Understanding the Determinants of Executive Compensation: An
Analysis on Dutch Listed Companies
Name: Cristina Ciobanu Student number: S2545861 Study program: MSc Finance Supervisor: Dr. Nassima Selmane
Abstract
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1. Introduction
Despite widespread public attention and research interest, the relationship between the executive compensation, board composition and firm performance is still insufficiently understood. The chief executive officer (CEO) is the highest-ranking executive in the company and their primary responsibilities include taking major corporate decisions, and managing the operations and resources of the company. A CEO is the main point of communication between the board of directors and corporate operations. Given that one person has so many responsibilities, a large amount of literature focuses on the agency theory. This theory addresses the issue of CEOs acting in their own interest instead of in the interests of the shareholders(Jensen and Meckling, 1976). This is because managerial actions are not perfectly observable. According to Jensen and Murphy (1990), shareholders tend to pay their CEOs much more than the average worker in order to give them incentives to take the actions that would lead to an increase in shareholder wealth.
On the other hand, the board of directors acts as an intermediary link between the managers and the shareholders. They take on the role of managing CEOs to make sure that they act in the best interest of the company. The board could have a big influence on the determination of executive compensation. This could be explained by the management power theory, widely discussed by Bebchuk, Fried and Walker (2002). According to this theory, boards engage at arm’s length transactions with executives over compensation plans. Such transactions help mitigate the agency problem. This creates compensation systems that align the interests of executives with those of the shareholders. However, Bebchuk and Fried (2004) argue that such practices rarely happen due to the power that CEOs have over the board members. This tends to influence board level decisions.
Executive compensation is important for evaluating investment opportunity. Executives who are paid improperly may not have the incentive to act in the interests of the shareholders. This could cost the shareholders too much.
3 1996; Okzan, 2007; Andres, Azofra and Lopez, 2005), board independence (Lambert, Larcker and Weigelt, 1993; Essen, Otten and Carberry, 2015), and supervisory board gender diversity (Bohren and Staubo, 2016; Brammer, Millington and Pavelin, 2007). Consequently, board characteristics of the management board include CEO duality (Essen, et. al, 2015) and whether or not the nationality of the executive is related to an Anglo-Saxon country (Cernat, 2004). CEO duality is only tested for the companies with unitary board type where both executive and non-executive members are included. As a robustness check, the companies in the sample were divided between unitary and two-tier board structures and the regression analysis was tested for each board structure. This is discussed in greater detail in the Methodology.
In addition to board characteristics, firm characteristics are also included in the regression analysis. They are tested as control variables in order to increase the reliability of the results. The following firm characteristics were considered: firm size (Nourayi and Mintz, 2008; Conyon and Murphy, 2000; Gabaix and Landier, 2008), stock performance (Mehran, 1995), debt level (Harvey and Shrieves, 2001), and growth opportunities (Mehran, 1995). Once again, the sample consists of large and mid-cap companies that are listed in the Netherlands.
The compensation data used in this thesis covers not only the compensation of CEOs, but also that of chief operational officers (COOs), chief financial officers (CFOs) and chair people. The aim is to capture the effect of board characteristics on all members of the executive board as their role in the company is equally important and complex. Just like the CEO, the CFO and COO also have to take major corporate decisions, and are responsible for managing the operations and resources of the company. However, the data on CFO and COO compensation is missing for a number of companies on this list since some in the sample do not have these positions on their management board (e.g. ArcelorMittal).
4 Veliyath and Neubaum, 2005). The aim of this thesis is to investigate whether board characteristics affect different types of compensation differently.
Beside the research interest, executive compensation is also a topic widely discussed by the public. It often revolves around the idea of whether the executives are being paid according to their merits. For example, in the beginning of 2018, the media made public that ING Bank had raised the salary of its CEO, Ralph Hamers, by more than 50%. This resulted in a total compensation of € 3 Million per year. ING received a lot of criticism as a consequence of this decision, causing an entire national scandal (NLTimes, 2018). It is known that executive pay is a sensitive topic for Netherlands, where the variable pay cannot exceed 20% of the fixed salary (PWC, 2018). However, in comparison to American CEOs of the largest banks, Ralph Hamers gets paid significantly less. For example, the CEO of JPMorgan, Jamie Dimon, made $ 29.5 Million in 2017, ten times more than ING’s CEO (Quartz, 2018).
