Executive incentive compensation with regards to CEO departure

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Executive incentive compensation with regards to CEO departure

Name: Sarahna Oemrawsingh

Student number: 11301791

Thesis supervisor: dhr. dr. Georgios Georgakopoulos Date: June 25th 2018, First Draft

Word count: 13634,

MSc Accountancy & Control, specialization Accountancy Faculty of Economics and Business, University of Amsterdam

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2 STATEMENT OF ORIGINALITY

This document is written by student Sarahna Oemrawsingh who declares to take full responsibility for the contents of this document.

I declare that the text and the work presented in this document is original and that no sources other than those mentioned in the text and its references have been used in creating it.

The Faculty of Economics and Business is responsible solely for the supervision of completion of the work, not for the contents.

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3 ABSTRACT

This thesis concentrates on the short horizon that CEOs have due to their retirement and whether moving form bonus compensation towards stock based compensation would mitigate the horizon problem. Another aspect of this study is the independence of compensation committees and whether they recognize the horizon problem. The data is collected from three databases within the WRDS database (Exucomp, CompuStat, ISS). This thesis focuses on the post-SOX period between 2007-2016. This timeframe was chosen, because ISS delivers information about compensation committees starting from 2007. A sample of 4213 observations are used for this research to regress 2 models for both bonus compensation and stock-based compensation. The data is based on North America. The results show that the short horizon and compensation committees are positively and significantly related to stock-based compensation. In other words, the compensation committees do recognize the horizon problem and try to mitigate this. They do this by providing more stock-based compensation, seen as this is a future-based compensation and doesn’t incentivize CEOs to focus on the short-term. This is not the case for bonus compensation.

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Tables:

Table 1: Compensation contracts ……….15

Table 2: Overview papers ………...20/21 Table 3: Final sample selection ………27

Table 4: Overview of variables and measurements ………..30

Table 5: Predicted effects of the variables ………31

Table 6: Pearson correlations ………...33

Table 7: Recognition horizon problem ……….33

Table 8: Descriptive statistics ………...34

Table 9: Average amount of compensation per SIC industry ………...34

Table 10: OLS regression table stock-based compensation ………..35

Table 11: OLS regression table bonus compensation………....36

Table 12: VIF test……….47

Figures:

Figure 1: Libby box………...25

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1 INTRODUCTION

This chapter is an introduction of the research that will be conducted. In this chapter I will write about the background information of the important elements of the research. This research emphasizes the switch from a bonus compensation to a stock-price related incentive as executives depart the firm. Furthermore, I motivate the choice for choosing this specific research. Lastly, I will research if incentive compensation moves away from bonus compensation and toward stock-price related incentives as CEOs approach retirement.

1.1 Background information

My research is based on the following aspects: incentive compensation, stock-based incentives, horizon problem and the compensation committee. These elements have been investigated in different ways in different studies. Some of these aspects have been broadly investigated, thus offer broad literature. To get a better understanding of the research, I shall present the background information of the aspects mentioned.

Before starting with the topics incentive compensation, stock-based incentives and others, I would briefly like to enlighten why these incentives are necessary in the first place. Starting with the so called agency theory. This theory describes an agency relationship as a contract in which one or more principal(s) engages with an agent to perform decision making authority to that agent (Jensen & Meckling, 1976). This is the delegation of decision rights from the principal to the agent. A classic example of the principal-agent problem is that which arises when there is a conflict of interest between a shareholder of a publicly owned organization and that organization’s chief executive officer (CEO). Jensen and Murphy (1990) argue that if shareholders had accurate and complete information concerning the CEO’s activities and the firm’s investment opportunities, they could design a contract stating and implementing the managerial action that has to be taken. Scholars have stated that if corporations want to realize their objectives, executives must be properly motivated with financial incentives (Jensen & Meckling, 1976). The separation of ownership and control in the organizations has created agency problems for shareholders. One option to be able to align the decisions of the managers with the interest of the shareholders is with the use of compensation systems as stated earlier. Researchers stated that top managers will only perform well and keep the interest of the shareholders in mind if they are handed incentive contracts than link their wealth to changes in firm value (Liao, 2011; Jensen & Murphy, 1990)

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8 The capability of incentive compensation to encourage the right managerial behaviors and influence organizational performance is a main focus of executive compensation (Han Ming Ching, Rodgers, Shih, & Song, 2012). In contrary to what is expected of the normative agency theory explained by Jensen and Murphy (1990), recent studies have showed that specific forms of incentive compensation, for example executive stock options, can actually motivate managerial behaviors that are believed to be unwanted, such as earnings manipulations (Jensen & Murphy, 1990). Sloan states that top executive compensation is unambiguously associated to earnings through annual bonus plans and long-term performance plans (Sloan, 1993). The objective of stockholders is the maximization of the firms’ value, stock-price-based incentives is seen as the most leading way in providing incentive alignment (Sloan, 1993). However, firms use both stock-price-based incentives and accounting-earnings-based incentives. The focus in this thesis is based on stock-price-based incentives.

Recent development in executive compensation practices of US organizations has presented a significant increase in the use of executives’ compensation packages (Hall & Liebman, 1998). By using equity-based compensation, managers are motivated to act on behalf of shareholders, because in this way the agent’s wealth is directly tied to the company’s stock performance (Liao, 2011). If these equity compensation plans are well designed, it provides powerful and effective incentives to managers that support the alignment of the parties interests with those of shareholders (Ng et al. 2011).

Also part of this thesis is the element of the horizon problem. The horizon problem indicates that earnings-based performance measures give executives the incentive to concentrate on short-term performance (Dechow & Sloan, 1991). Dechow and Sloan state that one group of executives who are likely to put less focus on future earnings are those who have a short horizon (Dechow & Sloan, 1991). This is because they are expecting to leave their position in the organization in the close future. These executives are incentivized to boost their short-term earnings, by rejecting the positive net-present-value investments.

1.2 Research question

The goal of this thesis is to look into the possibility executive incentive compensation goes from earnings-based compensation toward stock-price related incentive when the executive approaches retirement. The independent variable will be the short horizon and the dependent variable will be executive incentive compensation.

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9 There are other studies conducted that also focus on the elements that have previously been discussed. In the paper of Dechow and Sloan (1991) named ‘Executive incentives and the horizon problem’, the paper investigated the hypothesis that CEOs in their last years of office are organizing discretionary investment expenditures to improve short-term earnings performance (Dechow & Sloan, 1991). By focusing more on the incentive side of bonus compensations and stock-price based incentives, my research will add to the existing literature. The research question of this thesis is: Does executive incentive compensation change from

bonus compensation to stock-price related incentives as a CEO departs the firm?

