Bidder CEO compensation and
M&A
Thesis submitted in partial fulfillment of the requirements for the
degree of Master of International Financial Management
University of Groningen
Faculty of Economics and Business
Author: Xiangyu Li
Student number: S2799375 Supervisor: dr. H. (Halit) Gonenc
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Abstract
This research investigates CEO compensation following M&A activities employing a sample of 425 acquiring firms and 1615 non-M&A firms in 26 countries over the 2011-2014 period. The results of analysis indicate that CEOs receive higher
compensation for completing M&A deals. Corporate & country governance features have positive effects on CEO compensation, but these features do not influence the relationship between CEO compensation and M&A. Further, the analysis suggests that performance, CEO skills and effort are positively associated with the level of CEO post-M&A compensation among all acquiring firms in the sample. This finding is consistent with the predictions of the incentive alignment theory. Managerial power theory is only supported in countries with weaker governance. Finally, it can be concluded that the variation of CEO post-M&A compensation is primarily moderated by performance, CEO skills and effort.
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1. Introduction
“Mergers and acquisitions (M&As) are amongst the most visible and significant investment decisions executives can make due to their potential long-term effects” (Coakley & Iliopoulou, 2006). The increase in M&A activities raised a new wave of research on the drivers of CEO compensation in M&A context.
There are extensive literatures investigate the relationship between M&A activities and CEO compensation package. CEOs may choose negative NPV project due to the conflict of interests between CEOs and shareholders (Moeller et al., 2005). Cesari, Gonenc and Ozkan (2015) review previous studies in Europe and conclude that acquisitions mostly destroy shareholders value. Therefore, it is necessary for firms to design proper CEO compensation package, which aligns the interests of shareholders and CEOs. In other words, a proper CEO compensation can be seen as an instrument to create a win-win situation for shareholders and CEOs. Moreover, Bebchuk and Fried (2003) propose that the design of CEO compensation related to M&A can itself become an agency issue. A question is raised: whether the compensation package can really align the interests of CEO and shareholders to control value-destroying
behavior of CEO?
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Grinstein and Hribar (2004) conduct a research in US market. They find that CEOs who have more power to influence board decisions can significantly receive larger bonuses. Managerial power variables present much more explanatory power than measures of effort or performance. Coakley and Iliopoulou (2006) conduct a research in UK and US. They find that CEO pay of acquiring firms is dominated by
managerial power in both countries. While in UK, the incentive alignment theory is partly supported. Bugeja et al. (2012) suggest that the incentive alignment theory primarily moderate the variation of CEO post-M&A compensation in Australia. The above literatures show that the explanatory power of these two theories can be varying among different countries. However, very few extant researches include country factors in their analyses. And most of them only focus on one or two countries. Randøy and Nielsen (2002) provide evidence to support the idea that country difference has significant explanatory power in executive compensation. Jouber and Fakhfakh (2011) suggest that country features have significant effects on CEO pay intensity and sensitivity to performance.
This research focuses firms from many countries and includes country characteristics to provide additional insight into the study of CEO post-M&A. The investigation focuses on the following questions: Whether the completion of M&A deals can provide more compensation to CEOs? If the level of CEO post-M&A compensation is moderated by corporate & country governance? To what extent the CEO post-M&A compensation is moderated by performance, skills and effort? To what extent does managerial power moderate the level of CEO post-M&A compensation?
The empirical analysis of this research uses a sample of 2040 observations from 26 countries, which include 425 M&A firms and 1615 non-M&A firms. Information between 2011 and 2014 are focused to get an updated view. Following the previous literatures, firm-level characteristics, which have potential to influence CEO
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during the post-M&A period. Corporate & country governance factors are founded to have significant positive effects on CEO compensation. While the results present that the relationship between CEO compensation and the completion of M&A is not moderated by corporate & country governance factors. Secondly, skills & effort, performance and managerial power are measured to test the explanatory power of the incentive alignment theory and managerial power theory. This set of analyses only focus on the M&A sample. Regression results propose that both theories have
explanatory power. The incentive alignment theory presents strong explanatory power among all acquiring firms in the sample. While we cannot find any significant role of managerial power theory when we only focus on the acquiring firms with stronger governance. Thus, it can be concluded that the variation of CEO post-M&A compensation is primarily moderated by performance, CEO skills and effort, the managerial power theory only explain a small part of it.
This research extends the empirical literatures by focusing on firms from more countries and including country characteristics. The analysis presents the relationship between CEO pay and M&A and moderators of CEO post-M&A compensation. Specifically, the completion of M&A and country & corporate governance have significant effects on CEO compensation. But country & corporate governance do not moderate the relationship between M&A and CEO compensation. Moreover, skills, performance and effort are primary moderators of CEO post-M&A compensation in the sample. The managerial power theory doesn’t present significant explanatory power in countries with stronger governance.
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2. Literature review and hypothesis
This section reviews the prior studies and relevant theories. It also presents hypotheses of this research.
2.1 Literature review
CEO and M&A Decision
According to the previous literature, most of M&A deals in the market are beneficial for target shareholders, but very few bidders can gain from those activities. Thus, people will ask: why do companies participate in M&A activities? An idea of CEO “hubris” is raised in the paper written by Roll (1986). The argument presents that CEOs with more hubris have potential to overbid for targets, because they are over optimism in analyzing deal opportunities (Roll, 1986). Scharfstein and Stein (1990) suggest that the imitation of other firms and erroneously ignoring the valuable opportunity may cause the value destroying behavior completed by CEOs.