A fact in the literature of CEO compensation is that US CEOs are paid significantly more than their foreign counterparts (Abowd and Kaplan, 1999), stating that the differences in compensation are excessive. Bebchuk, Fried and Walker (2002) see this as evidence for managerial power theory, where US CEOs influence the way they are being paid. However, Fernandes, Ferreira, Matos and Murphy (2013) argue that there are no significant differences in pay levels between US and non-US CEOs after controlling for firm, board, and ownership characteristics. They also examine for the difference in the structure of pay.
5 This thesis also discusses gender diversity among CEOs and whether there is a gender pay gap. Gender diversity is already considered for the supervisory board as one of the board characteristics which could affect managerial power (Bohren and Staubo, 2016). Additionally, this thesis also discusses the gender diversity among the executives. A summary statistic is provided in order to emphasize the difference in compensation among male and female executives. The reason gender diversity is discussed in this paper is due to the fact that the Netherlands has a minimum quota for women on the board composition as of January 2013. In compliance with Dutch law, the Netherlands aims for 30% of both board members to consist of women (Luckerath-Rovers, 2017). So far, six companies meet the target for both boards: Wolters Kluwer, BAM, DSM, PostNL, AkzoNobel and Heineken. This shows the efforts of the country to bring gender equality in the workplace. However, I believe that an important factor in gender equality is not only the female composition on the management board, but also compensation. Accordingly, the differences in compensation between male and female executives are analyzed. A study on companies listed on Compustat between 1996 and 2005 by Hill, Upadhyay and Beekun (2015) finds evidence that female CEOs receive greater compensation than male CEOs, which goes against the common belief, that females are paid less. This finding is based on a resource-based hypothesis, where CEOs take advantage of their minority status in order to receive higher compensation. Other studies (Gupta, Mortal and Guo, 2018) find no gender pay gap.
The results confirm that board characteristics do influence the executive compensation. They are, however, not always significant. Board size impacts negatively all three types of compensation but it is only significant for total compensation. Board independence does not affect total and stock-based compensation. Executive nationality seems to have the largest positive impact on all three types of compensation. Most of the board characteristics considered for the analysis are statistically significant when tested individually. However, they cease to be significant once controlled for the firm characteristics. Hence, an improvement of the model or a larger sample might give better results.
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2. Literature Review
This study discusses some of the main factors that influence the executive compensation. The theoretical literature has been widely discussing some of these elements, like, managerial power (Bebchuk et.al, 2002), board and firm characteristics (Fernandes et.al, 2013).
2.1. Board characteristics
This paper tests the effect of board characteristics on executive compensation. The supervisory and management board characteristics tested are in line with the management power theory (Bebchuck et.al, 2002; Essen et.al, 2015) where CEOs are expected to have power over their payment setting process. The aspects of the board that are believed to have effect on the managerial power are further discussed in detail.
One of these traits is the board independence of the supervisory board. The board of directors acts as an intermediary between the principal and agent, principal being the shareholder and agent, the manager. Their primary role is to make sure that the CEO acts in the interest of the shareholders, therefore avoiding the agency problem (Jensen and Meckling, 1976). But, if board members are more loyal to the management board, then the CEOs could exert power over the board of directors (Lambert et.al, 1993). Hence, if the board of directors consists of independent members, then it is expected that CEOs have less power of the board of directors as they are free from conflict of interest (Essen et. al, 2015). In this case the CEO compensation is expected to be lower. Boyd (1994) analyzes the effect of board control on CEO salaries and, indeed, concludes that CEOs are paid more in those firms where the level of control is lower. However, other studies show results contrary to the belief. Lambert et al. (1993) also discuss board control and find evidence that the CEO pay level is higher as the percentage of outside directors on the board is higher. Other studies (Essen at al., 2015; Core, Holthausen and Larcker, 1999; Harvey and Shrieves, 2001) find similar evidence. Management power theory mentions several ways that management board can still have power over independent directors. These include the role of the CEO in electing directors; close connections between the board members and dependence of independent directors on managers for inside information about the company (Bebchuk and Fried, 2004).
7 (1996) finds evidence that CEO compensation exhibits less sensitivity when the board size is large because a larger board is less likely to fire CEOs who show poor performance. A study on US companies by Core et al. (1999) finds positive relationship between board size and CEO compensation. Fernandes et.al (2013) in their study on both US and non-US firms find that the relationship between board size and CEO pay is positive only for the firms outside United States. Other studies also find positive relationship between board size and CEO pay (Okzan, 2007; Essen et al., 2015).