1.3 Contribution to the literature

This paper makes the following contributions to the existing research. Firstly, this research provides information and focuses on making the reader understand what the purpose of earnings in top executive compensation contracts is and the horizon problem. Many studies have only focused on incentive compensation as a whole or on accounting based compensation with regards to the horizon problem (Dechow & Sloan, 1991; Camara, 2009; Brooks et al. 2001). Another study by Dikoli et al. (2003) only focused on equity based compensation. This study broadens this by taking both type of compensation into one regression model and comparing it to the horizon problem, even though they are influenced by the CEO. Thirdly this thesis adds to the corporate governance literature generally. We touch upon firm characteristics that influence compensation committee quality. In a study that concentrates on the influence of ownership structure on compensation committee independence, the independence is measured by the proportion of independent directors that are present on the board (Newman, 2000). Following the year 2003, the US major stock exchanges changed their listing rules requiring the compensation committees to only consist of independent directors (see NYSE Corporate Governance 303A.05, NASDAQ Rule 4350(c), and AMEX Enhanced Corporate Governance Rules Sec. 805). This resulted in the study of Newman (2000) being invalid under the new requirements. Hereby, letting this thesis contribute to the literature by measuring the quality of compensation committees by CEO appointing members on the committee and not on a CEO’s presence on the compensation committee.

Also adding the proxy for CEO propriety to this aspect, adds another perspective to the study. Secondly, this research adds new variables to this study, such as compensation committee independence measured by the CEO appointing members. Board of directors and audit

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10 committees have been the focus in many studies, meanwhile research on compensation committees is limited (Klein, 2003). The goal here is the ability to provide evidence that compensation committees actually do or don’t recognize the horizon problem. Subsequently, studies consider firm characteristics, but no study is available taking CEO characteristics into account (Bryan & Hwang, 2000; Bouaine et al. 2015). Lastly, it provides new information whether CEOs lean more toward bonus compensation or stock price related incentives when they depart from their role as CEO.

1.4 Structure

The remainder of this thesis is structured in a series of interconnected chapters. Chapter two provides the relevant literature needed to understand the topics. Chapter three proposes the research hypotheses. The research design and data is described in chapter four. Subsequently, the descriptive statistics associated with the samples are presented and discussed in chapter five. The empirical results are concluded in chapter six. Lastly, the conclusion, discussion, future research and limitations are described in chapter 7.

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2 LITERATURE REVIEW

This chapter begins with a review of the existing literature. The goal is to gather the most important information that will help with understanding the central elements. The literature consists of the description of the agency theory, institutional ownership structure, executive incentive compensation, the horizon problem, CEO turnover, and compensation committees. Taking these studies into account, I derive five hypotheses about the connection between executive incentive compensation and CEO departure controlled by compensation committees as well as the horizon problem.

2.1 LITERATURE REVIEW

2.1.1 The agency theory

The agency theory will be treated as a starting point of this chapter, as this topic is central to understanding the relationship with executive incentive compensation. The agency theory is the separation of ownership and control, described by Jensen and Meckling (1976). This separation of ownership and control has an impact on the performance of a firm. The agency theory relates to the agency relationship, which is defined as an agreement where one or more persons, the principal, appoints another person, the agent, to perform tasks on the behalf of the principal (Jensen & Meckling, 1976). The allocation of tasks towards the principal is accompanied by the delegation of decision making authority to the agent in order to perform the agreed tasks. The principal can be seen as the shareholders of a company, whereas the agent the executives of that company. In order for the agent to act out tasks with the best interest of the firm, the principal will establish appropriate incentives for the agent that is tied to firm performance. Incentives can be stock options or cash bonuses that are dependent on the returns on stock. In contrast to the expectations of the normative agency theory by Jensen and Murphy (1990), recent studies have showed that certain types of incentive compensation can reduce unwanted behavior such as earnings manipulations and fraudulent financial reporting (Harris & Bromiley, 2007; Zhang et al. 2008).

The principal is interested in maximizing stock prices, but want to bear as little of risk for achieving this. He delegates the task of maximizing profit to the CEO, who will be incentivized and vice versa. The problem that arises is that CEOs’ are risk-averse in most literature (Jensen & Murphy, 1990; Liao, 2011). CEOs will prefer to have their incentives structured so that the chance of bearing personal risk is less (Harris & Raviv, 1979). So by reducing their own

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12 personal risk they engage in activities that results in a decrease in the risk of the firm, but can also adversely have an impact on the shareholder’s wealth. Shareholders on the contrary, are not afraid to take risks , because they are able to manage their portfolio. They do this by investing in multiple firms, who all have their own risk levels.

Because shareholders and CEOs have different risk tolerances or risk appetites, this will have an effect on the decision processes that will have an impact on the payoff (Liao, 2011). As mentioned earlier one way to align the incentives of the CEO and the shareholders is through CEO compensation and another way is through monitoring by the Board of Directors (Michael & Pearce, 2004). This thesis will focus on CEO compensation as a solution.

2.1.2 Institutional ownership structure

There has been a number of studies that propose that institutional investors stress CEOs to realize short-term profit goals, losing sight on long-term equity value (Elyasiani & Jingyi, 2010; Margaritis & Psilaki, 2010). Institutional investors are excessively focused on long-term profit (Walther, 1997). On the contrary, institutional investors are often marked as sophisticated investors, who when it comes to obtaining and processing information have advantages in comparison with individual investors (Bartov et al. 2000). Bartov (2000) claims that the more sophisticated institutional investors are, the more able they should be to use current-period information to establish future earnings.

“The principle of proportionality” has been introduced by European firm laws, which aims to have proportional distribution of control rights and cash of investors in firms. A study by Claessens (2002) shows that when there is a disproportional ownership structure within a firm this has a negative influence on the value of the firm (Claessens et al. 2002). Firms with a proportional ownership structure, results in having more positive firm value opposed to firms with a disproportional ownership structure (Bennedsen & Nielsen, 2010).

Examples of ownership structure is ownership concentration, blockholders, and institutional ownership. According to the agency theory, monitoring done by large investors result in a positive and effective corporate governance mechanism. Large investors conduct more effective monitoring compared to small investors (Almazan, Hartzell, & Starks, 2005). The motive here is that related to large investors, small investors monitor passively and or less informed. Another study that contradicts above statements is one of Duggal and Miller (1999), where they find that large investors don’t have an effective monitoring role. The motive here

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13 suggests that when a firm performs poorly, the large investors don’t conduct more effective monitoring, but they sell their shares and depart the firm.

It is anticipated that ownership concentration will have a direct impact on a firm their performance. If a firm has a large number of shareholders, this will help the firm be actively monitored, which will cause an increased profitability of the firm, concluding that ownership concentration can be a positive incentive to maximize profits (Sánchez et al. 2007). On the other hand, according to the agency theory, when there is a high concentration of ownership within a firm, this can create ineffectiveness for taking profit-maximizing decisions (Claessens et al. 2002).

Managerial ownership is when a shareholder has an executive role or is a member of the board of directors who at the same time owns at least 5 percent of a firm’s common stock (Margaritis & Psilaki, 2010).

2.1.3 Executive incentive compensation

In order to align the incentives of shareholders and CEOs, managerial compensation contracts were introduced by the shareholders. These compensation contracts consists of a variable part and a fixed part. Examples of such contracts are basic salaries, annual bonuses, stock options, restricted stocks, and other long-term incentive arrangements (Lin et al. 2013). The fixed part is an annual salary that the CEO receives which is not dependent on firm performance, whereas the variable compensation can be split in two categories, namely short-term incentives and long-term incentives (Dechow P. , 2006).