Malmendier and Tate (2008) write one paper, which define CEOs as “overconfident” and “rational” CEOs. The finding presents that if a M&A deal is announced by a “rational CEO”, outside investors tend to present more positive reaction to the M&A announcement. M&A decision may also caused by CEOs’ opportunistic behavior. Managerial power theory suggests that CEOs can use their board power to benefit themselves by engage in larger M&As (Coakley and Iliopoulou, 2006).
The previous researches give a view on irrational and opportunistic M&A
decision-making. Dutta, MacAulay and Saadi (2011) have different views on above arguments. They suggest that CEOs are not willing to make M&A decision without rational analysis, because irrational decision-making is harmful for their reputation in an effective and competitive labor market (Dutta, Macaulay and Saadi, 2011). Besides, short-term M&A gain may not be very attractive for CEOs due to the long-term
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prefer the deal that brings long-term benefits rather than opportunistic behavior.
Agency theory
“The focuses of agency theory are organizational and market mechanisms that
facilitate the gap between shareholders’ interests and executive’s interests” (Bodolica, 2005). The standard agency theory suggests that the risk aversion of CEOs, individual benefits and information asymmetries are reasons of the conflict of interests between CEOs and shareholders.
The idea of risk aversion of CEOs presents that when an under-diversified CEO prefer to undertake the low risk deal rather than deal that beneficial for shareholders. It helps CEO get rid of under-diversified market portfolio. Weston, Siu and Johnson (2001) also find that CEOs will conduct harmful M&A for shareholders to limit the
employment and earning risk. The effect of individual/private benefits is that CEOs tend to choose suboptimal activities for shareholders due to the strong attractiveness of individual benefits.
In the case of compensation design, information asymmetries are significant
problematic. Information asymmetries provide difficulties for shareholders to monitor CEO’s behavior. The limited information of CEO’s activities, misunderstandings of CEO’s concern, unaware of the complexity of CEO’s activities and suboptimal monitoring have negative influence on the alignment of interests of shareholders and CEO.
There are several phenomena are caused by the agency problem in the M&A context. First of all, the managerial entrenchment indicates “CEOs, being already central figures to all aspects of the corporate life, voluntarily take steps to make themselves more difficult to replace is known as the managerial entrenchment” (Shleifer and Vishny, 1989). Second, CEOs are able to increase their board power by
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influence their compensation package due to their strong managerial power. Dutta, MacAulay and Saadi (2011) suggest that CEOs with strong relative board power are able to use firm-level decision to benefit themselves. CEOs can optimize their pay by conducting M&A or stealing /expropriation (La Porta et al., 2002). CEOs can ask more pay in bigger firm because they have to deal with the higher managing complexity. Normally, stealing is very risky for CEOs. Thus CEOs tend to conduct M&A to make their firm bigger to demand more compensation. The automatic increase in CEO post-M&As compensation is the third phenomenon. After M&As completed, the enhanced size of firm indicate the firm is more complex. Thus, it is rationale for CEOs to ask higher compensation, because they are required to exert more skills and effort to manage a bigger company (Himmelberg and Hubbard, 1999). Moreover, very few researches have presented that the poor M&A performance have negative influence on CEOs’ post-M&As compensation. The CEO of bidding firm is compensated equally for positive and negative M&A results despite the strength of corporate governance (Guest, 2009). In conclusion, CEOs are motivated to involve in M&A activities due to the benefit of increased company size.
In order to maximize shareholders’ wealth, firms need to formulate CEO compensation package, which have the function that align the interests of
shareholders and CEOs. In this case, the board plays an important role to protect shareholder’s interests. Board directors have to control compensation design to encourage CEO to conduct more value-adding behavior and limit negative behavior. A proper compensation package has optimized influence on executive behavior, which motivates CEO conduct value-maximizing behavior.
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and Vishny (1988) find that the increasing equity-based compensation package can limit the potential that CEO conduct value destroying activities. Bugeja et al. (2012) find that the level of CEO post-M&As compensation is strongly correlated to the firm financial performance after the completion of deal. However, “the very reasons for questioning the ability of optimal compensation contracting to adequately explain compensation practices also suggest that executives have substantial influence over their own pay”(Bebchuk and Fried, 2003). Greater power on board allows CEO extract rents. The incentive alignment view and managerial power view will be further defined and discussed in the following section.
Incentives alignment and managerial power
(i) Incentive alignment theory
The incentive alignment theory emphasized that CEOs will be rewarded for
value-generating decisions by exerting skills and effort based on a proper executive compensation contract (Girma et al., 2006). “The level of compensation depends both on supply and demand in the labor market for CEOs and on the skill and effort level that CEOs exert in managing the firm. CEO whose skill is in short supply or who is required to exert higher effort is paid more for his or her services”(Grinstein and Hribar, 2004). The board of directors has ability to design the compensation package for CEO by voting rights. However, in reality, investors may not able to fully access the objective of CEO’s M&A decision due to the information asymmetry. This phenomenon indicates that CEO might receive lower compensation because investors cannot realize the benefit of CEO’s decision. Thus, if the skill and effort exerted by CEO are not observable to investors, CEO might make M&A decision for his/her individual benefits. It is necessary for the board directors to create a CEO
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(ii) Managerial power theory
Bebchuk and Fried (2003) suggest that it is possible for board to apply and revise suboptimal compensation contracts due to the additional transaction costs of optimal compensation contracts. And they conclude “executive compensation is viewed not only as a potential instrument for addressing the agency problem but also as part of the agency problem itself’ (Bebchuk and Fried, 2003). Coakley and Iliopoulou (2006) conduct a research in UK and US market, they find the level of CEO post-M&A compensation is not strongly correlated to the skill and effort.
