkin & Gomez-Mejia). Long-term incentives reward achievement of strategic goals (Berger & Berger). Incentive performance measures should be: (a) aligned with organization strategy (Balkin & Gomez-Mejia; Berger & Berger; Lawler); (b) within the control of the executive (Lawler; Balkin & Gomez-Mejia); and (c) relative to performance of companies exposed to similar business risk (Antle & Smith, 1986; Baker, Jensen, & Murphy, 1988; Gibbons & Murphy, 1990).
Executive compensation is payment for contributing to an organization’s long-term success and short-term profitability (Patton, 1951a), that is, increasing shareholder wealth (Jensen & Murphy, 1990b). A prediction of both agency theory and expectancy theory is the increased likelihood of goal achievement when pay is variable and dependent on goal achievement (Gerhart & Milkovich, 1990). Goals can be behavior-based or outcome-based (Eisenhardt, 1985). Use of outcome-based accounting performance measures, such as cash flows and earnings, are appropriate for pay-for-performance analyses because they reflect expenditure decreasing and revenue increasing actions that directly affect shareholder wealth (Banker,
Huang, & Natarajan, 2011). When current expenditures create significant future value, the
incentive should be long-term based and lead to increased expenditures (Banker et al.). However, Bebchuk and Grinstein (2005) did not find a relationship between executive pay growth and firm size, performance, or industry classification during the period 1993 - 2003. Further, the variable portion of CEO pay increased from 37% in 1993, to 57% in 2003, to 81% in 2005 (Rost & Osterloh, 2009). Combined with rising stock prices during most of the period 1993 through 2005, increased variable pay for CEOs accounted for most of the wage disparity between CEOs and workers.
RI is one measure of expenditures expected to provide significant future value, is an appropriate indicator of investing behavior, and should affect incentive compensation structures. Strategy literature often computes RI as the ratio of R&D to sales, while accounting and finance use an R&D to assets ratio (Yoo, & Rhee, 2013). Yoo and Rhee employed the asset-based ratio and used sales as a control variable. Firms in less research intensive industries tend to focus more on process improvements relative to product innovation (Sorensen & Stuart, 2000). Firms in industries that focus on innovation and long-term projects tend to have larger R&D expenditures and a higher portion of CEO compensation in long-term incentives (Hannon et al., 1990). NEI may drive cost-efficiency advantages by improving production efficiency to lower costs, while EI may provide incentive for innovation and achievement of strategic goals (Schuler &
MacMillan, 1984; Stonich, 1981).
Compensation policies may also depend on the lifecycle stage of the organization (Balkin & Gomez-Mejia, 1987a; Hofer, 1975; Sorensen & Stuart, 2000). Growing firms may offer more incentive compensation and less salary and benefits than firms in a mature stage (Holland & Lewellen, 1962). Since incentives are paid out after an objective, financial or strategic, is
achieved, an organization can improve its flexibility to invest in R&D, technology, capacity expansion, marketing, and advertising to fuel growth instead of paying additional salary (Balkin & Gomez-Mejia). Mature firms tend to emphasize salary and benefits using formal job
evaluations, while growing firms rely more on incentives to emphasize unit or individual performance (Balkin & Gomez-Mejia). Setting minimum revenue levels for the entire period investigated minimized the number of small, growing firms that might use stock compensation due to cash limitations.
Agents must balance all stakeholders’ interests including shareholders, employees, unions, customers, suppliers, regulators, non-government organizations (NGO), and other societal constituencies (Becht, Bolton, & Roell, 2003). Therefore, incentives should reward specific behaviors and achievements rather than overall performance measures subject to
external forces. Incentives should be contingent on performance relative to other organizations in the same industry or organizations with similar environment risks (Antle & Smith, 1986;
Gibbons & Murphy, 1990; Holmstrom, 1982; Rosen, 1992).
Isomorphism is an institutional process that constrains possible actions for a set of environmental conditions (Meyer & Rowan, 1977). An important assumption for this study was institutional forces limit and homogenize CEO compensation structures. Therefore,
institutionalization of compensation practices was a viable explanation of isomorphic incentive compensation structures. Inventory, SG&A, advertising, and profit levels were operational performance metrics examined as possible determinants of NEI. R&D and PP&E were longterm investments examined as possible determinants of EI. The principal-agent model section contains descriptions of theoretical predications regarding the operational metrics related to NEI and the investment metrics related to EI.
Structure of the Research
The purpose of this study is to examine the relationship between CEO compensation (components and total) and presence of female board members in the S&P1500 listed companies during 2007-2013. The research in order to examine this is divided into five chapters. Chapter 1 of this study presents the background of the statement of the problem, research question, and theoretical framework, significance of the study and structure of the thesis. Chapter 2 presents the available literature on the compensation theories and theories surrounding CEO
compensation in organizations. Chapter 3 presents the research design and method adopted for this research. Chapter 4 then presents analysis and interpretation of the findings. Finally, chapter 5 presents the discussions, conclusion, and recommendations.
Chapter 2: Literature Review
Compensation Theory
A compensation system should reinforce the overall strategy of the organization (Tremblay & Chênevert, 2008), be tailored to the type of organization, and be customized to maximize the incentive by employee (Balkin & Gomez-Mejia, 1984; Ferracone & Gershkowitz, 2010). Every company must tailor its compensation plan to its needs (Patton, 1951b), leading similar organizations to employ different pay strategies and experience different degrees of success (Gerhart & Milkovich, 1990).
A compensation system should link each strategic objective to tasks assigned to particular job titles or operating groups affecting task outcomes (Balkin & Gomez-Mejia, 1987a). Links between specific task outcomes and specific reward levels provide eligible employees line-ofsight (Lawler, 1990) regarding the relationship between their efforts, specific outcomes, and associated rewards (i.e., expectancy theory). According to Patton (1951b), a bonus plan’s success is “measured by its effectiveness as an incentive” (p. 38).