Gender diversity depicts the number of female directors on the board. It could also have an effect on the managerial power. According to Bohren and Staubo (2016) female directors tend to be more independent than the male directors. The sample in this study covers companies subject to gender balance law (GBL) which was implemented in France, Germany, Netherlands, Iceland and Spain in 2013. Since the gender ratio in the board has influence on the board independence, then it could also affect the executive compensation. There are no studies yet that analyze this relationship. In a study of UK companies, Brammer et. al (2007) find positive relationship between the proportion of female directors on a board and the board size.
CEO duality is another element discussed in this thesis as a factor that could affect executive compensation. Dual position is when an individual has both the role of the CEO and board chairperson (Essen et.al, 2015). CEO-chairperson can control what information reaches the board of directors (Bebchuk and Fried, 2004) which could increase the managerial power on the decisions of the board. This theory is confirmed by Boyd et. al (1994) who find a negative effect of CEO duality on board control. Another paper by Essen et. al (2015) find positive relationship between CEO duality and total CEO compensation. So far, the literature on the relationship between CEO duality and executive compensation is not rich and mainly covers US-based firms. That because US firms tend to adopt CEO duality more (Rechner and Dalton, 1991).
8 the management which could imply that CEOs have more power over how much they are being paid. Hence, the origin of the members of the management board could influence the way they operate the company which could eventually affect the compensation structure. In this thesis I will differentiate between the members of executive board that come from Anglo-Saxon countries and those who do not.
2.2. Firm characteristics
The relationship between board characteristics and executive compensation is controlled for firm characteristics. This section covers relevant literature concerning the structure of compensation and why it is relevant when discussing executive compensation.
First firm characteristic considered is the firm size. Nourayi and Mintz (2008) find evidence that firm size is a significant explanatory variable of CEO’s cash and total compensation regardless of how long they have been in this position and their performance measure. To a similar conclusion arrive Gabaix and Landier (2008) stating that CEO payment depends on the size of the firm as well as the aggregate firm size. In addition, Okzan (2007) and Conyon and Murphy (2000) finds that large firms pay their CEO more. But not all studies agree with these results. Based on the largest listed US companies between 1980 and 1994, Baker and Hall (2004) find that although CEO marginal product increases with firm size, the incentives are roughly the same or decline slightly.
9 percentage of executive compensation that is equity-based, stating that the form rather than the level of compensation is what motivates the managers to increase the value of the firm. In addition, Hall and Liebman (1998) find that stock and stock option holdings are highly responsive to firm performance and that the changes in pay and performance are entirely driven by changes in value of stocks and stock options. However, not all research agrees with these results. Matolcsy and Wright (2011) find that both cash and equity-based compensation can be efficient depending on firm characteristics. Others distinguish between stock and stock options. Based on a research on 450 Standard and Poor 500 firms over 1995-1997, Cordeiro et.al (2005) finds that stock options have a greater impact on firm performance than stock grants. This thesis will also look into the difference between different types of compensations and how are these related to board and firm characteristic.
Next firm characteristic used is the debt level which refers to the amount of borrowed money that the company uses to finance assets. Harvey and Shrieves (2001) find inverse relationship between incentive compensation and debt level as debt can serve as a managerial discipline device. Lastly, growth opportunities will be controlled for. In the study on the link between firm performance and executive compensation, Mehran (1995) uses growth opportunities as control variable and finds that the relationship is not affected by this variable. Similarly, Fernandes et. al (2013) who study the differences in pay premium between US and non-US firms also find no relationship with growth opportunities. Nevertheless, these studies do not focus on the Dutch companies solely. It is not excluded that this variable could have an effect.
3. Data and Methodology
3.1. Data compensation
The sample consists of a total of 49 large and mid-cap Dutch listed companies. The data on compensation was collected from the companies’ annual reports over the course of 10 years, between 2007 and 2016. The annual reports are publicly available on the companies’ official websites. Executive compensation is divided into base pay, bonus, stock grants, stock options, termination benefit, other performance compensation and other compensation.
10 Table 1: Compensation summary statistics
Average compensation for all the executives of the 49 companies in the sample for the course of 10 years starting 2007. Compensation for all CEOs, CFOs, COOs and chair people is included. The data on other members of the executive board with the exception of the CEO is not available for all the companies in the sample. Some companies, like ArcelorMittal, do not have the position of CFO or COO. Additionally, not all companies have data available for the whole period between 2007 and 2016. There is a total of 11 companies who don’t cover data for the entire 10 years.