The idea of managerial power theory proposes that CEOs are able to negotiate compensation contract to protect their own benefits. Finkelstein (1992) define the board as the channel for CEO to exert his/her power. The stronger board power allows CEOs to encourage board members to make more positive decision for them. In other words, under the managerial power view, CEOs can set their pay and the pay will be less sensitive to the firm performance, effort and skill. In the paper written by Conyon (2006), CEO’s board power can be constrained by the outrage costs. When CEOs use their power to benefit themselves, they might face reputation loss and embarrassment. Conyon, 2006 suggests, “outrage matters because it can impose on CEOs both market penalties and social costs”.
How does the CEO use his/her power to influence the board decision? This question can be answered through two views. First of all, CEO can encourage board members to select director who meet the interests of him/her. Secondly, if the CEO
simultaneous chairs the board, he/she can easily control the information disclosed to the board.
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shareholder on this arrangement. Therefore, CEOs have to come up with justifiable reasons to make themselves worthy of additional pay.
Under the incentives alignment view, there should be a positive relationship between the level of CEO post-M&A compensation in bidding firms and skill & effort they exert to complete the deal and the firm performance. Under the managerial power view, the level of CEO post-M&A compensation in bidding firms is positively correlated to the managerial power of CEO on board.
Corporate & country governance mechanisms
Core, Holthausen and Larcker (1999) suggest that firms tend to have more agency problems and perform worse when their governance is less effective. Weaker governance allows CEOs use their power to skim more profit due to the inefficient monitoring. Rani, Yadav and Jain (2014) have similar findings, which suggests that firm with better corporate governance can reduce its agency costs and improve executive monitoring. Stronger corporate governance can maintain CEO pay in shareholders’ best interests.
However, Armstrong, Ittner and Larcker (2012) find more complicated relationship between corporate governance and CEO compensation. Weaker governance is not always negative for firm, because lower governance costs may offset higher
compensation costs (Armstrong, Ittner and Larcker, 2012). Stronger governance may also generate problem, a strictly monitored CEO may share less information to avoid more intensive monitoring. Thus, information asymmetry is raised.
Hartzell and Starks (2003) conclude that in well-governed firm, institutional investors are able to control CEO’s behavior to create more shareholders value. However, when CEOs feel they are forced to satisfy shareholders, they might engage in more earnings manipulation (Hartzell and Starks, 2003).
Acharya, Gabarro and Volpin (2013) provide further argument on the relationship between CEO compensation and corporate governance. Stronger corporate
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performance. However, some well-governed firms still pay excessive compensation to their CEOs. Acharya, Gabarro and Volpin (2013) argue that in a competitive market, high-quality CEO can be relatively scarce. Therefore, firms have to provide attractive compensation package for high-quality managerial talent. Moreover, good CEO pay also encourages CEOs keep exerting their talent to create long-term shareholders value.
Randøy and Nielsen (2002) examine the relationship between corporate governance and CEO compensation in Norway and Sweden. In their paper, country-level factors play a mediation role among the relationship between agency effects and CEO power. The location of firms may influence the level of CEO pay. The result of their research shows that the country difference is a significant variable in explaining differences in executive compensation.
Cremers and Grinstein (2011) suggest that country governance also influences the level and composition of CEO compensation. Country & corporate governance have effects on the relationship between CEO compensation and financial performance. In other words, the level of country & corporate governance influences the
pay-for-performance sensitivity.
Jouber and Fakhfakh (2011) conduct a research, which investigate the influence of institutional features on CEOs pay. They select three institutional & country
characteristics: strength of corporate governance, investor protection and the level of law enforcement. The results show that these three features have significant influence on CEO pay intensity and sensitivity to performance. There is a positive relationship between corporate & country governance and CEO pay to performance elasticity. Well-governed firms tend to compensate their CEO for performance.
Albuquerque and Miao (2013) investigate the relationship between country-level governance and firm-level governance. They find that country-level governance can play a role of substitute for firm-level governance. In other words, optimal
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High-powered CEOs with low risk aversion tend to implement more opportunistic behavior and divert output. Thus, firms have to improve firm-level governance to conduct stronger monitoring. When country-level governance is improved, firm-level governance is complemented. It allows firms to provide more performance-based compensation without unduly creating incentives to improve firm-level governance. Stronger country-level governance may not decrease CEO compensation. Firms with better governance are able to encourage CEO to implement more value-adding activities. Thus, CEO can be rewarded for the better performance. High-powered CEOs with high-risk aversion prefer formal compensation due to the high risk of diverting output. Therefore, it is also possible for firms with poor governance to provide performance-based CEO pay.
2.2 Hypothesis
According to the research objective and literature review, several hypotheses are proposed. First of all, this research investigates whether the CEO of biding firm is paid more after the completion of M&A deal. Following the previous literatures (Coakley and Iliopoulou, 2006, Grinstein and Hribar, 2004, Bugeja et al, 2012), the first hypothesis is proposed:
Hypothesis 1: M&A deals have positive effects on the level of CEO total
compensation.
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M&A decision-making and provide more formal bonus without unduly creating incentives to improve firm-level governance.
The second and third hypotheses are proposed:
Hypothesis 2: Corporate governance is a moderator of CEO compensation after
M&A deal.
Hypothesis 3: Country governance is a moderator of CEO compensation after M&A
deal.
Thirdly, literature review shows the variation of CEO post-M&A compensation can be moderated by the incentives alignment theory or managerial power theory. Under the incentives alignment view, CEO compensation should be positively correlated with the measures of skill & effort and firm performance. Managerial power view suggests that managerial power have positive effects on CEO compensation. This research will analyze measures of these theories to test their explanatory power. Thus, the forth hypothesis is:
Hypothesis 4: The variation of CEO post-M&A compensation is primarily moderated
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3. Data, Variables and Empirical Methodology
The following content includes data collection, definition of variables and empirical methodology. The methodology of this paper is formulated based on previous researches (Bugja et al., 2012, Grinstein and Hribar, 2004, Coakley and Iliopoulou, 2006).