Matejka et al. (2009) study the concept of the horizon problem. They find that relative emphasis is put on forward-looking performance measures increases as the employment horizon of the CEO decreases (Matejka et al. 2009). The idea is that a CEO who is expected to leave the firm in the upcoming period has low incentives to invest in long term effort, because this is costly and generates result in the future that he will not benefit from (Matejka et al. 2009). When it comes to bonus compensation, Healy (1985) discusses that managers are probable to manipulate earnings resulting in an increasing bonus compensation. The degree of self-serving attitudes by CEOs are much higher when the firm uses bonus compensation (Almadi & Lazic, 2016). Firms that limit bonus compensation are more prone to report income-deferring accruals, which is inversely related to similar firms who don’t limit bonus compensation (Healy, 1985). Gaver (1993) on the contrary finds that when earnings before discretionary accruals fall below the cap, managers will choose income-increasing discretionary accruals

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14 (Gaver et al. 1995). Holthausen (1995) also disagrees with Healy and finds no evidence that managers will manipulate their earnings downwards when earnings are below the minimum required to receive any bonus (Holthausen et al. 1995).

The reason that firms choose this type of compensation contract is because of the lack of separation from other contracts (Brooks et al. 2001). By working with bonus compensation contracts, firms are able to use more than one compensation contract in their renumeration bundle. Another reason why firms choose to use bonus compensation contracts is that the firm van be more efficient by solving agency problems. Nevertheless, a company has an infinite liftetime, whereas CEO compensation contracts have a finite lifetime, indicating that a CEO has a shorter horizon that the firm. This indicates the issue of the agency problem where a firm has a longer horizon with a CEO who has short-term focus. CEOs who are facing retirement are subject to more horizon problems, because their horizon is not as long as the horizon of the firm (Cheng, 2004). The biggest disadvantage of bonus compensation contracts is that they incentive short-term decision making. They encourage CEOs to concentrate on short-term performances rather than long-term performances. Seen as bonus compensation contracts are accounting-based compensations, they are sensitive to manipulation because they are backward-looking measures. CEOs are able to manipulate the numbers in order to achieve higher annual bonuses and maximize their personl gains at the expense of the shareholder (Almadi & Lazic, 2016).

Executive stock options are a primary form of equity-based compensation that has become the most common type of compensation in the US in the recent years. Reviewing data from Denis et al. (2006), it is concluded that equity-based compensation covered less than 1% of total CEO pay for the median company (Denis et al. 2006). The stock-based compensation contracts are seen as one of the most effective type of variable compensation contracts. “Equity compensation” is a compensation provided other than cash which characterizes as ownership in a firm (Engel et al. 2010). Many public companies use equity- based incentives in their compensation packages. These include shares, stock options, or restricted stock (Zhang et al. 2008). The popularity of using stock options in executive compensation has recently become very controversial. Advocates claim that, as options connects the compensation of CEOs with deviations in shareholder wealth, options increase shareholder wealth by lowering agency problems (Denis et al. 2006). The study of Jensen and Murphy (2009) states that this type of compensation contract incentivizes the CEO the most. Because the private wealth of the CEO is directly linked to shareholders wealth, CEO are incentivized to concentrate less on annual bonuses, but more on long-term compensations (Jensen & Meckling, 1976). Also providing

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15 CEOs with stock options will limit opportunistic behavior in the CEO’s pre-departure period (Dechow & Sloan, 1991). There are several reasons why firms like to use stock-option based contracts (Tzioumis, 2008; Sun et al. 2009). Firstly, as indicated before, stock options aligns the interest between CEOs and shareholders, while reducing the agency problem. Secondly, stock options will draw in employees who are less likely to be risk-averse and are more motivated to achieve their goals. Lastly, Firms with financial limitations will gain more from using stock-options seen as they don’t affect a firm’s cash flow.

Denis et al. (2006) on the other hand have multiple arguments against using stock-price based incentives . Firstly, options incentivizes managers to take unnecessary risks. Secondly, the usefulness of stock options is reduced as incentives by their restrictive downside risk and the possibility that firms will ‘reprice’ their underwater options. Lastly, managers will consciously perform fraudulent activities to manipulate the firm’s stock price. This will result in an enhancement in the value of the options (Denis et al. 2006).

The results of Tzioumis (2008) don’t support previous literature (Gibbons & Murphy, 1992; Dechow & Sloan, 1991), since he provided evidence that CEO age is negatively associated with the implementation of stock options. Reasons for this cause are that stock-options are considered to have a long-term focus in contrast to retiring CEO’s who are less likely to be determined to exercise their stock-options. Secondly, firms retention issues are more likely to occur with younger CEOs than older CEOs. Lastly, the older the CEO the higher the degree of risk-aversion, so CEOs find stock-based compensation more riskier than bonus compensation contracts (Eaton & Rosen, 1983). A better picture is outlined, consisting the forms of compensation, in the table below:

TABLE 1

Compensation contracts

Compensation Fixed/Variable Type Description

Salary Fixed

Short-term Fixed part of the compensation Annual bonuses Fixed

Short-term Variable part that CEO gets when targets are achieved Stock options Variable

Long-term

Is issued at the money, and is appreciated when the price is above the exercise price.

Restricted stocks Variable

Long-term Variable part that CEO gets when targets are achieved Other long-term

contracts Variable

Long-term This is dependent on the performances Table 1: Compensation contracts

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16 2.1.4 The horizon problem

Theoretically speaking when a manager has the intention to depart the firm, his incentives to act in the best interest of the firm is lower, than a manager who does not have the intention to leave (Cheng, 2004). This is also referred to as the horizon problem. Hypothetically, in the case of the manager leaving the firm due to retirement, he/she is incentivized to make accounting decisions that will increase the short-term value of the firm in order to amplify his/her compensation. The theory of the horizon problem builds on earnings management that extends into two streams of literature: the first one researches the influence of managerial compensation on discretionary choices, whilst the second one researches the influence on managerial horizon. There have been many prior studies that examines the link between managerial horizon and discretion. The effect of the horizon problem on a firm is not only restricted to earnings management but also suboptimal investments and accounting fraud (Kalyta, 2009). Kalyta (2009) looked at the a CEOs pension plans that was estimated by the performance, and suggested that when such a pension plan existed CEOs would be more likely to engage in earnings management. The proxy used in his research to estimate the horizon problem was managerial retirement.

A study by Gibbons and Murphy (1992) suggests that the probability of a CEO as he nears retirement, has a more evident horizon problem, in contrast to a CEO departing the firm and still participating in the labor market (Gibbons & Murphy, 1992). This could be due to the fear of the CEO for discipline from the market. In order to receive the bonus compensation a CEO is more prone to engaging in income-increasing earnings management in the pre-departure years, as a means to increase their compensation, because he can anticipate the retirement. Another study by Smith and Watts (1982) finds that lower net present value projects with high current accounting earnings are preferred by managers with a short horizon. Despite the theoretical predictions surrounding the horizon problem and discretionary accounting choices, empirical evidence is infrequent and questionable. The study of Pourciau (1993) finds contradictory result, as CEOs during their final year in the firm record accruals and write-offs that decrease earnings. Wells (2002) finds no evidence that CEOs in their pre-departure period engage in income-increasing earnings management.