On average members of the executive board are paid almost € 2 Million in total compensation. The compensation is mainly received in cash. Base pay and the bonuses cover 53% of the total compensation on average. Second largest part of the total compensation after base pay is stock-based compensation, consisting on average 27% of the total payment. Stock option-based compensation represents the smallest percentage of total compensation, namely 5%. This is because the number of companies that choose to pay their executives in the form of options is significantly lower than the number of companies that choose to pay in stocks. In addition, the majority of the companies in this sample have stopped paying their executives in option awards over the years. Hence, the median for option awards is zero. Other compensation includes pension funds, termination benefit, other performance compensation and other benefits.
(amount in €)
MEAN % MEDIAN MIN MAX
TOTAL COMPENSATION 1.987.661 1.394.414 53.838 24.198.000 BASE PAY 597.638 30 525.000 23.551 2.001.000 STOCK AWARDS 539.949 27 149.760 0 7.701.000 OPTION AWARDS 91.872 5 0 0 4.954.200 BONUS 463.358 23 463.358 0 4.292.000 OTHER COMPENSATION 310.134 16 144.500 0 18.635.000
3.2. Data Management Board
11 management board. Hence, the members of the executive board were divided by gender. A summary of their compensation was constructed. The summary statistics can be found in table 2a and table 2b. This section aims to address the issue of gender pay gap. Although the Netherlands makes an effort to include more female directors on the management board, they are still significantly underrepresented. Given this, I want observe whether they are also significantly underpaid compared to male directors.
Table 2a: Summary statistics of male and female compensation for CEOs and CFOs
The difference in compensation was calculated by subtracting the average female compensation from the average male compensation and was tested for statistical significance using the t-test. The values in parentheses are negative. There is a large difference in observations between the two groups. Approximately 3.5% of the total number of CEOs and 9% of total number of CFOs are female. Hence, female directors are significantly underrepresented on the management board. Nevertheless, female CEOs receive a significantly higher total compensation, stock awards and other compensation than male directors. Other compensation includes pension funds, social security, tax equalization and other benefits. It does not include termination benefits and other performance compensation given that these types of compensation cover only a small part of the total compensation and I believe them to be insignificant. Female CFOs tend to be paid less than male CFOs on average. The differences in compensation are only significant for base salary and other compensation.
(amount in €)
CEO: Mean Difference CFO: Mean Difference
Male Female Male Female
Total compensation 2.577.213 4.951.200 (2.373.987)*** 1.491.261 1.182.990 308.271 Base pay 725.127 812.471 (87.345) 493.859 423.827 70.032 * Stock awards 703.732 2.326.917 (1.623.186)*** 399.874 276.568 123.306 Option awards 143.944 0 143.944 61.161 52.476 8.686 Bonuses 632.441 767.607 (135.166) 331.807 284.773 47.034 Other 319.507 1.203.631 (884.124)*** 183.726 122.232 61.494 * Observations 406 15 336 33
12 the results when the sample is small, which could be the case for female CEOs. On the other hand, the t-test shows that the differences are significant. Based on that, it could be concluded that female CEOs are indeed paid more, which supports the resource-based hypothesis (Hill et. al, 2015). Based on this hypothesis, CEOs benefit from their minority status to receive higher compensation. Minorities, in this case women, are seen as less likely to “climb the corporate ladder” and when they do get an executive position, they tend to be treated (intentionally or not) differently than male executives (Hill et. al, 2015).
Table 2b: Summary statistics of male and female compensation for COOs and chair people The differences in compensation were calculated by subtracting average female compensation from average male compensation and were tested for statistical significance using t-test. Similar to previous results, females are underrepresented on the management board in the position of COO or chairperson. 7% of the total number of COOs and 9% of the total number of chair people are female. Male COOs receive a significantly higher salary, stock-based compensation, bonus and total compensation comparative to female COOs. However, the opposite holds for the chairperson position. Female chair people are paid significantly more in terms of salary, stock-based compensation, bonus, other compensation and total compensation.
(amount in €)
COO: Mean Difference Chairperson: Mean Difference
Male Female Male Female
Total compensation 1.292.571 450.333 842.238*** 1.622.784 6.748.657 (5.125.873)*** Base pay 476.488 350.000 126.488 ** 527.360 911.700 (384.340)*** Stock awards 337.989 0 337.989 ** 369.855 3.201.757 (2.831.902)*** Option awards 47.616 0 47.616 144.019 0 144.019 Bonuses 325.100 0 325.100 *** 337.407 980.900 (643.493)*** Other 152.363 100.333 52.029 183.856 1.654.300 (1.470.444)*** Observations 82 6 91 10
13 chairperson, females are paid more. Only female COOs and CFOs tend to receive lower compensation compared to the males in the same position.