CEO compensation contracts define the incentives used to align principal and agent goals and risk tolerances over a limited horizon (Lewellen, Loderer, & Martin, 1987). Agency theory holds that performance incentives and bonuses, such as cash and stock, reduce monitoring costs and can reduce total agency costs (Jensen & Meckling, 1976) by strengthening the performance reward relationship and motivating the affected employees (Byars & Rue, 2004). However, findings regarding the fit of agency theory with observations have been mixed (Core, Guay, & Larcker, 2003; Devers et al., 2007; Tosi et al., 2000).
Compensation experts differentiate CEO compensation theory from that of other employees (Balkin & Gomez-Mejia, 1987a; Berger & Berger, 2000; Lawler, 1990), but fail to provide the necessary linkage between compensation components and behavioral and outcome measures. Executive compensation is payment for contributing to an organization’s long-term success and for short-term profitability (Patton, 1951a), i.e., sustainability while increasing shareholder wealth (Jensen & Murphy, 1990a). Total cash payments reveal a company’s use of performance-based cash payments (Milkovich & Newman, 2004). Total compensation adds stock incentives to total cash and “reflects the total overall value of the employee (performance, experience, skills, etc.) plus the value of the work itself” (p. 229).
A prediction of both agency theory and expectancy theory is the likelihood of goal achievement increases when pay is variable and dependent on goal achievement (Gerhart & Milkovich, 1990). Goals can be behavior-based or outcome-based (Eisenhardt, 1985). Use of outcome-based accounting performance measures, such as cash flows and earnings, are appropriate for pay-for-performance analyses because they reflect revenue increasing and expenditure decreasing actions that directly affect shareholder wealth (Banker et al., 2011). When current expenditures create significant future value, the incentive should be long-term based and lead to increased expenditures (Banker et al.).
Two assumptions of the classical view of executive compensation are: 1) trade-off of risk-sharing and reward is efficient; and 2) stock prices are unbiased estimators of firm
performance (Holmstrom, 1979). According to Bebchuk (as cited in Dillon, 2009), both EI and NEI compensation can generate undesirable incentives to seek short-term gains at the expense of long-term performance. Patton (1951b) also recognized the potential for “stimulating short-term profit consciousness” (p. 40) and suggested realistic budgets and controls as safeguard
mechanisms. For example, making EI awards contingent on achieving specific goals helps ensure investing decisions align with investor goals (Narayanan, as cited in Dillon, 2009), as the executive must focus on both operating objectives and stock price (Carey, 1978).
Incentivizing a CEO in a manner that aligns CEO and principal time-horizons, risk tolerances, and other strategic objectives is a complex problem (Conyon, 2011; Ellig, 1981; Farid, Conte, & Lazarus, 2011; Gomez-Mejia & Balkin, 1992; Lawler, 1990; McNeil, 2013). Prior studies examined various performance metrics such as sales revenue (Lewellen &
Huntsman, 1970), profits (Antle & Smith, 1985; Cao & Laksmana, 2010; Deckop, 1988; Keller, 2013; Murthy & Salter, 1975), and stock price (Core, Guay, & Verrecchia, 2003; Ittner & Larker, 1998; Lewellen, Loderer, Martin, & Blum, 1992; Westphal & Zajac, 1994) as
determinants of total CEO compensation. There is conflicting evidence linkages exist between specific CEO incentives and desired CEO behaviors and performance. While some studies examined the effects of R&D on compensation (see Cao & Laksmana), there is no direct linkage to incentive compensation, only total compensation. The studies cited above also ignore potential institutional effects on the distribution of CEO compensation components used to align goals and risk tolerances of agents and principals.
Executive human capital, the employer’s ability to pay, and job complexity are the basic factors affecting executive compensation and are affected by the lifecycle stage of the
organization (Balkin & Gomez-Mejia, 1987a; Hofer, 1975; Sorensen & Stuart, 2000). Growing firms may offer more incentive compensation and less salary and benefits than firms in a mature stage (Holland & Lewellen, 1962). Patton (1961) stated that company philosophies are so varied that similar jobs in the same industry would have significantly different compensation packages.
Given different strategies for organizations in the same industry, compensation structures should be unique to each organization. Prior studies focused mostly on total compensation or the ability to incentivize a particular behavior with a specific incentive. Little examination of the compensation structure provided opportunities for study. The theoretical foundation of the study follows and links theory to the proposed study methodology.
A compensation system should be internally equitable and externally competitive to attract and retain qualified employees, and should motivate the employee (Wolf, 2000). A compensation system should reinforce the overall strategy of an organization, be specific to the type of organization, and maximize the incentive by employee (Balkin & Gomez-Mejia, 1984; Mazer & Larre, 2000). Each company must tailor its compensation plan to its needs (Patton, 1951b), leading similar organizations to employ different pay strategies (Gerhart & Milkovich, 1990). Company philosophies are so varied that similar jobs in the same industry would have significantly different compensation packages (Patton, 1961).
The most commonly used model to examine executive compensation from accounting and economic perspectives is Jensen and Meckling’s (1976) principal-agent model (Baeten, Balkin, & Van den Berghe, 2011; Cao, 2007). Empirical studies regarding the predictive accuracy of agency theory with respect to pay-for-performance (Devers et al., 2007) and corporate governance (Doscher & Friedl, 2011; Yanadori & Milkovich, 2002) had equivocal results. When pay-for-performance relationships were identified, the relationships were often weak or statistically insignificant (Jensen & Murphy, 1990b).