Another study researched the link between career horizons and earnings management, where they suggest that not only retirement age, but also the structure of compensations incentivizes managers to engage in earnings management (Davidson et al. 2007). The proxies they used were CEO turnover in combination with CEO age, whereas earnings management was defined

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17 by discretionary accruals. Results of this study was that the higher the degree of discretionary accruals, the closer the CEO was to retiring.

Also a study is conducted where the authors sought to find a connection between the horizon problem and CEO tenure on firm performance (McClelland et al. 2012). Evidence provided information that in dynamic environments, higher CEO tenure reduces firm performance. Furthermore, other results also indicated that CEO whos horizon is short have bad firm performances compared to CEOs with a longer horizon.

2.1.5 CEO characteristics

There is a clear distinction as to how CEO turnover can occur. These are whether due to forced resignation, voluntary departures or age-related retirements. There has been much research with regards to the connection between CEO turnover and firm performance (Coughlan & Schmidt, 1985; Parrino, 1997; Jenter & Kanaan, 2015). Results from these studies show that if a CEO is more likely to be forced to resign if stock performance and accounting performance is poor. Even though there is significant statistical evidence for the connection between CEO turnover and firm performance, it has no major economic impact. Another study supporting the previous is that of Srivastav et al. (2017). They claim that in the theoretical models regarding CEO dismissal, the main idea is that boards evaluate the quality of the choices CEOs makes based on the performance, volatility and other aspects (Srivastav et al. 2017). When these aspects turn into clear signals regarding the bad results of a firm and when these are due to a lack of ability and/or effort in the bad choices of the CEO, he will be dismissed (Srivastav et al. 2017)

Besides CEO dismissal resulting from bad stock price and accounting performance, the age of a CEO is more important. Jensen and Murphy (1990) document that CEO turnover has a positive relation to the age of the CEO, which result in retirement. The probability of a turnover event is higher the older the CEO is (Jensen & Murphy, 1990). According to Murphy (1991) when an CEO is over the age of 65, the probability is 30% that he is leaving the office in contrast to when he is younger (Murphy, 1999).

CEO tenure is also a reason for CEO turnover. The number of years a CEO occupied his/her chief executive position, is defined as CEO tenure. Evidence summarized by Brickley (2003) captures a significantly negative relation with forced turnover (Brickley, 2003). These findings are the same with the association between CEO age and a turnover due to retirement reasons. CEO tenure is measured by the number of years that a CEO worked in a firm. The longer the

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18 CEO tenure the better the managerial performances. When a CEO has a longer tenure this indicates that the CEO has more knowledge and is more capable of making necessary investments (Miller & Shamsie, 2001). On the contrary, when a CEO has a longer tenure they are less like to take risk in comparison with a CEO with a relatively shorter tenure (Hambrick & Mason, 1984).

Associated with these findings, there is a ton of different literature that studies whether sensitivity of CEO compensation to stock returns, which is a forward-looking measure of performance, increases when the retirement of CEOs approach (Dikolli et al. 2003; Bryan & Hwang, 2000; Yermack, 1995; Lewellen & Loderer, 1987). The differences in findings can be due to inefficiencies in how stock-based incentives balance the short- and long- term managerial effort (Matejka et al. 2009).

The market also reacts to CEO departing the firm. Denis and Denis (1995) examined 69 forced resignations, which show that financial markets positively respond to underperforming CEOs dismissal. Voluntary resignations by CEOs don’t seem to provoke price reactions in the market, whereas forced resignations are professed positively by the market showing significant positive abnormal returns (Denis & Denis, 1995). On the opposite side evidence is provided for significant negative abnormal returns when forced turnover has taken place (Warner et al. 1988).

2.1.1 Compensation committee

Setting, implementing, and monitoring a firm their compensation procedures and programs is a leading role of compensation committees. Even though the compensation committees can make recommendations for the final approval to the whole board of directors, they have the only right to establish the compensation for the CEO of the firm. Compensation committees who have high quality are more able to determine efficient executive compensation to better align the interest of the CEO with the shareholders, resulting in maximization of the firm value (Sun & Cahan, 2012).

Compensation committees can come across difficulties when establishing the pay in the last years of a CEO. These difficulties partially relate to the deviations in the CEOs’ incentives in their pre-retirement period. An example is of CEOs who are leaving the firm and facing the horizon problem, which tempts the CEO to manage their earnings in order to boost their earnings-based compensation (Smith & Watts, 1982). Another difficulty that can arise is the differences between the actions of the CEO leaving the firm and the successor. For example, a

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19 CEO can lower investments in order to lessen the legacy assets inherited by the continuing CEO (Casamatta & Guembel, 2010).

A significant aspect that has to be considered in this thesis is the fact that the compensation committee is independent. When a CEO is a present member of the compensation committee, this invites rent extraction by self-serving CEO according to the managerial power view of executive incentive compensation. Literature on existing board independence provides evidence that the more independent members may promote shareholder wealth (Lee et al. 2016). Independence of the committee may lower the agency costs due to the misalignment between CEO and shareholders (Claessens et al. 2002). The study of Klein (2002) have also provided evidence that compensation committees with independent members have fewer occurrences of CEOs managing their earnings and higher quality disclosures. The study of Kim (2006) reveals that independent directors monitor and challenge CEO better if necessary. On the other hand, individuals associated with the firm may take actions that will encourage their own best interest rather than that of the shareholder (Kim et al. 2006).

2.1.2 Overview used papers

As showed above, there is a huge amount of literature where researchers all have their own opinions and different results. Table 1 presents a summary of all leading papers used, including their proxies and samples.

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TABLE 2 Overview papers

Author Year Topic

Sample size and

country Control Variables

Executive compensation

Healy 1984 The effect of bonus schemes on accounting decisions.

239 company years; 1964-1980: US

Discretionary and non-discretionary accruals, Bonus plan earnings, Account receivables and Inventory.

Dechow & Sloan 1991 The relationship between R&D expenditures and CEO compensations

58 firms; 1974-1988; US

R&D expense, Value of CEO stock options, Firm value, Changes in advertising and capital expenditures.

Bryan & Hwang 2000 Stock-based compensation 1700 firms; 1992-1997; US

CEO stock option awards, incentive intensity, restricted stock options. Dechow 2006 Asymmetric sensitivity of CEO cash compensation

to stock returns

Based on previous studies; 1993-2003

ROA, Annual Bonus and Stock options.

Wu & Tu 2006 The effect of R&D spending on CEO stock option pay

273 firms; 1534 observations ;1995-2004; US

CEO stock ownership, total current compensation, restricted stock holding, and long-term incentive plans.