3.3.Data Board of Directors
Data on board size, board independence and board gender diversity were extracted from BoardEx and Datastream. Table 3 illustrates the distribution of the size of the board of directors, the percentage of independent directors and the percentage of female directors. Table 3: Summary statistics board of directors
The data on board composition, diversity and independence was taken from Datastream. For the unitary board structure, the management board and the supervisory board are counted as one. For the two-tier board structure, management board and supervisory board are counted separately. Hence, for the unitary board, Datastream provides information on the entire board, including management board. For the two-tier structure, only the supervisory board is included. Since the unitary board structure does not allow separation of the management board from the supervisory board, both were included for these companies. Out of 49 companies included in this sample, 11 of them do not provide board data. From the remaining companies, 17% have a unitary board structure and 83% have a two-tier board structure. The two-tier board type is characteristic to companies headquartered in the Netherlands and the unitary board is characteristic of companies that are either headquartered outside the Netherlands or partly owned by the Dutch (for example, Unilever, Air France-KLM, Unibail Rodamco).
The majority of board members of the companies in this sample are independent. 63% of the board members in the sample are independent on average. The percentage of female directors is 17%, which is still below 30%, as imposed by Dutch Law. However, there are companies which exceed this percentage, where half of the board members are female.
Mean Median Min. Max.
Size of the board 8,1 7 4 18
Independent directors 63% 80% 0% 100%
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3.4.Firm Data
In this thesis, firm characteristics are used as control variables. The data on firm characteristics and performance were collected from Datastream. These include firm size, growth opportunities, debt level and stock return. The value for firm size was calculated as the natural logarithm of market capitalization, which refers to the market value of the company. It is calculated as the share price multiplied by the total shares outstanding.
Growth opportunities is another firm characteristic used as control variable. It represents the potential of the company to attract investment and projects that would lead to profit for the investor. Market-to-book ratio is documented to be a measure for growth opportunities. Firms with a higher market-to-book ratio have lower debt financing costs and borrow more (Chen and Zhao, 2006).
Debt ratio is calculated by dividing the total debt level by the total assets. It provides the percentage of the company’s assets that are supported by debt. The last control variable is stock return, which represents the company’s profitability. The formula for stock return is the appreciation of the price divided by the original price of the stock.
3.5. Methodology
The regression model used to test the relation between board characteristics and total compensation is the following:
Ln(total compensationit) = α + β1(board sizeit) + β2(board independenceit) + β3(board gender
diversityit) + β4(executive nationalityit) + β5(firm sizeit) + β6(growth opportunitiesit) + β7(debt
levelit) + β8(stock returnit)
where board size, board independence, board gender diversity and executive nationality are independent variables, and firm size, growth opportunities, debt level and stock return are control variables.
Board gender diversity is a binary variable which is one if the board member is male and zero if female. For unitary board structures, the management board is included, but for the two-tier board structure, the management board is excluded.
15 Regression models that include the same independent and control variables are used to test the relationship between board characteristics and stock-based compensation; and board characteristics and stock option-based compensation.
In order to test the robustness of the results, the companies are separated by unitary board structures and two-tier board structure. The relationship between board characteristics and compensation are tested again. This additional analysis aims to capture the differences between the two types of board structures. For the two-tier board structure, the same independent and control variables are used as in the main regression analysis. However, for the unitary board structure, an additional independent variable is added, which is CEO duality. When an executive takes the role of both CEO and chairperson in a unitary board structure, it is considered a dual position since they are considered to be the chairperson of the entire board, including the supervisory board. However, when the board is divided between supervisory and management board, it is no longer considered a dual position. In this case, the role of chairperson is only valid for the management board. The regression analysis that captures the relationship between board characteristics and total compensation for the unitary board structure is the following:
Ln(total compensationit) = α + β1(board sizeit) + β2(board independenceit) + β3(board gender
diversityit) + β4(executive nationalityit) + β6(CEO dualityit) + β6(firm sizeit) + β7(growth
opportunitiesit) + β8(debt levelit) + β9(stock returnit)
The same regression analysis is used to test the effect of board characteristics on stock-based compensation and stock option-based compensation.
4. Results
4.1. Total compensation
Results for the regression analysis on the effect of board characteristics on total compensation are presented in Table 4.
Table 4: Coefficient estimates for total compensation
16 Board size has a significant positive impact on the total executive compensation, but when it is controlled for firm characteristics, the relation becomes negative. Hence, as the board size increases, the total compensation slightly decreases. But this relation is only true for 6.28% of the data in this sample. Board independence has almost no effect on the total compensation. Board gender diversity has a positive significant impact on 3.38% of the observations but becomes insignificant and negative when controlled for firm characteristics.