Issues associated with stock price as a performance measure (Cheng & Indjejikian, 2009; Garvey & Milbourn, 2006; Rajgopal, Shevlin, & Zamora, 2006) may explain the equivocal findings of empirical studies regarding the predictive accuracy of agency theory with respect to
outcome-based pay-for-performance (see Devers et al., 2007) and corporate governance (see Doscher & Friedl, 2011; Yanadori & Milkovich, 2002). Although agency theory is an important theoretical framework used to establish executive compensation, the predictive value of the theory regarding CEO compensation is questionable because of failures to find a strong link between pay and performance. Conyon & Murphy (2000) found similar business environments and markets for CEOs in the US and United Kingdom, but different compensation structures, amounts, and pay-performance sensitivities. To be valid, the principal-agent model should account for CEO compensation structures globally. Conyon and Murphy suggested cultural and corporate tax differences regarding stock options accounted for the differences in compensation structures and amounts; both are institutional forces not considered in agency theory.
The other side of the argument is that executive pay structures are responsible for the economic growth the United States has experienced since the 1960s. Myths and Realities of Executive Pay (Kay & Van Putten, 2007) contended that the United States model of executive compensation is responsible for the outstanding performance of companies and the United States economy in general. Although the overall environment has changed, Kay and Van Putten argued that the current model of pay-for-performance is the model that should be applied going forward with a few small changes.
Differing points of view on agency theory verses the value of pay-for-performance compensation bring about new questions about how to measure leadership and compensate appropriately. The idea that leadership is measurable, quantifiable, and has a specific value that can be compensated developed into an extensive field of research. One of these research projects evolved into a book; Good to Great (Collins, 2001) which introduced a study of companies that had outstanding performance relative to their peers. Pay-for-performance issues were evaluated
in this study. The Good-to-Great study indicated the CEO was a key determinate in the
transformation of the company from good-to-great status. This 2001 study separated companies into groups based on financial performance and then looked at possible determinates to explain the transition from average to outstanding performance.
Collins’ (2001) study identified leadership as the primary determinant for the overall performance of the company and specifically developed a “Flywheel Model of Level 5
Leadership” (p. 17) that resulted in outstanding performance. The model is a tiered approach to leadership qualities consisting of level 1= Highly Capable Individual, level 2= Contributing Team Member, level 3=Competent Manager, level 4=Executive Leader, and Level 5=Executive. “The Level 5 Executive builds enduring greatness through a paradoxical blend of personal humility and professional will.” (p. 20). The original focus of the Good-toGreat study was on the company and not the leader, but according to Collins, the data lead the research team to focus on leadership levels and the flywheel model as the deciding factor on outstanding company
performance.
In a case study on leadership, The Extraordinary Leader (Zenger & Folkman, 2002) focused on how individuals become great leaders and analyzed the United States Marine Corps in a specific case study. The point of the case study was to validate the concept that leaders could be trained to become great leaders through a process. Leadership Without Easy Answers
(Heifetz, 1994) provided a look at leadership style within an organization and focused on the use of authority, its misuse, and consequences. The idea that leadership is sometimes a process of walking a razor’s edge with the possibility that you might fall off one side or the other is the focus of this study in leadership. This book has relevance to the leadership aspects of the study
by helping to identify the relevant leadership traits companies might develop for pay-for-performance metrics.
Wilkes (2004) looked at the relationship between corporate governance and offered several ideas on measuring performance relative to leadership. Ying-Fen (2006) studied
executive performance for international companies that helped shed light on the differences for measuring international companies relative to United States based companies. This is relevant because many of the companies in the population of this study are globally engaged.
Understanding the way in which organizations select and change their top management teams can be challenging without inside access. Boards are reluctant to share that information and shareholders rarely have access. A study in The Academy of Management Review (Hambrick & Mason, 1984) was helpful because it compared the organization and changes within it to its’ top executives and provided insight into how changes occur within an organization.
Research on the Standard and Poor’s 500 companies by Morningstar was used to narrow the population to a series of companies that had available data, pay-for-performance
compensation arrangements, and are well recognized for their business practices. The evidence of using SEM for the analysis of data for this study included Hoyle (1995), Hoyle (2000), and Hu and Bentler (1999).
Three Paradigms
Baeten et al. (2011) categorized 18 theories of executive compensation into three
paradigms: (a) control, (b) social-psychological, and (c) fit. The focus of the control paradigm is goal incongruence between managers and shareholders and the need for “institutional control
mechanisms” (p. 8) to ensure shareholder value creation. Agency, managerialism, and
stakeholder theories, among others, fall under the control paradigm. The social-psychological paradigm focuses on how compensation components motivate judgment and decision-making under social influences. Equity and expectancy are two of the theories included in the
socialpsychological paradigm. The fit paradigm adds a contextual dimension with a focus on “national institutional contexts at a macro level as well as sector- and firm-specific
characteristics” (p. 9). Human capital, institutional, and contingency theories are part of the fit paradigm. Incorporating behavioral, institutional, and contingency factors adds to the
understanding of executive compensation (Baeten et al.). The remainder of this section expands agency, equity, expectancy, contingency, human capital, and institutional theories and develops the theoretical foundation for this study.
Agency Theory
Since the creation and development of the corporation, researchers have explored theories of the firm and management in efforts to align diverging goals and risk tolerances of the CEO and the owners (shareholders) resulting from separation of ownership and control (Berle, 1929; Berle & Means, 1932). Coase (1937) described a firm as a series of economic transactions governed by contracts. The underlying theory developed from the separation of ownership and control, property rights, and contracts is agency theory (Devers et al., 2007), which focuses on aligning the goals of managers (i.e., agents) and owners (i.e., principals) by monitoring
managerial actions (i.e., behaviors) and linking managerial incentives to performance (i.e., behaviors and outcomes) (Eisenhardt, 1988; Fama, 1980; Fama & Jensen, 1983; Farid, Conte, & Lazarus, 2010; Girasa, & Ulinski, 2009; Jensen & Meckling, 1976).