Tzioumis 2008 Determinants of stock option as a part of CEO compensation

909 observations; 1992-2004; US

CEO turnover, CEO age, firm sales and CEO ownership

Sun, Cahan & Emanuel

2009 The relationship between future firm performance and CEO stock option grants (Sun, Cahan, & Emanuel, Compensation committee governance quality, chief executive officer stock option grants, and future performance, 2009)

1771 observations; US

CEO tenure, board service, outside directors, board seats, committee size

Li, Mark & Lee 2016 The effect of executive earnings management on compensation

11.838

observations; 2000-2009; US

CEO cash salary, discretionary accruals, non-discretionary accruals, operating cash flows, leverage, sales

The horizon problem

Coughlan & Schmidt 1985 The effect of executive compensation and management turnover on firm performance

249 firms; 597 observations;1977-1980; US

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21 Gibbons & Murphy 1992 Effects of optimal incentive contracts when

workers have career concerns

785 firms; 1971-1989; US

Year’s sales, Stock price, CEO age, Tenure and total compensation.

Cheng 2004 Effects of horizon and myopia problems on CEO compensations

160 firms, 1984-1997, US

CEO Compensation, R&D Expenditures, Annual stock returns, ROE and RET.

Kalyta 2009 The effect of CEO pension plans on discretionary accruals

1137 observations, 1997-2006; US

Firm size, leverage, growth, performance, operating cash flows Matejka, Merchant &

van der Stede

2009 The effect of employment horizon on nonfinancial performance measures

869 firms; 1997-2001; US

Emphasis placed on nonfinancial performance measures, CEO age, CEO stock ownership, CEO as chairman, firm size

McClelland, Barker & Oh

2012 The influence of CEO career horizon and tenure on the future performance of firms

206 firms; 2001-2003; US

Institutional shareholdings, separation of the CEO and chairperson position, outside directors, debt-to-asset ratio, total CEO composition

Bouaine,

Charfeddine, Arouri, & Teulon

2015 The effect of CEO departure on firm performance 271 firms, 1994-2006; US

Departure, Tenure, Duality, Propriety, Board size, Board independence, firm size, leverage

Chen, Ni, & Zhang 2016 The effect of CEO retirement on conditional accounting conservatism

16.604

observations; 1994-2006

Retirement, accruals, operating cash flows, sales, assets, size, leverage

Srivastav, Keasey, Mollah & Vallascas

2017 CEO turnover 261 banks;

2005-2013; 46 countries

Turnover, expected shortfall, daily stock returns, stock returns

Compensation committee

Vafeas 2003 The relation between insider membership in compensation committees and CEO pay

1500 firm year observations; 1991-1997; US

Insider compensation committee, return on assets, annual shareholder return, CEO stock ownership, sales, total compensation, age, tenure, CEO tenure in CEO position

Boyle & Roberts 2012 CEO presence on the compensation committee 149 companies; 1998-2005; New Zeeland

Firm performance, CEO on compensation committee, CEO not on board of directors, CEO on compensation committee

Sun & Cahan 2012 The economic determinants of compensation committee quality

844 firms, 2001; US

Members not appointed by the incumbent CEO, committee members who are senior directors , committee members who are CEOs of the other firms, committee members who have large block shareholdings in the firm, the proportion of committee members who are directors in fewer than three other firms, and compensation committee size

Lee, Bosworth & Kudo

2016 The effect of compensation committee independence and firm performance

53 firms; 1995-2001; US

Return on assets, Tobin Q’s, firm size, leverage Table 2: Overview used papers

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3 HYPOTHESES DEVELOPMENT

This thesis aims to test whether incentive compensation tends to move away from bonus compensation to stock-price related incentives when CEOs depart the firm. If this is the case, evidence is provided that with the help of compensation committees, effort will be made to control the horizon problem. Looking at the outcomes from the literature review with regards to the theories, the hypotheses shall be formulated.

3.1.1 Institutional ownership structure

A CEO knows the reasons behind lower earnings in a given period of the firm. A reason could be that the CEO has made a large investment which will hurt short-term profit, but increase long-term profit. Shareholders have incentives to monitor the actions and decisions of CEOs. If the shareholder is not satisfied with the way the firm performs, they have the option to sell their shares for a steady price. On the contrary, CEOs who own stocks in the firm cannot sell them for steady prices, because the shares are in a large block which has a negative direct impact on the share price when they are sold (Zhong et al. 2007). The capital market will pick this up and believe that the decrease in share price is because of bad performance. The presence of CEOs who have ownership in the firm, may put more pressure on managers to meet or beat the benchmarks (Bolton et al. 2006). Managers will engage in earnings management by upwarding the earnings in order to at least meet the targets set out for them. When a firm doesn’t perform accordingly, a CEO can put pressure on managers to improve performance. Managers are then mobilized to engage in earnings management in order to keep the revenues stable. When a CEO has a high stake in the company, this CEO is strongly incentivized to keep an eye on the firm performance (Shleifer & Vishny, 1986). This is because a CEO with a high percentage of shares owned in a company have more to lose than small investors. On the other hand, the association of a CEO’s individual concentration on ownership and the firm performance is determined by the benefits of an effective monitoring process and the cost that other ownership structures have. In other words, situation can arise where it is not beneficial for the CEO to monitor management’s performance when he has a high concentration of shares (Demsetz & Lehn, 1985). By establishing this I predict that in the event of the CEO leaving the firm, his interest will be more aligned to the firm, when he has a high concentration of shares in the firm. As explained in the literature review, the longer the CEO has worked in a

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23 firm, the more able he is to maximize the firm performance. The higher the firm performance, the higher the bonus compensation that he will receive.

Hypothesis 1: The relationship between the short horizon and stock compensation is accentuated by the propriety of the CEO.

Hypothesis 2: The relationship between the short horizon and bonus compensation is more pronounced for CEOs who have a longer tenure in the firm.

3.1.2 Executive incentive compensation

There are a lot of changes in CEO compensation compared to before. Between 1993 and 2006 the use of long-term incentives and the gains from stock sale by CEOs have enlarged (Clementi & Cooley, 2009). As mentioned in the section of the agency theory, CEOs want to earn as much as possible, where the compensation structure affects that. The bonus compensation plans provide executives a part of the annual earnings of a firm and has the purpose to increase the effort of management. This should result in the alignment of shareholders and managers. I predict that the short horizon is more pronounced when the CEO receives bonus compensation. This can be due to the fact that the CEO can anticipate him leaving the firm, and want to capture a higher bonus compensation before leaving. Directors use stock options to increase the pay-performance of the CEOs when agency costs are high. This happens because when CEOs are aware to be leaving the firm in an expected period of time, they will try to increase the earnings, resulting in them receiving more bonus. This means that the CEOs will not act in the best interest of the firm, but of themselves. Incentivizing CEOs with stock options will support in aligning the incentives of the CEO and the shareholders (Dong et al. 2010). On the other hand, stock options lead to high risk taking. In this thesis we will focus on retiring CEOs having stock ownership in the firm. When comparing stock ownership to stock options, stock ownership has a more direct influence on CEOs’ current wealth. This is because of the ownership that the CEO has over the stocks (Zhang et al. 2008). Having stock ownership lets the CEO benefit alongside the shareholders when the stock prices increases, and adversely when the stock price decreases. Based on the agency theory when CEOs have a large amount of stock ownership, the alignment of interest are more likely with the shareholders. CEOs will incorporate the view of a shareholder and put effort in maximizing firm value, hence reducing self-interest conflicts. A study by Gray and Cannella (1997) conducted a research to find the relation between risk

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24 and the CEO compensation structure. They used the CEO compensation structure as a measure to impact the CEO’s behavior when taking risk. The evidence stated that as a CEO retires, this impacts the decisions they make regarding investments, which proves the existence of the horizon problem (Gray & Cannella, 1997). I hypothesize that firms using stock option-based incentives are more able to affect managerial behavior in order to mitigate the horizon problem.