Dependent variable: Total compensation Independent variables (1) (2) (3) (4) (5) Intercept 13.719*** (0.096) 14.264*** (0.057) 14.141*** (0.049) 13.579*** (0.106) 11.649*** (0.233) Board size 0.076*** (0.011) 0.064*** (0.012) -0.026* (0.014) Board Independence 0.001 (0.001) 0.001 (0.001) -0.000 (0.001) Gender board diversity 0.011*** (0.002) 0.008*** (0.002) -0.001 (0.002) Executive nationality 0.236*** (0.079) 0.261*** (0.079) Firm size 0.352*** (0.031) Growth opportunities 0.013 (0.011) Debt level -0.006*** (0.002) Stock return -0.083 (0.083) Adjusted R2 (%) 6.28 0.15 3.38 9.31 29.74 F-statistics 44.86 2.00 23.89 17.76 29.73 Observations 656 654 656 654 544
Asterisks indicate significance at 0.01 (***), 0.05 (**) and 0.1 (*) levels, two-sided test
Given the results, board characteristics affect only a small portion of the sample. Only board size and executive nationality significantly affect total compensation.
17 effort to come to an agreement (Zahra and Pearce, 1989). Additionally, a larger size of the supervisory board could diminish managerial power leading to managers having less influence over the decisions of the supervisory board.
The results show that executives who come from Anglo-Saxon countries are paid more in comparison with others. This could be due to differences in corporate governance structures (Cernat, 2004). In Anglo-Saxon companies, managers have more managerial power due to dispersed equity holding and broad management responsibilities (Cernat, 2004). Given their executive position, nationals of Anglo-Saxon countries could influence in some way the companies they lead even if the company is not Anglo-Saxon. Wage theory could also explain this relationship.
4.2.Stock-based compensation
Results of the regression analysis on the effect of board characteristics on stock-based compensation are illustrated in Table 5.
Table 5: Coefficient estimates for stock-based compensation
The effect of board size, board independence and gender board diversity on stock-based compensation were tested individually. Since not all companies reward their managers in the form of stocks, the number of observations has decreased to 473.
18 Dependent variable: Stock-based compensation
Independent variables (1) (2) (3) (4) (5) Intercept 11.748*** (0.207) 12.916*** (0.112) 12.560*** (0.105) 11.435*** (0.227) 9.550*** (0.524) Board size 0.155*** (0.025) 0.140*** (0.026) -0.011 (0.035) Board Independence 0.001 (0.002) 0.001 (0.001) -0.000 (0.002) Gender board diversity 0.022*** (0.005) 0.017*** (0.004) 0.003 (0.005) Executive nationality 0.280* (0.156) 0.353** (0.165) Firm size 0.411*** (0.074) Growth opportunities 0.052** (0.022) Debt level -0.012*** (0.004) Stock return 0.146 (0.195) Adjusted R2 (%) 7.47 -0.07 4.79 11.17 18.80 F-statistics 39.10 0.66 24.74 15.78 12.64 Observations 473 471 471 471 403
Asterisks indicate significance at 0.01 (***), 0.05 (**), 0.1 (*) levels, two-sided test.
Except executive nationality, none of the board characteristics are significant after controlling for firm characteristics. Although still negative, as in table 4, board size does not have a significant impact on stock-based compensation. The independence of the board does not seem to affect compensation, which contradicts previous literature discussed in this paper (Essen et. al, 2015; Harvey and Shrieves, 2001) which finds evidence that executive compensation is higher as the percentage of outside directors is higher.
19 Moreover, managers of Anglo-Saxon companies tend to have dispersed equity holdings (Cernat, 2004). Knowing this, shareholders might be tempted to pay managers that come from Anglo-Saxon countries higher levels of stock-based compensation in an attempt to increase their equity holdings in one particular company. This could motivate managers to stay in the company.
4.3. Stock option-based compensation
Results for the regression analysis on the effect of board characteristics on stock option-based compensation are summarized in Table 6.
Table 6: Coefficient estimates for stock option-based compensation
The effect of board size, board independence and gender board diversity on stock-based compensation were tested individually. Since not all companies reward their managers in the form of stock option-based compensation, the number has decreased to 119.