3.1 Sample
The sample of M&A activities between 2011 and 2014 are obtained from the Orbis and Zephyr database. Observations are limited to M&A deals with public bidders due to data availability. Deal related information is also extracted from the Orbis and Zephyr database.
Executive compensation, financial performance, governance and board related information is obtained from Asset4 series of Datastream database. Asset4 ESG is a product of ThomosonReuters business concerning environment, social and
governance data at firm level. The series provide data on more than 5000 public companies worldwide. Firms’ ISIN number is applied to match two sets of information collected from Datastream and Orbis & Zephyr. The analysis also
requires a sample of non-M&A firms. These firms are public listed and must not have been involved in any M&A activities in the current financial year. The required information of non-M&A firms are also obtained from Datastream and Orbis & Zephyr.
Observations without enough required information for this research are eliminated. Finally, the whole sample includes 425 M&A observations and 1615 non-M&A observations from 26 countries (US, UK, AU, BE, CA, CW, CH, CL, CN, DE, DK, ES, FI FR, HK, IE, IN, IT, LU, MY, NL, NO, PL, SE, SG and ZA).
Additionally, this research also requires country characteristics. Country related information is extracted from the World Bank’s DoingBusiness.org website and
World DataBank.
3.2 Empirical Methodology
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Four sets of variables are identified to complete this research. They are measuring firm-level financial performance, skills & effort, managerial power and country & corporate governance.
(i) The correlation between CEO compensation and M&A deals
The first set of analyses is addressed to investigate whether CEO compensation is actually influenced by M&A deals and the role of country & corporate governance. Following the methodology of previous researches, the regression model is estimated: CEO Compensationit = α + β1Firm Sizeit-1 + β2ROAit-1 + β3ROA Growthit-1 +β4Total Shareholder Returnit-1 + β5Sales Growthit-1 +β6Marginit-1 +β7Margin Growthit-1 +β8Acquisition Dummyit-1+β9Corporate Governanceit-1+β10Law Enforcementit-1+β11 Investor Protectionit-1+(Interaction Terms)+εit.
The dependent variable CEO Compensation is total remuneration paid to CEO of firm i in year t. M&A deals are completed in year t-1. Performance and control variables measure firm i’s financial performance and institutional characteristics in the year of deal completion. Firm Size is measured by total book value of assets at the end of year t-1. ROA, ROA Growth, Return, Sales Growth, Margin and Margin Growth are financial performance variables in the year of M&A completion. Acquisition Dummy is a dummy variable coded as one if the firm completes the deal during the year t-1, zero otherwise. If CEO get paid more after the completion of M&A deals, then the coefficient of Deal Result Dummy should be positive and statistical significant. Corporate Governance is the variable that measures the capacity of firms to encourage CEOs to make good decisions to maximizing long-term firm value. “Shareholders use pay to provide incentives for the CEO to focus on maximizing long-term firm value” (Conyon, 2006). Thus, the coefficient of this variable is expected to be positive. Existing literature presents that country characteristics have effects on firm’s
compensation structure and corporate governance. Law Enforcement and strength of investor protection are employed to investigate the effects of country-level
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variables and Acquisition Dummy are interacted to create interaction terms (Corporate Governance*Dummy, Law Enforcement*Dummy, Investor
Protection*Dummy). These interaction terms are included in the first regression equation and regressed separately to assess whether features of country & corporate governance moderate the relationship between Acquisition Dummy and CEO Compensation.
(ii) The influence of CEOs’ effort, skill, performance and power on their compensation package received after M&A deals
The second set of analyses is addressed to investigate the extent to which effort, skill, performance and managerial power can explain the level of CEO compensation package after M&A deals. Country characteristics are also considered to investigate whether the explanatory power of the incentive alignment theory and managerial power theory is varying among different level of country governance. The regression is estimated as follows:
CEO Compensationit = α + β1Firm Sizeit-1+ β2Deal Sizeit-1 + β3Completion Timeit-1+β4Diversifyit-1+ β5CAR (-1,1)it-1 +β6Total Shareholder
Returnit-1+β7ROAit-1+β8 CEO Chair it-1+β9Insider Ratio it-1 +β10Board Size it-1+β11 Corporate Governanceit-1+β12 Investor Protectionit-1 +β13 Law Enforcementit-1+εi.
The dependent variable is same as the previous regression; CEO Compensation capture the compensation package paid to the CEO after the completion of M&A deals. Incentive alignment theory suggests that CEOs can gain more if the deal requires CEOs to exert more effort and skill. It is very difficult to directly capture how much effort and skill does CEO exert in doing M&A activities. Therefore, the exerted effort and skill have to be measured by some indirect variables. These
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different major industry sector (Diversify) and cumulative abnormal return between one day before announcement (CAR (-1,1)) and one day after announcement. CAR (-1,1) is employed to capture the market reaction to the M&A announcement. CEOs can be rewarded for the optimal M&A decision-making. Three-day event window is employed for this variable, because small event window can prevent the influence of other business activities. According to Mackinaly’s (1997) paper, the market-adjusted return model is employed for the calculation of expected return. It assumes the
expected return is similar with the market return. The abnormal return for each stock is the difference between the stock return and expected return. Cumulative abnormal return equals to the sum of abnormal returns. Jensen (1986) suggests that larger M&A deals have potential to create additional agency issues. Therefore, larger deals require CEO exert more skills and effort due to the higher complexity. Moreover, CEOs have to exert more effort when they spend longer time to finish the deal. Thus, completion time can be seen as a indicator of effort requirement. If acquiring firm and target have same major industry sector, the CEO of acquiring firm will not have to gain new knowledge about new industry. Thus, the effort requirement should be lower than M&A deal across different industry. According to the expectation of incentive alignment theory, the above variables should be positively associated with the dependent variable.