Principal-agent problems addressed in agency theory arise because managers are self‐ interested and risk-averse, and shareholders cannot perfectly monitor manager actions; therefore, executives will pursue their own well‐being at the expense of creating shareholder value (Abels & Martelli, 2013; Eisenhardt, 1989; Jensen & Meckling, 1976). To mitigate principal-agent problems, the principal uses combinations of monitoring and incentives (agency costs) to align an agent’s actions (i.e., behaviors) and subsequent performance (i.e., outcomes) with the principal’s objectives.
Fama (1980) described compensation as a reward for prior performance. The concept of pay-for-performance is to provide monetary incentives that increase worker’s utility by
rewarding increased productivity (Baker et al., 1988; Rost & Osterloh, 2009). A common failure of most prior studies was examining total compensation rather than specific incentives against performance metrics such as investment in R&D and PP&E. Prior pay-for-performance studies measured changes in total CEO compensation to various financial and market metrics (Bebchuk & Grinstein, 2005; Jensen & Murphy, 1990a), ownership structures (Hambrick & Finkelstein, 1995), and board independence and structure (Abels & Martelli, 2013).
One group of incentive mechanisms prescribed by agency theory to align principal and agent goals is equity-based. However, EI compensation relates directly to absolute returns and not relative returns (Baker et al., 1988). Lambert and Larker (1987) noted that stock price is not an ideal measure of agent performance because of the noise in the stock price, and suggested change in ROA as a better measure of performance. Bolton, Scheinkman, and Xiong (2006) found the optimal compensation contract overemphasizes short-term stock performance and induces managers to take actions to increase the speculative component of stock prices.
Compensation packages that include equity-based options can lead to rewards based on general market trends instead of performance (Bebchuk & Grinstein, 2005; Rajgopal et al., 2006). Cheng and Indjejikian (2009) adjusted stock returns based on a regression of returns on the value-weighted market return for each 2-digit SIC. What remained were the returns due to the CEO’s performance. They found most of the returns were due to luck and not CEO decisions. Garvey and Milbourn (2006) found executives benefit more from a rising stock market than they are penalized in a declining stock market. Bebchuk and Spamann (2010) examined the
relationship between equity-incentive compensation and capital structure of banks and found the CEO’s ability to share in gains and be insulated from losses from equity price declines
incentivizes risky behavior beyond shareholder-desired levels.
Changes in price-earnings (P/E) multiples also affect stock performance. Bogle (2008) noted the market P/E for the S&P 500 increased from eight to 32 during the 1980s and 1990, and accounted for approximately 7.5%, more than half, of the annual return during the two decades. During the same period, corporate earnings grew at only a 5.9% annual rate. The majority of the increase in stock prices during the period was the result of changes in market psychology and not CEO performance.
Peng and Roell (2013) posited stock performance might not be a good measure of CEO performance or incentive strengths because of uncertainty regarding manipulation of reported performance. Benmelech, Kandel, and Veronesi (2010) stated “earnings management,
misreporting and restatements of financial reports, and outright fraudulent accounting” (p. 1772) are associated with stock-based executive compensation. The clawback provisions of the
Sarbanes-Oxley Act of 2002 were enacted because of manipulation and misconduct of executives (Bogle, 2008; Peng & Roell).
Finally, there is an issue with compensation structures differing by country and not explained by agency theory. For example, stock options are less necessary to solve agency problems in Japan and most of Europe (excluding Great Britain) because of concentrated ownership (Baeten et al., 2011) and differing social norms and mores (Crossland & Hambrick, 2011; Van Essen, Heugens, Otten, & Van Oosterhout, 2012). While agency theory supports lower levels of stock options in firms with high levels of ownership concentration, the theory does not address institutional effects (i.e., social norms and mores) on compensation contracts. Limiting companies to those based in the US places all companies under the same social and legal forces.
Lambert et al. (1993) correlated pay-for-performance with both stock market and accounting performance measures for 303 large publicly traded US manufacturers and service organizations. They found the accounting measure regression coefficient significantly higher than the stock market regression coefficient. Keller (2013) examined publicly traded companies in Wisconsin and, for 2010, found no relationship between changes in executive compensation and stock price, but did find a relationship between changes in executive compensation and firm net income.
Kaplan (as cited in Dillon, 2009) posited total CEO compensation overestimates
compensation because it includes pay estimates the CEO cannot spend; therefore, take-home pay is a more appropriate measure of CEO compensation and pay for performance assessments. Income tax was one factor leading to Kaplan’s conclusion. Details of the effects of tax laws on compensation structures are in the tax and regulation review below.
Patton (1961) suggested company size, industry, and the importance of the CEO’s contribution to decision making determine CEO compensation. Firm size is the largest single
factor affecting executive compensation, accounting for more than 40% of the variance in total CEO compensation (Tosi et al., 2000). Firms with high RI paying more than firms with low RI (Hannon et al., 1990) may reflect the importance of the CEO’s contribution to decision-making. Kole (1997) found food and chemical manufacturing industries had significantly different RI. Selecting large firms within these two industries for this research study allowed investigation of CEO incentive compensation with regard to industry, size, and importance of the CEO’s
contribution to decision-making vis-à-vis RI.
Rather than examining total compensation and performance, disaggregating
compensation components provided an opportunity to examine behaviors such as investment in R&D and PP&E as determinants of EI compensation, and outcomes such as gross profit margins and net income as determinants of NEI compensation. While the CEO is not responsible for all R&D and PP&E decisions, the CEO is responsible for the implementation of corporate strategy. Therefore, comparing behaviors and outcomes between similar organizations at the corporate level provides a meaningful hurdle for determining CEO performance as determinants of incentive compensation.