20 Dependent variable: Stock option-based compensation
Independent variables (1) (2) (3) (4) (5) Intercept 12.361*** (0.509) 12.131*** (0.474) 13.189*** (0.171) 12.502*** (0.595) 11.049*** (1.464) Board size 0.009 (0.056) 0.005 (0.050) -0.008 (0.071) Board Independence 0.004 (0.005) 0.007 (0.005) 0.012** (0.006) Gender board diversity -0.055*** (0.009) -0.055*** (0.010) -0.050*** (0.011) Executive nationality 0.246 (0.360) 0.100 (0.429) Firm size 0.102 (0.190) Growth opportunities -0.101 (0.012) Debt level 0.010 (0.011) Stock return 0.081 (0.362) Adjusted R2 (%) -0.83 -0.46 22.15 21.83 19.58 F-statistics 0.03 0.46 34.58 9.24 4.29 Observations 119 119 119 119 109
Asterisks indicate significance at 0.01 (***), 0.05 (**), 0.1 (*) levels, two-sided test.
Since the number of observations for stock option-based compensation is significantly lower than for total and stock-based compensation, the results could be less reliable. In addition to that, they are slightly different than the previous results where gender board diversity was not significant and executive nationality was significant for both total and stock-based compensation.
21 There is a negative relationship between gender board diversity and stock option-based compensation meaning that a high percentage of female directors on the supervisory board leads to a lower stock option-based compensation. This could also be a representation of the period closer to 2007, before the Netherlands joined GBL which required a minimum of 30% of the board members to be female. This could indicate that back in 2007, females were highly underrepresented on the supervisory board.
Generally, board characteristics, except board independence, tend to have significant impact on all three types of compensation when tested individually. Once tested for firm control variables, they cease to be significant. On the other hand, firm characteristics have a significant impact on all typed of compensation, less so on the stock option-based compensation. This may suggest that the model needs improvement. In addition, the results for stock option-based compensation do not match those for stock-based and total compensation. Data limitations may affect building accurate measures for stock option-based compensation.
4.4. Robustness check
The companies included in the sample use two types of board structures: unitary and two-tier. The difference between these two types of structures is important to consider since they affect variables like board size and gender board diversity. The unitary board structure does not distinguish between the management board and the supervisory board. As a result, it could affect the results if companies with this type of board structure are included in the same sample as companies with a two-tier board structure. Hence, the two are separated into two samples and tested separately. The results are presented in table 7 and table 8.
Table 7: Coefficient estimates for unitary board structure
22 executive compensation. This also related the board independence variable. Female directors tend to be more independent (Bohren and Staubo, 2016), which diminishes the power of the executives. CEO duality affects the compensation positively and significantly for total and stock option-based compensation. Since the CEO also acts as the chairperson of the supervisory board, it increases his/her influence over the decisions of the board giving him/her more power and control. Executive nationality affects the compensation negatively and significantly for total compensation. This could be due to another aspect of the governance structure of Anglo-Saxon companies that has not yet been discussed through the course of this thesis.
Dependent variable Independent variables Stock-based
compensation Stock option-based compensation Total compensation Intercept 19.518** (7.289) 29.869*** (8.956) 8.358*** (2.143) Board size -0.272* (0.147) -0.041 (0.152) -0.078 (0.049) Board Independence -0.010* (0.006) -0.040** (0.017) -0.002 (0.002) Gender board diversity 0.008
(0.016) 0.037 (0.022) 0.010* (0.006) CEO duality 0.233 (0.565) 0.745*** (0.251) 0.304* (0.181) Executive nationality -0.512 (0.322) -0.107 (0.335) -0.498*** (0.146) Firm size -0.121 (0.505) -1.495* (0.754) 0.744*** (0.141) Growth opportunities 0.644*** (0.213) -0.029 (0.328) -0.008 (0.048) Debt level -0.090** (0.041) -0.000 (0.031) -0.014 (0.013) Stock return -0.920 (0.710) 0.727 (0.549) -0.313 (0.221) Adjusted R2 (%) 57.02 46.17 77.52 F-statistics 9.11 4.24 32.80 Observations 56 35 84
Asterisks indicate significance at 0.01 (***), 0.05 (**), 0.1 (*) levels, two-sided test.