Bebchuk and Fried (2003) give a definition of managerial power in this field of study, which is the ability of the CEO to influence directors to optimal his/her compensation structure. A dummy variable that equals one if the CEO simultaneous chairs the board (CEO chair), insider ratio and board size are measures used to assess the strength of managerial power. The most important role of board of directors is to evaluate management performance and monitor managers’ behavior. The board of firm can improve the effectiveness of its control & monitor by separate the role of CEO and chairman (Jensen, 1993). Hallock (1997) proposes that the board with more
independent members is able to conduct stronger control over CEO. Insiders
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to be influenced by the CEO due to the lower level of independence. In contrast, outsiders (non-executive directors) are independent and they care more about the firm’s performance because being directors of a firm with good performance signals their ability to the market (Ozkan, 2007). Paul (2007) suggests that the firm with diversified board is less likely to take suboptimal deals due to the optimized
management practices. Jensen (1993) and Yermack (1996) argue that when board has more members, it requires more communication and coordination. Therefore, the bigger size of board can weaken the control over CEO due to the efficiency loss. The managerial power theory suggests that CEO compensation and managerial power have positive relationship. Thus, above variables are expected to have positive
coefficients. Lastly, Corporate Governance, Law Enforcement and Investor Protection are also included in this set of analyses. Law Enforcement will be used to divide acquiring firms into two subsamples to investigate whether the explanatory power of the incentive alignment theory and managerial power theory is varying among different level of country governance.
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Table1 Variables
Variables Definition Sources of Data
CEO compensation Log of the total compensation package paid to CEO in USD. Datastream, Asset4
Performance and Characteristics of acquiring firm
Firm Size Log of acquiring firm’s book value of total assets in USD. Datastream, Asset4 ROA Earning before tax divided by total assets. Datastream, Asset4 ROA Growth The result of current ROA divided by ROA in the prior year minus
one.
Datastream, Asset4 Total Shareholder
Return
Total shareholder return in the year of deal completion. Datastream, Asset4 Sales Growth The result of current sales divided by sales in the prior year minus
one.
Datastream, Asset4 Margin Earnings before interest, depreciation and amortization divided by
sales in the year of.
Datastream, Asset4 Margin Growth The result of current margin divided by margin in the prior year
minus one.
Datastream, Asset4
Deal characteristics
Deal Size Log of the deal value in USD. Orbis & Zephyr Completion Time Log of the time period (days) between M&A announcement and
completion.
Orbis & Zephyr Diversify Dummy variable equals one if bidder and target firms have different
major industry sector, zero otherwise.
Orbis & Zephyr CAR (-1,1) Cumulative abnormal return between one day before announcement
and one day after announcement.
Datastream Acquisition
Dummy
Dummy variable equals one if the firm completes a deal, zero otherwise.
Orbis & Zephyr
Governance characteristics of acquiring firm
CEO chair Dummy variable equals one if the CEO simultaneous chairs the board, zero otherwise.
Datastream, Asset4 Insider Ratio Number of on-board executive directors divided by board size. Datastream, Asset4 Board Size The total number of board members at the end of fiscal year. Datastream, Asset4 Corporate
Governance
The measure reflects the firm’s capacity, through its use of best management practices, to direct and control its rights and
responsibilities through the creation of incentives, as well as checks and balances in order to generate long-term shareholder value.
Datastream, Asset4
Country characteristics
Law Enforcement The index refers to the quality of policy formulation and
implementation and the credibility of the government’ commitment to such policy.
World Databank
Investor Protection The index measures the protection of shareholders against director’s misuse of corporate assets for individual benefits.
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4. Empirical Findings 4.1 Descriptive Statistics
The summary descriptive statistics of sample is summarized in Table 2. The first row presents the summary statistics for the total compensation that received by CEOs in non-M&A firms sample and M&A firms sample. Firm-level financial characteristics, deal characteristics, governance characteristics and country characteristics are
presented in four panels. The mean of total CEO compensation of non-M&A firms ($8528 thousand) is lower than bidding firms ($9646 thousand), while bidding firms have higher standard deviation.
Panel A presents firm-level financial characteristics in the sample. The average size of bidders in the sample is $578 million in total assets, this figure is $673 million for non-M&A firms. The median firm size of both samples are $106 million and $107 million, while their value of standard deviation is higher than median ($166 million and $221 million). Hence, these figures indicate high variance and skewed
distribution of firm size. Firms in both samples have positive average return on assets and average total shareholder return. On average, the value of these figures show that the performance of bidding firms and non-M&A firms are similar. Total shareholder return of both samples has high standard deviation and there is big difference between mean and median. It can be seen as an indication of skewness. The summary statistics for growth measures (ROA Growth, Sales Growth and Margin Growth) also present high standard deviation.
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Most of bidding firms prefer target from similar industry, only 34.1% of bidding firms in the sample focus on target from different industry.