According to Bebchuk and Fried (2004), public companies have so many layers of stakeholders, and the individual shareholders are at such a disadvantage in terms of distance from decision making, pay and compensation practices have become a negative for United States public companies. Bebchuk (2013) further argues “insulating boards serves long term value” (p. xx) is a myth often used by proponents of the current pay-for-performance structure. Principals have a difficult time, according to Jones (2004), judging the effectiveness of management. Complex long-term and short-term factors related to performance have been studied by many
researchers (Aboody & Kasznik, 2000; Aggarwal & Samwick, 1999; Baum, Sarver, & Strickland 2004; Cordeiro & Veliyath, 2003; DeFusco, Johnson, & Zorn, 1990).
The resulting landscape has seen new regulation by the United States Government. The Sarbanes-Oxley Act of 2002 was meant to curb senior executive compensation by providing the public with more information and scrutiny of the process. According to Bebchuk and Fried (2004), the increased public information resulted in an increase in senior executive compensation as senior executives began to compare their salaries against other senior executives and demand more. This is the concern Friedman (2008) argued would occur with regard to agency theory.
The American Recovery and Reinvestment Act, on February 17, 2009, was signed into law limiting senior executive pay and compensation for financial firms that accepted TARP funds. This resulted in many companies attempting to pay back TARP funds as quickly as possible. According to Jones (2004), a manager might prefer to pursue an initiative that maximizes short-term results where the principal might pursue a strategy that maximizes long-term goals. Shedding light on the difficult question of evaluating and delong-termining performance relative to the divergence of the goals of the principal to the agent is the essence of this research relative to agency theory.
Expectancy Theory
The bases of expectancy theories of motivation are expectancy, instrumentality, and valence (Vroom, 1964 as cited in Chen-Ming, Hu, & Nai-Tai, 2006). Expectancy is the relationship between effort and performance. Instrumentality is the link between performance and rewards. Valence is the value of the rewards compared to the efforts required to attain them. Incentive systems must establish strong relationships between expectancy, instrumentality, and
rewards (Chen-Ming et al.), indicating the individual must be able to influence the outcomes associated with the performance criteria (Milkovich & Milkovich, 1992). There must be line-of-sight (Lawler, 1990) between the outcome and the reward, and the agent must have control or influence over the outcome (Holmstrom, 1979; Mirrlees, 1976) for a contingent reward to be effective. An agent may reduce effort or take actions to reduce his risk if there is low
instrumentality (Miller, Wiseman, & Gomez-Mejia, 2002), while high instrumentality reduces social loafing by individuals and teams (Shepperd & Taylor, 1999). Understanding the
relationship between performance and desired rewards enhances employee performance
(Larraza-Kintana, Gomez-Mejia, & Wiseman, 2011; Ungson & Steers, 1984). The principal must ensure the appropriate linkage between the desired behaviors and outcomes and the agent’s rewards. For example, some authors felt a focus on profitability led to a short-term strategic orientation (Bebchuk, 2010; Murthy & Salter, 1975; Stonich, 1981) rather than longterm investment (Rappaport, 1978).
Expectancy theory describes the relationship between individual effort and the value of a reward, so the principal must ensure the compensation structure provides the appropriate
incentives for the firm’s CEO. Pay may have different symbolic meanings under different contingency relationships, and affect motivation (Mahoney, 1991). Differences between
individuals may affect reactions to agency controls (Begley & Lee, 2005). Guth and MacMillan (1986) found evidence middle managers may redirect, delay, or even sabotage organizational strategies when their self-interest was compromised. Therefore, contingent compensation must include considerations of the agent’s values.
To reduce systemic risk exposure without reducing the agent’s incentives (Antle & Smith, 1986, Gibbons & Murphy, 1990), the basis of management compensation should be
performance relative to all firms or firms in the same industry (Baker et al., 1988). Homogeneity of comparison firms is critical to relative performance evaluation (RPE) (Albuquerque, 2009; Barakova & Palvia, 2010). The ability to respond to external shocks includes a firm’s
technology, complexity, and access to external credit, and is a function of firm size
(Albuquerque). To ensure homogeneity of comparison firms in this study, the basis of company selection was the NAICS from which the major source of revenue was earned. Level of RI and size, based on sales and assets, further homogenized the comparison groups.
Contingency Theory
According to Qiu, Donaldson, and Luo (2012), size, diversification, and task uncertainty are some of the contingency variables affecting organizational structure. Organizational structure variables such as specialization, formalization, decentralization, and divisionalization have contingent effects on performance. For example, the larger an organization, the more layers of management and the more decentralization. Organizations with one or two products have fewer divisions, layers of management, and rules (formalization). As organizational product offerings grow, the organization decentralizes management and increases the number of divisions, layers of management, and formalization of rules (Qiu et al.).
Uncertainty affects formalization, specialization, and decentralization. Organizations can establish formal rules and highly specialized jobs for tasks with high certainty. Tasks with high uncertainty are not programmable with policies and procedures, so organizations must empower employees to make decisions, which requires greater decentralized decision-making (Qiu et al., 2011). Thus, even in the same industry, different organizations will have different organizational structures, different goals, and different compensation structures.
The more decentralized an organization, the “more reason there is to differentiate the reward systems of each group” (Salter, 1973, p. 101). In complex organizations, Fama and Jensen (1983) expected “delegation and diffusion of decision control as well as separation of decision management and control at different levels of the organization” (p. 308) below the top level of management because that is where the knowledge to make the decisions resides. Williamson (1975, 1985, as cited in Hoskisson et al., 1993) theorized multidivisional structures free “top level managers from operating responsibilities” (p. 326). As the number of divisions increases, financial controls of divisions replace subjective strategic controls (Hoskisson et al.).