Table 8: Coefficient estimates for two-tier board structure
option-23 based and total compensation, these effects are significant. This is in line with the previous literature (Core et. al, 1999; Fernandes et. al, 2013). Moreover, the managerial power of the supervisory board could decrease as a result of the increase on the supervisory board size, because it creates inefficiency and communication problems (Bebchuck and Fried, 2004). As a result, managerial power over the supervisory board increases. Board independence has a positive effect on all types of compensation. Managers can still exert power over the independent directors who rely on them for inside information about the company (Bebchuck and Fried, 2004). Gender board diversity has a statistically significant and negative effect only on stock option-based compensation. As in previous results, this could be a result of the fact that option-based compensation is more characteristic of the period before the financial crisis and less about today. It could indicate a large underrepresentation of the females on the supervisory board. The results for executive nationality are conflicting. It affects the stock-based and total compensation positively and significantly, while the effect on stock option-based compensation is negative and significant. This effect cannot be explained based on the literature discussed in this thesis. It could be attributed to governance structures of Anglo-Saxon companies that were not discussed in this thesis.
Dependent variable Independent variables Stock-based
compensation Stock option-based compensation Total compensation Intercept 9.425*** (0.684) 11.363*** (1.611) 12.201*** (0.318) Board size 0.063 (0.051) 0.195** (0.080) 0.064*** (0.025) Board Independence 0.002 (0.002) 0.014** (0.006) 0.002* (0.001) Gender board diversity 0.006
(0.007) -0.073*** (0.011) -0.002 (0.004) Executive nationality 0.532*** (0.190) -2.909*** (0.527) 0.231** (0.098) Firm size 0.308*** (0.095) -0.195 (0.211) 0.181*** (0.047) Growth opportunities 0.037 (0.023) -0.089 (0.111) 0.009 (0.012) Debt level -0.003 (0.005) 0.066*** (0.017) 0.000 (0.003) Stock return 0.479** (0.231) 0.188 (0.299) 0.176 (0.113) Adjusted R2 (%) 17.58 68.89 19.37 F-statistics 7.22 18.16 11.27 Observations 272 63 343
24
5. Conclusion
Compensation contracts are a way to align the interests of shareholders with those of the managers. Executive compensation has often been a topic that generated a lot of attention from the public. Similar to the case described in the introduction about the CEO of ING, every year when executive compensation data is made public, there is going to be debate around this topic. Who got the biggest raise? Was a specific CEO paid too much? Who were the highest paid CEOs?, and so on. In addition to that, executive compensation is also a topic of research interest. Studies show that there are multiple factors that determine influence how much are the executive managers paid. Board characteristics like the size of the board (Core et. al, 1999), board independence (Lambert et.al., 1993), board gender diversity (Brammer et. al, 2007) are among some of those determinants. Other attributes, like firm size (Nourayi and Mints, 2008) CEO duality (Boyd, 1994) and growth opportunities (Mehran, 1995) are also considered. There is little research, however, on European countries, especially on Netherlands specifically. Most of the literature focuses on US firms. However, there are studies that focus on US as well as non-US firms (Fernandes, et.al, 2013) in order to cover the differences in compensation between the two.
This paper provides empirical evidence on how board characteristics affect the executive compensation. The sample consists of 49 large and mid-cap Dutch listed companies. Data covered includes the time period between 2007 and 2016. Based on the results, a large board size does not indicate that executives are paid more, on the contrary, they are paid less. This is not in line with the literature discussed in this thesis (Core et. al, 1999; Fernandes et. al, 2013) based on which there is a positive relationship between the board size and CEO pay. Board size only has a positive effect on the compensation of the executives of companies with two-tier board structure. Furthermore, an independent board of directors does not indicate a lower executive compensation as it was expected given the literature (Core et. al, 1999; Harvey and Shrieves, 2001). In fact, the relation between board independence and compensation is very weak, except for the stock-option-based compensation.
25 board. This could explain the negative relationship. Lastly, an executive coming from an Anglo-Saxon country is paid more comparative to other executives.
The coefficients for board characteristics tend to have significant effect on all three types of compensation, when tested individually. Once controlled for firms, size, growth opportunities, debt level and stock return, they cease to be significant. Changes in the model or in the sample size could improve these results.
The main limitation of this paper is the data. Since the aim of this thesis was to focus on Dutch listed companies only, the data was limited to only 50 companies in total. For one company, data on executive compensation could not be found. For other 11 of these companies the data on board characteristics was not available on Datastream. In addition, some of the firms either got listed recently (Takeaway, Flow Traders) or were founded recently (GrandVision), therefore, it was not possible to gather information on compensation for all 10 years for these companies. Lastly, not all companies have a CFO or a COO on their management board (ArcelorMittal, Air France-KLM). This means that the data could be more representative for CEO than for the rest of the members of the board.
An area for future research may focus on the executive compensation in other European countries. Since countries in European Union tend to trade a lot between each other, they could have influenced each other in their way of governing a company. This may also give more insight about why executives who come from an Anglo-Saxon country are paid more.
26
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