Hypothesis 3a: The horizon problem decreases when CEOs receive stock compensation.

Hypothesis 3b: The horizon problem increases when CEOs receive bonus compensation.

3.1.1 Compensation committee

By acknowledging compensation committees we can see if they tend to recognize the horizon problem and want to mitigate it. But being able to do so, they need to be an independent body. This will not be achieved if the CEO is also a member of this committee. There is a general absence of CEOs on the compensation committees in the US (Anderson & Bizjak, 2003). For this reason the independence of the compensation committee will be measured by the members who are appointed by the CEO. By using their influence and bargaining power, CEOs are able to extract rents. By appointing members to the compensation committee by the CEO, may lead to an opportunistic pay structure. They do this by placing insiders in the compensation committee. By acknowledging whether bonus compensation or stock compensation increases executives to engage in earnings management in their pre-departure period, the role of compensation committees to identify the horizon problem increases.

Hypothesis 4: Stock-based compensation increases when a CEO has influence on the compensation committee.

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26

4 RESEARCH METHOD AND DESIGN

In this chapter a description of the databases that are used in this research are given. This chapter also consists of the definitions and statistics that are used in the dataset. Furthermore, the methodology of the five hypotheses that are tested is discussed.

4.1 Data and sample selection

This thesis will use the quantitative data research method. The best database for collecting data on this topic is the Wharton Research Data Service (hereafter WRDS). The data that has been collected to answer the empirical questions of this thesis and to support the hypotheses has been collected from: ExuComp database delivered by WRDS, CompuStat (North Amerika) Fundamental Annual updates delivered by WRDS, and the ISS database. The sample includes US public traded firms from after the introduction of SOX. To avert problems relating to exchange rates, the thesis is limited to companies who trade in US dollars. The timeframe is between 2007 till 2016. This timeframe is chosen, because the ISS database doesn’t provide information before 2007. Regression analyses will be performed for all the variables.

The ExuComp database is used to extract data for CEO departure (retirement, age, tenure, pay, and propriety, salary, shares owned, and compensation). The financial information included is net income, total assets, total shareholders’ equity, and market value. The previous study has focused on the different types of ways that a CEO can depart the firm (Bouaine et al. 2015). I have modified this research to only test for CEO retirement, because CEOs can anticipate them leaving the firm and won’t be susceptible to further consequences. Also the study of Dechow and Sloan (1991) only used annual accounting earnings (bonus compensation) to estimate the relationship between executive incentives and the horizon problem.

The last database from which data is extracted is the ISS database where data is gathered concerning the CEOs’ involvement in the compensation committee. This database gives information about the characteristics of the director. These characteristics include age, employee positions, board service time, committee membership, board affiliations for estimated 1500 firms. Variables used to test the independence of the compensation committee are nominating compensation committee members by the CEO and whether the CEO is also present on the compensation committee. This is an additional test to see whether a compensation committee will recognize the horizon problem and put effort in reducing it within

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27 a firm. By adding the independence of the compensation committee to this research, this study also takes into account the firms that have not obeyed the 100 percent independence of compensation committee criteria.

The data about CEOs had to be filtered first before it was useable for regression. The first sample of CEO compensation data (Exucomp) consisted of 119.113 observations and 20 variables. Subsequently data for financial data (CompuStat IQ) was downloaded and consisted of 88.368 observations and 18 variables. The data from the ISS database consisted of 14821 observations and 8 variables. The data was merged using a 6-number cusip code and the fiscal year. The result provided 6125 of merged data for the three databases. Missing data related to the different variables were dropped from STATA. Also data with negative values and missing values from the financial data and compensation committee had to be deleted. The sample size reduced significantly due to elimination of many observations because of the missing values of equity compensation that CompuStat did not provide. Seen as this thesis is fixated on splitting the type of compensation it was necessary to do so. Also what significantly reduced the number of observations was the focus on only CEOs (CEOANN). Even though the sample size is small it will still be able to provide results on how CEO departure moves away from bonus compensation towards equity compensation. Below a table is presented that schematically shows the clean-up of the raw data after merging:

TABLE 3 Final sample selection

Number of observations

Initial sample (after merging databases) 6125

Less: missing values stock compensation 368

Less: missing values shares owned 18

Less: mising values propriety, firm size 497

Less: missing values net income 120

Less: missing values market value 270

Less: negative values for total compensation, bonus, stock, and shares owned 540

Less: negative values for tenure 99

Final sample 4213

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28 4.2 Independent Variable

Horizon (IDV 1) is not a given variable which can be extracted from the database, but should

be measured by proxies. The proxies to measure the short horizon of a CEO are the age and particularly in this study the CEO retiring. Retirement causes changes in the type of compensation CEOs receive. The departure of CEOs with other reasons than retirement are less likely to be affected by the horizon problem (Chen et al. 2017), we will only focus on retirement and the affect this has on executive incentive compensation with regards to the horizon problem. If a CEO has a shorter horizon he will be more incentivized to boost his short-term compensation (Dechow & Sloan, 1991). This proxy is a dummy variable indicating one when the CEO left the firm due to retirement and zero when the reason they left is not because of retirement (other). Other reason why the CEO can leave the firm in the WRDS database are: retired, resigned, dismissal, and unknown.

Age (IDV1) indicates the age of the executive in a fiscal year when he left the firm. The age of

the CEO will be used as a measure to determine the nearness to retirement, By eliminating departures other than retirements, retirements will be determined if the CEO’s age when departing is 65 or higher. This proxy is a dummy variable where one is considered the CEO’s age to be 65 or higher, otherwise zero for below the sixty. The variable code used here is AGE.

4.3 Dependent variable

Executive incentive compensation is measured by the salary, total compensation, bonus compensation, and the stock compensation. Salary is an agreed amount and is independent of the targets that the CEO has achieved. The agreed amount can deviate from one CEO to another and from type of industry. Another factor that can also influence the height of a CEO’s salary is the CEO’s level of experience he has acquired before. Total compensation in contrast to the salary, the compensation is not a fixed amount. It can deviate per year based on the performance of a CEO during that year. The total compensation consists of the salary plus the type of compensation he is provided. This varies in bonus, other annual compensation, total value of stock (options) granted.

Bonus compensation (DV1) is an accounting earnings number. The CEO is given his bonus

compensation in cash, also based on his performance during that year. In contrast to the salary, the bonus compensation changes from fiscal year to fiscal year.