As firms increase product diversity, financial performance measures are pushed down the management hierarchy. Therefore, as organizations diversify product offerings, the complexity of the organization increases, leading to decentralized practices and removing the top managers from operating decisions. Financial controls replace subjective controls at lower and lower management levels as complexity increases. Thus, the CEO’s actions with respect to specific financial decisions are not directly observable or the cost of obtaining information is prohibitive. In such cases, the bases of rewards are outcomes that are surrogates for behavior (Singh, 1985). However, surrogate measures such as company stock frequently used in pay-performance analyses have issues as noted in the agency theory subsection above.
Compensation incentives should be contingent on achieving prescribed behaviors and outcomes (Balkin & Gomez-Mejia, 1987a; Bettis, Bizjak, Coles, & Kalpathy, 2010; Lawler, 1990). Gerhart and Milkovich (1990) explored the consequences of base pay, bonus pay, and eligibility for long-term incentives on subsequent firm performance for firms operating under similar conditions. They did not find pay level associated with performance, but did find
al. examined equity-based awards and found those with contingent-vesting provisions based on “meaningful performance hurdles...provide significant incentives for executive[s]” (p. 3849). They also found firms using contingent-vesting provisions had better future performance than firms not using contingent-vesting provisions.
If there is a decoupling of pay and performance, then agents may select performance measures and achievement levels that make the incentive almost guaranteed (Balkin & Gomez- Mejia, 1987a; Bebchuk & Fried, 2004; Crystal, 1991a), mitigating the effectiveness of the incentive. Additionally, CEOs may believe they are entitled to receive all of their incentives as part of their compensation (Balkin & Gomez-Mejia, 1987a; Bebchuk & Fried; Crystal), again mitigating incentive effectiveness. Balkin and Gomez-Mejia go so far as to suggest that annual bonuses may be to supplement annual salary, which then are not contingent on performance. Decoupled pay and performance would result in incentive pay not contingent on performance and small or non-significant relationships in ANOVA and regression analyses performed for this study.
The characteristics of the agent also affect the value of different incentives (Zajac, 1992). Behaviors are a function of perception, so understanding the values and needs of the individual CEO is important in designing a compensation package (Lawler, 1990). For example, deferred income plans could incentivize managers in the highest tax bracket with short times to retirement and a high likelihood of vesting, while deferred income would provide less incentive for younger executives who need the money today for homes, children, and savings (Patton, 1953). That is, the valence (from expectancy theory) for deferred compensation likely will be lower for young executives than those near retirement. CEO age or tenure could affect compensation structures,
but was not included in this study. However, because the incentive structure and not the total compensation was the focus of this study, the effects were insignificant to the study findings.
Human Capital Theory
Human capital is the skills, knowledge, and mental and physical abilities, the “imbedded resources” (p. 9) of an individual (Becker, 1962). Companies must recruit and motivate
individuals having the characteristics essential to success in their industry (Patton, 1961). The greater the human capital, the greater the performance level expectation and the greater the compensation (Agarwal, 1981; Hogan & McPheters, 1980). As noted in the History of the Corporation section above, as corporations grew from single productlocation to multiple product-location manufacturers, CEO roles changed, became more complex, and required greater human capital. However, the focus of most prior studies regarding human capital focused on total compensation and not the incentivizing of behaviors and outcomes.
Hogan and McPheters (1980) examined total compensation, excluding stock options, of the 45 highest paid US CEOs in 1975 and found a positive correlation between years as CEO and compensation. They suggested experience as CEO may be a form of training, increasing the CEO’s human capital and resulting in wage premiums. Deckop (1988) analyzed CEO
compensation from 120 firms from 1977 through 1981 and found a positive relationship between CEO compensation and profits as a percentage of sales, but found little effect from firm value, CEO age, or CEO tenure. Harris and Helfat (1997) examined non-contingent compensation, contingent performance compensation, and guaranteed deferred income for 305 successor CEOs in large US corporations for the period 1978-1987; however, they did not differentiate between EI and NEI.
One issue associated with executive compensation levels and pay-performance relationships may be that non-executive investors focus on performance over human capital factors while executive investors are more attentive towards human capital factors in determining executive compensation (Fleming & Schaupp, 2012). Most BoDs consist of executives from other organizations who would focus on human capital factors, according to Fleming and Schaupp. Uygur (2013) found human capital-intensive firms had higher overall compensation and more compensation tied to incentives than asset intensive firms did. In addition, he found lower pay performance sensitivity in human capital-intensive firms.
Murphy and Zabojnik (2006) examined CEOs hired for companies appearing in the Forbes annual surveys between 1970 and 2000. They found the number of CEOs hired from the outside increased from a low of below 10% in 1983 to a high of over 30% in 1999. They also found externally hired CEOs received a compensation premium of 6.5 percent in the 1970s, 17.2 percent in the 1980s, and 21.6 percent in the 1990s (p. 27). Hamori and Koyuncu (2013)
examined the three-year performance of CEOs of S&P 500 companies as of 2005 and found those with prior CEO experience averaged 48% lower ROA than those with no prior experience (p. 15).
Increasing hiring of and premiums for external CEO replacements and focusing on human capital by BoDs are potential explanations for rising disparities between CEO and worker compensation levels and the decoupling of pay and performance. The focus of this study was not on the amount of pay but the structure of the compensation package, specifically incentive allocations. While human capital factors may be used to rationalize increasing CEO compensation levels, they were beyond the scope of this study.
Institutional Theory
Berger and Luckmann (1967) posited institutionalization results from habitualization of human activities. Establishing a habit reduces stress by eliminating the need to consider choices regarding how to perform a task, providing time for innovation. Institutionalization is the “reciprocal typification of habitualized actions by types of actors” (p. 72), and “any such
typification is an institution” (p. 72). That is, institutionalization is a process of assigning similar meaning to a repeated action across participants (Scott, 1987).