Table 2
Sample statistics
Non-M&A firms(N=1615) M&A firms(N=425)
Mean Std.Dev Median Mean Std.Dev Median
Total CEO Compensation
($thousand) 8528 9741 5893 9646 12406 6416
Panel A:Financial Characteristics
Firm Size ($million) 673 221 107 578 166 106
ROA 6.2% 6.3% 5.3% 6.3% 5.6% 5.4%
ROA Growth 5.9% 20.6% -2.7% -4.5% 20.9% -4.7%
Total Shareholder Return 23.5% 71.7% 9.7% 23.8% 75.9% 12.4%
Sales Growth 10.3% 25.1% 6.1% 9.7% 19.1% 6.5%
Margin 14.3% 12.9% 11.9% 11.5% 11.6% 9.5%
Margin Growth -8.3% 50.7% 1.6% 13.7% 28.7% 1.9%
Panel B: Deal Characteristics
Deal Size ($million) 218 725 60
Completion Time(days) 102 112 69
CAR(-1,1) -0.01% 2.3% -0.03%
Diversify 34.1%
Panel C: Governance Characteristics
CEO Chair 35.5% Insider Ratio 31.9% 21.4% 25.1% Board Size 10.67 2.86 10 Corporate Governance 75.4 17.9 80.4 76.6 16.8 80.9 Panel D: Country Characteristics Law Enforcement 90.9 7.9 91.0 91.4 5.2 91.0 Investor Protection 7.5 1.4 8.3 7.6 1.2 8.3
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average corporate governance index of 76.6 with standard deviation of 17.07 and median of 80.93.
The last panel, panel D, presenting measures of country characteristics. Non-M&A firms and M&A firms have similar median of law enforcement (91.0). Their means of this measure are also close, which are 90.9 and 91.4. The values of standard deviation are 7.9 and 5.2. The statistics for investor protection index are close in two samples. Non-M&A firms have mean of 7.5, standard deviation of 1.4 and median of 8.3. Bidding firms have mean of 7.6, standard deviation of 1.2 and median of 8.3.
4.2 Regression results
(i) The effect of M&A on CEO compensation and moderation role of country & corporate governance
This section presents the results of regression relating to the first, second and third hypothesis. Models are estimated by using the first regression equation. The results are shown in following tables. Both non-M&A firms and M&A firms are focused. Table 3 presents the correlation between variables of the first regression equation. Total CEO Compensation has positive correlation with Acquisition Dummy at 5% level. This result is similar with the prior researches that conducted in UK and US markets. CEOs tend to earn more after the completion of M&A deals. Corporate Governance, Law Enforcement and Investor Protection are positively correlated with total CEO compensation and these three measures are significant correlated with each other. The positive correlation between country & corporate governance variables is consistent with Albuquerque and Miao’s (2013) findings that there is positive
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In order to test the effects of each governance variable (Corporate Governance, Law Enforcement and Investor Protection) and their interaction’s role on CEO
compensation, different models are designed based on the first regression equation. Model I, Model II and Model III are addressed to test the effects of governance variables separately. Model IV is addressed to test the role of governance variables’ interaction. The results are presented in Table 4.
In the Table 4, the coefficients on Acquisition Dummy are positive and statistically significant among Model I, Model II and Model IV. Thus, the first hypothesis is supported. The completion of M&A deals provides additional compensation to CEOs of acquiring firms. This finding is consistent with the papers written by Bugja et al (2012). ROA and Sales Growth present significant positive coefficients in all models. It proves that CEOs are rewarded for the better financial performance. The positive
Table 3 Correlation matrix Variables 1 2 3 4 5 6 7 8 9 10 11 12 1. Total CEO Compensation 2.Firm Size 0.509*** 3.ROA 0.032* 0.159*** 4.ROA Growth 0.034* 0.008 0.035* 5.Total Shareholder Return -0.003 0.030* -0.015 -0.005 6.Sales Growth 0.023 0.080*** 0.022 0.022 -0.003 7.Margin 0.004 0.012 .408*** -.033* 0.050** 0.065** 8.Margin Growth 0.020 0.003 0.090*** 0.211*** 0.096*** 0.016 0.061** 9.Acquisition Dummy 0.048** -0.018 0.001 -0.020 0.001 -0.010 0.089*** 0.019 10.Corporate Governance 0.347*** 0.087*** 0.063** 0.059** -0.056** 0.088*** -0.008 0.033* 0.028 11.Law Enforcement 0.090*** -0.016 -0.065** 0.027 -0.043** -0.011 -0.032* 0.013 0.029* 0.234*** 12.Investor Protection 0.340*** -0.021 0.020 0.018 0.024 0.053** 0.047** -0.023 0.039** 0.243*** 0.211*** N=2040
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and statistically significant coefficients of Corporate Governance, Law Enforcement and Investor Protection suggests that country & corporate governance have positive effects on CEO compensation. This result is consistent with the papers written by Holthausen and Larcker (1999), Acharya, Gabarro and Volpin (2013), Jouber and Fakhfakh (2011) and Albuquerque and Miao (2013). Well-governed firms tend to perform better and provide higher CEO compensation for good performance. Additional CEO pay also creates incentive for CEOs to keep focusing on
value-adding projects. The coefficients of Firm Size are positive and statistically significant in all models, proposing that CEOs from larger firms received larger compensation package. This result can be explained by the idea of incentive alignment view. Larger firms are relatively more complex; CEOs are paid to exert more skills and effort to deal with the higher managing complexity.