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Stock compensation (DV2) contrary to the bonus compensation, is a non-monetary

compensation. This incentive includes shares that are provided to the CEO is the targets are met. The CEO is able to sell the shares in a pre-determined date, which is called the vesting period.

4.4 Control variables

The control variables that are used in this research are chosen because they are believed to best measure the above discussed section. The control variables used in this research are firm size, return on assets, market-to-book ratio, CEO propriety, and tenure.

Firm size (CV1) includes a logarithm of total assets, where the idea is that the bigger the firm,

the greater the compensation the CEO will receive. In a study by Wright et al. (2002) they found that the CEO’s compensation changes when the firm size increases. This variable is used in many other studies (Matsunga, 1995; Haugen & Senbet, 2015). The variable code used here is SIZE.

Return on Assets (CV2) and market-to-book ratio (CV3), when a CEO is monitored and

evaluated based on accounting performance measures, they are more likely to receive more cash-based compensation. The studies of Zhang (2012) and Roychowdhury (2006) included ROA in their research. This variable will put in as a measure to for the accounting-based compensation, as used in the research of Brickley (2003). It is used to measure the profitability of the firm. When this is the case there is a positive relation between the financial performance of a CEO and their bonus compensation (Davila & Penalva, 2006). The variable code used here is ROA.

CEO tenure (CV3) indicates the number of working years the CEO has been present in the

firm. The longer the tenure of a CEO the more knowledge and capability he accumulates to make better investment decision that should positively affect the firm performance on the long run (Miller & Shamsie, 2001). Another view is that the longer the tenure of a CEO the more focused they are in the short-term and the less risks they take (Hambrick & Mason, 1984).

CEO propriety (CV4) indicates the measurement of ownership concentration is the percentage

of shares controlled by the CEO. To achieve a symmetric scale of CEO propriety, the variable will be converted using logistic transformation: Log[CEO propriety] 𝑙𝑙𝑙𝑙𝑙𝑙 = (_{(𝐶𝐶𝐶𝐶𝐶𝐶 𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝−100)}𝐶𝐶𝐶𝐶𝐶𝐶 𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝𝑝 ) . This method has been vastly used when recording ownership structures (Demetz & Villalonga, 2001)The variable code used here is PROP.

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CEO influence (CV5) is determined by the situation were the CEO appoints members to the

compensation committee. This way the CEO is able to exert influence and power on the compensation committee regarding his compensation.

4.5 Summary table

TABLE 4

Overview of variables and measurements

Explanatory variable Symbol Code Measurement

Independent variable:

Horizon:

- Age AGE IDV1 Dummy variable for 1= age older than 65 and 0= younger than 65

Dependent variables:

Executive incentive compensation:

- Bonus compensation BONUS DV1 Based on performance

- Stock compensation STOCK DV2 Total compensation – Salary – Bonus – Other compensation

Control variables:

Firm size SIZE CV1 Logarithm of total assets

Return on Assets ROA CV2 Net income/total assets

MtoB MTOB CV3 Market value / total shareholder equity

Tenure TEN CV4 Date left CEO – Date became CEO

CEO influence INFL CV5 CEOs appointing members = 1 and CEOs not appointing members = 0

Propriety PROP CV6 Logarithm of propriety

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31 4.6 Analysis

An ordinary least squares analysis is used to examine the effect of a CEO’s short horizon on the incentive compensation they will receive. The independent variable is the short horizon and the dependent variable is the distinction in bonus compensation and stock compensation. There are four proxies that measure the independent variable. In addition four control variables are added to the research. The regression formula has been based on the study of Bouiaine et al. (2015). The variables have been replaced been replaced by those that is used in this study. Because of the distinction in incentive compensation, two regression models will be used to test for bonus compensation and stock compensation. The following regression formulas will be used to test the above:

𝐵𝐵𝐵𝐵𝐵𝐵𝐵𝐵𝐵𝐵 = 𝛽𝛽_0 + 𝛽𝛽_1 𝐴𝐴𝐴𝐴𝐴𝐴 + 𝛽𝛽_(2 ) 𝑇𝑇𝐴𝐴𝐵𝐵 + 𝛽𝛽_3 𝑃𝑃𝑃𝑃𝐵𝐵𝑃𝑃 + 𝛽𝛽_4 𝐵𝐵𝑆𝑆𝑆𝑆𝐴𝐴 +

𝛽𝛽_5 𝑀𝑀𝑀𝑀𝑙𝑙𝐵𝐵 + 𝛽𝛽_6 𝑃𝑃𝐵𝐵𝐴𝐴 + 𝛽𝛽_7 𝑆𝑆𝐵𝐵𝐼𝐼𝐼𝐼 + 𝜀𝜀

𝐵𝐵𝑇𝑇𝐵𝐵𝑆𝑆𝑆𝑆 = 𝛽𝛽_0 + 𝛽𝛽_1 𝐴𝐴𝐴𝐴𝐴𝐴 + 𝛽𝛽_(2 ) 𝑇𝑇𝐴𝐴𝐵𝐵 + 𝛽𝛽_3 𝑃𝑃𝑃𝑃𝐵𝐵𝑃𝑃 + 𝛽𝛽_4 𝐵𝐵𝑆𝑆𝑆𝑆𝐴𝐴 +

𝛽𝛽_5 𝑀𝑀𝑀𝑀𝑙𝑙𝐵𝐵 + 𝛽𝛽_6 𝑃𝑃𝐵𝐵𝐴𝐴 + 𝛽𝛽_7 𝑆𝑆𝐵𝐵𝐼𝐼𝐼𝐼 + 𝜀𝜀

The variables are explained in the previous section. In the table shown beneath the prediction of the regression variables will be presented. These are the predicted signs of the impact on the short horizon with regards to bonus and stock compensation.

TABLE 5

Variable Predicted sign

Stock Bonus AGE + + TENURE + + PROP + - SIZE + + MTOB ? ? ROA ? ? INFLUENCE + +

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32

5 DESCRIPTIVE STATISTICS AND EMPIRICAL RESULTS

5.1 Pre-test

Before starting with the analyses of the different regressions, the multicollinearity is tested. This takes places when two or more independent variables are correlated amongst each other. In order to test this the variance inflation factor (VIF) is conducted for the variables in this thesis. Referring to Chau and Gray (2002) a cutoff point of 10 is agreed to be an acceptable level. In the Appendix the VIF values are presented (Table 9), where as a result no multicollinearity has been traced. This test is done successfully.

Another important issue is that the regression should be absent of heteroscedasticity. Another test that should be run is to check for homoscedasticity. Here the Breusch Pagan test is conducted and the results are presented in the Appendix (Figure 2). The p-value (0,000) indicates that the null-hypothesis can be rejected. After trying to reduce the heteroscedasticity in my thesis, the results are that this doesn’t improve it. So the issue of heteroscedasticity is present in this thesis.