Institutionalization increases as societies become more rational (Scott, 1987). Laws, rules, and regulations replace customs and traditions, and traditional forms of authority give way to nation-states, professions, and systems of laws (Scott). Meyer and Rowan (1977) posited formal organizational structures, such as compensation programs, have highly institutionalized contexts because modern society establishes rationalized concepts based on professions, policies, and programs. Legal and professional institutions provided the rationalization for
bureaucratization and other forms of homogenization in the second half of the 20th century (DiMaggio & Powell, 1983), and led organizations to employ prevailing societal practices and procedures, regardless of immediate efficacy, to increase the organization’s legitimacy and survival prospects (Berrone & Gomez-Mejia, 2009; Hambrick & Finkelstein, 1995; Westphal & Zajac, 1994). However, institutionalized practices can lead to the decoupling of formal structures and work activities (Meyer & Rowan).
Baker et al. (1988) and Jensen and Murphy (1990b) argued organizational and public political forces constrain compensation contracts. Jensen and Murphy posited these forces “operate in informal and indirect ways” (p. 3), which makes them difficult to document. Two institutions affecting compensation options are compensation consultants’ salary surveys and the
Federal government’s regulations and tax laws. Rappaport (1978) concluded resource
allocations, such as compensation, must consider “the coercive power of government regulation and its attendant ability to effect significant redistribution of wealth” (p. 88). Hall and Murphy (2003) concluded laws affected consideration of cash versus stock option incentives, and helped explain the “explosion in executive options grants in the 1990s” (p. 53). Walters, Hardin, and Schick (1995) offered suggestions for increasing compensation committee and shareholder leverage over CEO compensation contracts to “stem the threat of increased government intervention” (p. 227). Further, interactions with political groups and government regulatory agencies increase CEO role complexity and these interactions must be part of any comprehensive understanding of effective CEO reward systems (Ungson & Steers, 1984).
Management Theory
According to Wren (1994), management theory has progressed through four major eras to its present state. Early management theory developed around a cultural framework of economics, social, and political effects. The leaders who were most effective at organizing and developing resources gained political, social, and economic status.
Early “CEOs” were born into the position in the cultures of ancient China and Egypt. Rome and Greece developed leaders as managers based on merit. The advent of industrial growth led to changes in management theory that included the scientific approach. Frederick Taylor pioneered the concepts of efficiency and systemization in management thought beginning at Midvale Steel in early 1890s. Taylor’s philosophy of scientific management spread throughout the United States and led to developments in automation that Henry Ford later used to create the assembly line processes familiar today.
The social person era of management theory was a significant departure in terms of how leaders were able to organize and develop resources. According to Wren (1994), the work of Mary Parker Follet centered on the concept of “power-with instead of power-over the
workforce” (p. 260). Chester Barnard studied the nature of cooperative systems and applied the theories of Vilifredo Pareto, Kurt Lewin, and Max Weber to the analysis of organizations as cooperative systems. Wren (1994) stated that Barnard viewed executives as “interconnecting centers in a communication system that sought to secure the coordination essential to cooperative effort.” (p. 271).
The stock market crash and the ensuing depression that followed in the 1930s was a cultural facet of the social person theory of management. Wren (1994) stated that in 1929 over 48 million Americans were employed and only 1.5 million unemployed. The number of unemployed rose to 12.8 million by 1933. The political regime of Franklin Roosevelt tried to stimulate the economy through government intervention and the government became
increasingly involved in the economic life of managers and leaders.
The economic turmoil of 2007-2008 led the Obama administration in 2009-2010 to become more involved in the economic well-being of companies throughout the United States financial system. The administration developed a new position known as the pay czar. CEO compensation in relationship to the social person theory of management has become a focus throughout the United States economic system. In the modern era, efforts to improve
performance have created a series of academic schools of thought that Wren (1994) described as the operational school, the human behavior school, decision theory and mathematical schools, and the general management theory jungle. Research on CEO compensation and performance in
relationship to management theory continues to evolve around changing economic, social, and political landscapes.
Organizational Theory
Jones (2004) defined an organization as a “tool to coordinate actions to achieve a goal” (p. 28). He further stated that organizations create value by obtaining inputs such as raw materials, capital, human resources, and information and converting those into outputs that are released back to the organization’s environment, where the cycle continues. The senior
executives of an organization are directly responsible for the organizational structure described by Jones as the “system of task and authority relationships that control how people coordinate their actions and use resources to achieve organizational goals” (p. 34).
Boards and compensation committees often have difficulty evaluating senior executive performance measures (Epstein & Josee Roy, 2005). Jones (2004) suggested measuring organizational goals by “developing benchmarks in the relationship to the control of external resources, innovation through internal systems, and technical measures of efficiency” (p. 46). Chowdhury (2003) described the future of organizations in relationship to the talents of the workers and how managers and leaders leverage those talents into operational strategies. Leaders who can develop teams that can support and reinvent themselves as the environment changes help the organization continue to evolve as political, social, and environmental changes impact the organization. Chowdhury further described two-sided accountability in terms of getting informed as a leader and keeping others informed in the organization while conserving time and energy.
The concept of total rewards as opposed to compensation is described in terms of respecting shareholder value and putting that value in perspective relative to value creation within the organization. Schein’ (2004) approach focused on the development of a culture within the organization. Schein described three levels of culture: “visible organizational structure; strategic goals and philosophies; and unconscious, taken-for-granted beliefs, perceptions and thoughts” (p. 26). The effort to evaluate the three levels of culture within an organization can lead to significant insights into value creation. Schein described a ten-step process for assessing the culture of an organization and how leaders can embed and transmit cultural change.