Overall, in the whole sample, the analysis shows that CEOs of acquiring firms receive higher total compensation for the completion of M&A deals. Corporate governance, law enforcement and investor protection have positive effects on total CEO
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Table 4
Regression of performance, size, country characteristics and M&A activity on total CEO compensation
Total CEO compensation (log)
Model I Model II Model III Model IV
Firm Size(log) 0.519*** 26.962 0.586*** (30.397) 0.558*** (30.756) 0.525*** (28.530) ROA 0.164*** 7.961 0.213*** (10.108) 0.194*** (9.812) 0.174*** (8.830) ROA Growth -0.055 -2.773 -0.057 (-2.778) -0.45 (-2.359) -0.53 (-2.815) Total Shareholder Return 0.016 0.891 0.016 (0.883) 0.002 (0.131) 0.010 (0.603) Sales Growth 0.132*** 7.310 0.123*** (6.670) 0.091** (5.208) 0.105*** (6.115) Margin -0.099 (-4.961) -0.120 (-5.894) -0.130 (-6.751) -0.115 (-6.609) Margin Growth 0.014 (0.695) 0.017 (0.823) 0.019 (0.976) 0.015 (0.803) Acquisition Dummy 0.034* (1.897) 0.035* (1.899) 0.025 (1.465) 0.024** (1.377) Corporate Governance 0.236*** (12.794) 0.160*** (8.675) Law Enforcement 0.133*** (7.215) 0.034* (1.921) Investor Protection 0.307*** (17.752) 0.261*** (14.709) Constant 8.446*** (39.238) 6.983*** (19.872) 7.333*** (32.690) 6.704*** (20.448) Observations 2040 2040 2040 2040 R-squared 0.395 0.352 0.401 0.426 *P<0.10;**P<0.05;***P<0.01 Figures in brackets are t-statistics
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The above analysis suggests that corporate & country governance variables have positive effects on total CEO compensation among both non-M&A firms and acquiring firms and CEOs of acquiring firms receive higher compensation after the completion of M&A deals. In order to test whether the CEO post-M&A compensation is moderated by corporate & country governance features, three interactions terms are included in the equation and regressed separately. The results are presented in Table5. This set of analyses also supports the first hypothesis. Acquisition Dummy presents positive and significant coefficients in Model I and Model II. Corporate Governance, Law Enforcement and Investor Protection have significant positive coefficients at 1% level in all models. However, the coefficients of interaction terms (Corporate
Governance*Dummy, Law Enforcement*Dummy and Investor Protection*Dummy) are not statistically significant. It can be concluded that greater governance can generally optimize CEO compensation package, but it doesn't significantly influence the relationship between CEO compensation and the completion of M&A deals. The coefficients of size and performance variables provide similar results with the analysis in the Table 4.
In summary, in the whole sample, the CEO post-M&A compensation is not
moderated by the level of corporate and country governance. The second hypothesis and third hypothesis are not supported.
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Table 5
Regression of performance, size and interactions on total CEO compensation
Total CEO compensation (log)
Model I Model II Model III
Firm Size (log) 0.519***
(26.954) 0.587*** (30.406) 0.558*** (30.756) ROA 0.164*** (7.952) 0.213*** (10.110) 0.194*** (9.810) ROA Growth -0.055 (-2.774) -0.057 (-2.748) -0.045 (-2.352) Total Shareholder Return 0.016 (0.892) 0.016 (0.889) 0.002 (0.108) Sales Growth 0.132*** (7.307) 0.123*** (6.639) 0.090*** (5.142) Margin -0.099 (-4.947) -0.120 (-5.873) -0.129 (-6.695) Margin Growth 0.013 (0.527) 0.015 (0.745) 0.017 (0.891) Acquisition Dummy 0.035* (1.9) 0.032* (1.895) 0.020 (1.355) Corporate Governance 0.233*** (11.456) Law Enforcement 0.124*** (6.414) Investor Protection 0.296*** (15.706) Corporate Governance*Dummy 0.026 (0.320) Law Enfocement*Dummy 0.405 (1.353) Investor Protection*Dummy 0.156 (1.491) Constant 8.457*** (38.749) 7.099*** (19.630) 7.402*** (32.319) Observations 2040 2040 2040 R-squared 0.395 0.425 0.401 *P<0.10;**P<0.05;***P<0.01
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(ii) The role of performance, skills, effort and managerial power
This section presents the results of regression relating to the forth hypothesis. This hypothesis gives a view on whether the managerial power theory moderate the level of CEO post-M&A compensation. Models are estimated based on the second
regression the determinants of CEO post-M&A compensation to assess the extent do the incentive alignment theory and the managerial equation, which includes measures of firm performance, skills, effort in completing the deal and managerial power. Corporate & country governance variables are also involved. Only acquiring firms are focused in this set of analyses.
The coefficients of deal size in all models of Table 6 are significant positive. It indicates that CEOs are rewarded more for M&A deals with higher complexity. The coefficients of Completion Time and Diversify are not significant. It can be concluded that there is no evidence proposing that CEOs receive different compensation due to the different completion time and target’s major industry sector doesn't have
significant effects on acquiring firm’s CEO pay. CAR (-1,1) measures the market’s reaction on M&A decision. There is no significant coefficient on this variable in Table 6. It suggests that CEO post-M&A pay is not related to the market reaction to the announcement of M&A deal. Positive coefficients of ROA in all models indicate that CEOs of acquiring firms are compensated for better financial performance. The coefficients of CEO Chair are positive and statistically significant in each model, showing that CEOs with greater board influence are able to optimal their
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models. The second equation’s results also suggest that governance features are positively associated with the level of CEO compensation.