5.2 Pearson Correlations

Using the Pearson correlations test, multicollinearity is tested which is presented in a correlation matrix. Running this type of test is very important before running regressions. The is a relation between variables. Using the Pearson correlation test it can be determined whether there is a positive or negative relation between the variables. Moreover, the strength between the variables can also be estimated. There are three levels of significance can be determined with the Pearson correlation test. There is a 1%, 5% and 10% level of correlation significance. The value 1 indicates there is a very positive linear relationship, whereas the value -1 indicates a very negative linear relationship. If any variables in the Pearson correlation matrix show coefficients higher than 0.7 or lower than -0.7, these variables will be deleted to keep the reliability of the model stable (Dancey & Reidy, 2004). There seems to be no trace of multicollinearity in this model.

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33

TABLE 6 Pearson correlation

STOCK AGE TENURE PROP SIZE MTOB ROA

STOCK 1 AGE -0,016 1 TENURE -0,0678*** 0,2338*** 1 PROP -0,1616*** -0,0693*** -0,1976*** 1 SIZE 0,5974*** 0,0745*** -0,0906*** -0,1449*** 1 MTOB 0,2025*** -0,0569*** -0,0462*** -0,0148 -0,0085 1 ROA 0,5203*** 0,0762*** -0,0249* -0,1089*** 0,54665*** 0,1018*** 1 INFLUENCE -0,0096 -0,0499*** -0,0802*** 0,0597*** -0,0501*** 0,0072 -0,0183 Notes: The table shows the results for the variables for firm years observations from fiscal years 2007- 2016. The sample consist of 4312 observations.

All numbers are rounded up to three four decimals. *** Correlation is significant at the 1% level ** Correlation is significant at the 5% level ** Correlation is significant at the 10% level

5.3 Descriptive statistics

In this thesis CEO’s who left the firm due to retirement are identified. The goal of this study is to find evidence that when the CEO retires his compensation moves away from bonus compensation towards stock compensation.

TABLE 7

Age Frequencies Percent

Younger than 65 1942 46%

Older than 65 2271 54%

Notes: This table shows the results for the number of CEOs who retired at the age 65 and older or 65 and younger during the fiscal years 2007-2016.

The above table indicates the total % of the whole sample where the horizon problem can be recognized. As stated before the age for retirement is set at 65. Also, 54% of the total sample recognizes the horizon problem.

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34 Table 7 presents the means and medians that are associated with the CEO characteristics and the firm characteristics. Also the standard deviations, minimum and maximum values are presented. These values are a result for the dependent, independent and the control variables. The total research sample in firm years consists of 4.213 observations. A CEO receives $5170,41,- stock on average per year and $1102,93 bonus on average per year. The mean for the return on assets is 0,46 and mark-to-book ratio is 2,87.

TABLE 8 Descriptive statistics Panel A: CEO and firm variables

Variable Observations Means Std. Dev. Min Max Median

STOCK 4213 5170,41 5004,65 4,97 26088,500 3694,50 BONUS 4213 1102,93 1856,16 302,5 77926,00 918,00 AGE 4213 0,54 0,50 0 1 1 TENURE 4213 11,06 6,81 1 36 10 PROP 4213 0,32 0,45 0,06 2,66 0,15 SIZE 4213 8,15 1,61 7 12,33 8,05 MTOB 4213 2,87 2,70 0,49 18,38 2,09 ROA 4213 60,60 162,09 -135,82 1109,59 16,26 INFLUENCE 4213 0,48 0,50 0 1 0

Notes: Panel A reports the descriptive statistics for the sample of CEOs who retired between 2007-2016

TABLE 9 1-digit SIC

code Industry Frequencies Stocks ($) Bonus ($)

1 Agriculture, forestry and fishing 206 67.477.839 21.665.048

2 Mining and construction 774 65.429.612 11.763.406

3 Manufacturing 1308 46.897.647 9.404.351

4

Transportation, communications, electric, gas and sanitary

service 364 55.472.530 11.343.653

5 Wholesale trade and retail trade 547 54.073.345 10.621.827

6 Finance, insurance and real estate 466 44.933.649 10.488.232

7 Services 423 53.780.306 9.585.700

8 Public administration 119 43.058.174 11.811.053

9 Non-classifiable 6 88.413.142 45.209.937

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35 5.4 Regression analysis

TABLE 10 Model 1: Stock

Variables Coefficient Std. Err. t P>|t|

AGE -530,7412 122,0745 -4,35 0,000*** TENURE -9,2236 9,1652 -1,01 0,314 PROP -876,6995 134,2636 -6,53 0,000*** SIZE 1823,2360 37,3974 48,75 0,000*** MTOB 311,6333 22,9721 13,57 0,000*** ROA 7072,8670 786,4952 8,99 0,000*** INFLUENCE 194,8839 118,3993 1,65 0,100 Adjusted R-sqaured 0,4188 F-statistic 0,0000 Number of observations 2981

Notes: this table present the regression on stock and related variables for the firm years 2007-2016 Coefficients significant at the 0.01, 0.05, and 0.1 levels using a two-sided

test

Table 8 represents the hypothesis related to stock compensation. It should accept or reject hypothesis 1, 3 and 5. As the regression model shows, CEO influence and CEO tenure are not significantly related to stock compensation. This is in line with the study of Vafeas (2003), who also did not find sufficient evidence to state that CEO influence and reforms of compensation committee independence did increase the stock compensation of CEOs. This does not confirm H5, which is against the prediction. CEO tenure is also not significantly related to stock compensation, which is in line with the study of Bouaine et al. (2015). Our results also provide evidence that the relation between stock compensation and the short horizon. Hypothesis 1 can be confirmed as it is significant, but negatively affect the proportion of shares a retiring CEO has in a firm. The variables ROA, MTOB and SIZE are significantly and positively related with stock compensation. The values for these three variables could not be predicted. AGE is significantly, but negatively related to stock compensation. AGE was a proxy for the short horizon of the CEO, which confirms H3, that the closer the CEO is to retiring, the lower the adoption stock compensation. This can be because stock-based compensation is a future-based compensation and seen the short horizon of the CEO they are less likely to exercise their stock options. This is in line with our prediction.

Table 9 show the result for the regression relating to bonus compensation. The variables AGE, PROP, MTOB and ROA are not significantly related to bonus compensation. I predicted that AGE would be significantly and positively related to bonus compensation, but evidence

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36 from the results show the contrary. SIZE is positively related to bonus compensation, what is in line with prior research, seen as the bigger the firm, the more the compensation increases. Based on the significant and positive relation between the variable INFLUENCE and bonus compensation, we can see that if the CEO appoints members to the compensation committee, the bonus compensation increases. This is in line with our prediction.

TABLE 11 Model 2: Bonus

Variables Coefficient Std. Err. t P>|t|

AGE 49,1269 57,7665 0,85 0,395 TENURE 17,7407 4,337 4,09 0,000 PROP -107,3552 63,5344 -1,69 0,091 SIZE 252,8993 17,6967 14,29 0,000 MTOB 18,1564 10,8706 1,67 0,095 ROA 234,5602 372,175 0,63 0,529 INFLUENCE 176,092 56,02737 3,14 0,002 Adjusted R-sqaured 0,0538 F-statistic 0,0000 Number of observations 4213

Notes: this table present the regression on stock and related variables for the firm years 2007-2016

Executive incentive compensation with regards to CEO departure