Scott (2003) focused on the environments, strategies, and structures of an organization and defined them in terms of “rational systems that function on task information requirements and the development of basic coordination rules verses natural systems that are roughly
organized around social factors, the relationship between technology and structure and informal organizational design” (p. 246). Open systems transition between natural and rational
organizational design. Senior executives that can use the theory and technology of organizational design are, in concept, more successful and therefore more highly compensated.
CEO compensation and company performance have been subjects of research and multiple contentions for executives, stakeholders, and academic researchers alike. “Over the last 50 years executive pay in general and CEO pay in particular have shifted
dramatically…dependent on individual and company performance” (Hamm, 2009, p. 22). According to Hamm, CEO compensation has shifted from pay-for-time to pay-forperformance. Extensive data has been collected and research has been performed in that 50-year time frame concerning CEO pay and company performance. “Academic economists have long ago recognized the importance of understanding the issues involved in determining executive pay
and have been studying them for decades” (Jarque, 2008, p. 265). “Over the years, academics and consultants have proposed a number of…systems…developing the critical measures to guide long-term decisions [concerning pay and performance]” (Epstein & Josee Roy, 2005, p. 76).
Weiner and Mahoney (1981) studied 193 manufacturing firms over a period of 19 years to determine if the top leadership positions of the organization were important. The researchers used three performance standards for this study: profit performance, profitability, and stock prices. After discounting other factors, the researchers discovered that leadership accounted for 40% of the variance observed with profitability and stock prices. However, Weiner and Mahoney went on to address the need to identify the proper leadership variables appropriate for the
corporate level. They believed top leadership was primarily concerned with interacting with the organization’s environment and making strategic decisions. The variables associated with these responsibilities may more accurately reflect the impact of an organization’s top leadership (Weiner & Mahoney, 1981). This study is relevant because it calls for the proper leadership variables to be studied, without being all-inclusive regarding those variables. Weiner and Mahoney’s research proposed that the length of time a leader is in place is a relevant variable to the successful transformation of any organization. In their study, Hambrick and Mason (1984) sought an empirical relationship between top management and organizational outcomes by proposing a model to be tested. The researchers acknowledged that multiple disciplines (such as psychology, sociology, etc.) were involved when assessing top managers. Hambrick and Mason hoped stability among top managers would become apparent as paramount to an organization’s success. The researchers attempted to set themselves apart from previous research by showing the shortcomings, or the narrow vision, of prior research.
Summary
As firms grow in size and complexity, the impact of the external environment also increases and requires more of the CEO’s time (Cavanagh, 1987). In addition, Jensen and Murphy (1990b) noted “parties such as employees, labor unions, consumer groups, Congress, and the media create forces in the political milieu that constrain the type of contracts written between management and shareholders” (p. 254). Changes in tax laws significantly affected CEO compensation structures and total compensation (Lewellen, 1972; Long, 1992; Patton, 1965). Disparities in income levels between CEOs and average workers resulted in regulations (Long; Dew-Becker, 2009), union tracking and reporting of CEO compensation (AFL-CIO, 2013), and increased use of compensation surveys to legitimize CEO compensation contracts (Wade, Porac, & Pollock, 1997). A detailed description of the method and design of the study follows in Chapter 3.
Chapter 3: Research Method
This chapter presents the research method of the study. The chapter includes the hypotheses development using previous studies on CEO compensation and female board members. The chapter then presents the test model and descriptive statistics of data sample. In addition, the chapter presents the statistical tests that will be used to validate the hypotheses.
Hypotheses Development
The primary focus of this research is to determine whether there is a relationship between CEO compensation and female board members. It is important to achieve good control
mechanisms as well as right board composition (size and diversity) when using pay-for-performance or bonus elements in CEO compensation as these control mechanisms and board composition can greatly influence the quality of above elements of CEO compensation (Erhardt et al., 2003; Fahlenbrach, 2009; Campbell and Minguez-Vera, 2008). In particular, it is
suggested that females have tendency to influence the behavioral control tasks in a positive manner which eventually suggest that females are likely to be more superior and effects in activities with human and social aspect (Huse et al., 2009). In addition, it is shown that when conducting monitoring activities, female board members are more successful than their male counterparts (Adams and Ferreira, 2009). Moreover, Gill and Prowse (2010) argued that females are less influenced by the rewards or being rewarded which also pointed to the manner in which females assign awards. As for as risk taking is concerned, Ertac and Szentes (2011) revealed that females are likely to take same risks when give more information as their male counterparts. This pointed out that female board members in organizations have tendency to look for more
information or examine the available information in a great detail before they could present such information to boards in discussions or meeting and even when voting on board related
decisions. Fahlenbrach (2008) suggested that this in turn improves the quality of board, and with such improvement in monitoring quality, the equity related CEO compensation is expected to decline.
In light of above discussions, the first hypothesis of this study is to examine the whether there is impact of female directorship on compensation of CEO. Previous studies suggested that is difficult to quantify the effects of gender diversity since the synergy between two leads to increase in performance (Adler, 2002) while discrimination leads to its decline (Becker, 1993). Hence, the effect of female board members, as a minority, on the group as a total is difficult to determine in a linear fashion and could only be shown when acceptance of female board
members increases. Therefore, it is important to determine relative as well as absolute number of female board members in order to determine the respective relationship between specific output of CEO compensation and female board member representativeness. The consideration of absolute and relative numbers will enable to provide better results in the aforementioned effects of diversity. Apart from that, it is expected that with increase in female board members, the minority quality of board of directors increases while equity related compensation decreases. Therefore, the first hypothesis of this study is further divided to address both equity related and total compensation of CEO as well as the relationship with relative and absolute female board of directors as shown below:
H1a: Total amount of CEO compensation is negatively affected by the number of female