Table 6
Regression of measures of performance, effort, skills, and managerial power on CEO post-M&A compensation
Total CEO compensation (log)
Model I Model II Model III Model IV
Firm Size(log) 0.390*** (7.353) 0.409*** (7.690) 0.449*** (8.944) 0.434*** (8.692) Deal Size(log) 0.178*** (3.167) 0.184*** (3.245) 0.121** (2.253) 0.138** (2.586) Completion Time(log) -0.025 (-0.511) -0.035 (-0.727) 0.004 (0.092) -0.003 (-0.063) Diversify 0.011 (0.310) 0.016 (0.438) -0.005 (-0.138) -0.002 (-0.074) CAR(-1,1) -0.052 (-1.464) -0.057 (-1.604) -0.042 (-1.242) -0.046 (-1.368) Total Shareholder Return 0.029 (0.818) 0.029 (0.790) 0.015 (0.450) 0.022 (0.645) ROA 0.111*** (3.012) 0.135*** (3.642) 0.129*** (3.720) 0.123*** (3.542) CEO Chair 0.184*** (4.793) 0.204*** (5.264) 0.133*** (3.584) 0.139*** (3.777) Insider Ratio -0.196*** (-4.790) -0.207*** (-5.041) -0.225*** (-5.992) -0.186*** (-4.782) Board Size -0.074* (-1.696) -0.070 (-1.571) -0.115** (-2.770) -0.094** (-2.267) Corporate Governance 0.147*** (3.887) 0.075** (1.973) Law Enforcement 0.112*** (3.001) 0.076** (1.973) Investor Protection 0.280*** (8.005) 0.264*** (7.501) Constant 8.613*** (13.248) 6.801*** (6.437) 7.649*** (12.215) 5.647*** (5.631) Observations 425 425 425 425 R-squared 0.483 0.475 0.536 0.549 *P<0.10;**P<0.05;***P<0.01
Figures in brackets are t-statistics
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In order to assess whether the explanatory power of managerial power theory and incentive alignment theory is varying among countries with different level of
governance. The acquiring firms are divided into two subsamples based on the mean of law enforcement index. The second regression equation is repeated separately on these samples. Table 7 presents the results of this set of analysis.
In the Table 7, Size variables (Firm Size and Deal Size) and ROA have significant positive coefficients among acquiring firms with stronger country governance and acquiring firms with weaker country governance. This finding supports the view of incentive alignment theory. In both subsamples, the coefficients of CEO Chair are still positive but only significant in the weaker country governance sample. Insider Ratio has negative significant coefficient in the stronger country governance sample, which contradicts the managerial power theory. The coefficients of Board Size are not significant. Corporate Governance is positively associated with the CEO post-M&A compensation in the weaker country governance sample. It doesn't have significant coefficients in the stronger country governance sample. Investor Protection
coefficients are positive and statistically significant in both subsamples.
In summary, the results in the Table 6 and Table 7 suggests that firm size, deal size and ROA play a dominant role in CEO post-M&A compensation. We can conclude that CEO post-M&A compensation are strongly influenced by skills & effort and performance. The positive coefficients of CEO chair indicate that more power on board allows CEOs receive more post-M&A compensation. While when we only focus on acquiring firms with stronger country governance, this factor is not
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performance and less by managerial power. The forth hypothesis is not supported.
Table 7
Regression: acquiring firms with stronger country governance vs acquiring firms with weaker country governance
Total CEO compensation(log)
Weaker country governance Stronger country governance
Firm Size(log) 0.495*** (9.329) 0.378*** (3.671) Deal Size(log) 0.139** (2.328) 0.127* (1.296) Completion Time(log) -0.074 (-1.359) 0.029 (0.358) Diversify -0.035 (-0.870) -0.001 (-0.013) CAR(-1,1) -0.059 (-1.243) -0.026 (-0.419)
Total Shareholder Return -0.033
(-0.813) 0.066 (1.074) ROA 0.078* (1.856) 0.164*** (2.741) CEO Chair 0.057* (1.330) 0.093 (1.491) Insider Ratio -0.067 (-1.367) -0.220*** (-2.981) Board Size -0.072 (-1.562) -0.017 (-0.203) Corporate Governance 0.123*** (2.762) 0.070 (1.064) Investor Protection 0.474*** (9.886) 0.126* (1.955) Constant 3.042*** (3.301) 9.434*** (9.474) Observations 248 177 R-squared 0.645 0.407 *P<0.10;**P<0.05;***P<0.01
Figures in brackets are t-statistics (iii) Robustness
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proportion of observations from US (37.1%) is relatively high. The country factors of US firms might have too much influence on the results. Thus, the observations from US are eliminated for robustness checks. The first and second regression equations are repeated without US observations. New sample includes 221 M&A firms and 1080 non-M&A firms. The coefficients of Firm Size are significant in both regressions and other variables present qualitatively unchanged coefficients. Therefore, the robustness checks support the original models.
5. Conclusion
There are many literatures highlight the effects of performance, skills & effort and managerial power on CEO post-M&A compensation. Very few of them consider the influence of country characteristics. This research develops a set of hypotheses regarding how country & corporate governance features, managerial power, performance, skills and effort influence CEO pay following M&A.
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Further analyses only focus on the M&A sample to investigate the explanatory power of the incentive alignment theory and managerial power theory in determining CEO post-M&A compensation. Deals Size and ROA present positive coefficients, which propose that CEOs are rewarded for skills & effort and performance. This finding is consistent with the expectation of incentive alignment theory. The coefficients of CEO Chair suggest that CEO with greater board influence can receive more
compensation following M&A. However, the coefficients of Insider Ratio and Board Size contradict the managerial power theory. When we only focus on the acquiring firms with stronger country governance, none of the managerial power measures present significant coefficients. CEO Chair presents significant positive coefficient in the subsample that consist of acquiring firms with weaker country governance.
Coefficients of Insider Ratio and Board Size are not significant in this subsample. The incentive alignment theory presents significant explanatory power in both acquiring firms with stronger country governance and acquiring firms with weaker country governance. In summary, both theories play moderation role in determining CEO post-M&A compensation. But the explanatory power of managerial power theory is relatively weaker. The results provide more evidences to support the incentive alignment theory. Moreover, the control variable, Firm Size presents significant positive coefficients in all models. It shows that larger firms provide more CEO pay due to the higher complexity, which also supports the incentive alignment theory. The findings of this research help improve our understanding of determinates of CEO post-M&A compensation in an international context.
Acknowledgements
I sincerely thank Mr. Gonenc for his supervision and encouragement in completing this master thesis. I also thank my family and friends who always support me. This thesis would not have been completed without these people’s help.
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