CHAPTER 1


 


PROBLEM AND ITS BACKGROUND


 


Introduction

In recent years, chief executive officer (CEO) remuneration has come under increasingly close and harsh scrutiny, both in the academic literature and the popular press.[1] The popular business press has tended to portray executive salary and benefits as excessive[2] or out of control[3] and has generally supported legislative initiatives aimed at reform. Such attempts include the recent U.S. political decision to question the corporate tax deductibility of executive salaries above million and the efforts of some firms to limit CEO compensation to a multiplier of entry-level-employee compensation. Opponents of these efforts, often economists, decry the visible hand of regulation in the presumably economic decision about the level of CEO compensation[4] and, in the case of multiplier limits, suggest that there is efficiency in structuring compensation in large organizations as “tournaments” in which compensation at higher levels is much greater than that at lower levels.[5]


This debate has expanded to include long-term incentive remuneration, which has become an increasingly significant component of executive pay.[6] Once viewed by most observers as connoting managerial value and devotion to shareholders’ interests,[7] long-term incentive plans have recently been negatively portrayed as insidious devices that serve only to enrich top management at the expense of shareholders.[8] Such trenchant criticism has helped create widespread skepticism among corporate stakeholders about the motivation for long-term incentives while bolstering legislative efforts to curtail their use.  Jensen and Murphy[9] have suggested that firms are deterred from making full use of long-term incentive plans for CEOs because of the threat of “media criticism and ridicule,” which they view as a regrettable form of “implicit regulation.” Thus debate surrounding CEO remuneration reflects the tension between the economic efficiency of an ideally constructed compensation contract versus the alleged political reality of entrenched, overcompensated CEOs and weak boards. In this study, we argue for the need to consider a third perspective: the possibility that CEO compensation debates are also driven by symbolic considerations.


From a symbolic management perspective, the concern about whether CEOs in large U.S. corporations are overpaid or “worth every nickel they get”[10] is less important than how firms communicate the rationales underlying their CEO compensation decisions. According to this perspective, existing CEO compensation debates typically revolve around the subjective assessment of whether CEO compensation decisions can be considered “justifiable” in the eyes of organizational stakeholders and appeal less to economic logic than to the subjective social perception that some fixed amount or multiplier is the limit of what constitutes justifiable compensation for a CEO. Compensation beyond that amount could be subject to different interpretations by different stakeholders, some negative and some positive. Very high CEO compensation could be viewed either as an indication of corruption in the upper echelons of management or as a deserved reward for an extraordinary CEO. Thus, given ambiguity about the purpose or implications of high CEO rewards, new incentive arrangements that increase the upper bound of CEO compensation levels represent a justification problem (or opportunity) for corporate leaders. Accordingly, there may be value in studying not only how and how much firms decide to compensate their CEOs but also how firms explain their compensation decisions to shareholders and other interested constituents, including stock analysts, governmental regulators, governance activists, and prospective shareholders.


To illustrate, a study of Belliveau et al.[11] hypothesized that high social similarity between a CEO and a remuneration committee chairperson would be positively related to the overall level of CEO compensation. Similarly, Zajac and Westphal[12] found that the demographic similarity between a firm’s CEO and board of directors affects the explanation the board uses to justify the adoption of a long-term incentive plan (stock options, performance shares, and bonuses) for the CEO. Specifically, they found that when the board of directors is demographically similar to the CEO they are more likely to use human resource explanations (e.g., the need to attract talented persons) when adopting a long-term incentive plan. On the other hand, if the board is less demographically similar to the CEO, they are more likely to use agency explanations (e.g., the need for motivation) when adopting a long-term incentive plan. Finally, Daily et al.[13] found that the composition of the compensation committee (affiliated directors and CEOs) affect the level as well as the structure of the remuneration package that is afforded the CEO.


 


Background of the study


Agency theory[14] provides an initial framework for understanding the relationship between boards of directors and CEOs.[15] It has been used by scholars in disciplines such as economics,[16] finance,[17] marketing,[18] strategic management,[19] and sociology.[20] Briefly, agency theory attempts to explain the agency relationship in which one party (the principal) delegates work to another party (the agent). Problems develop in agency relationships when the goals, interests, and risk-preference of the principal and agent diverge, with the principal being unable to verify that the agent has acted appropriately. These problems may be reduced when the contract between the principal and agent provides rewards for the agent that is contingent on the outcomes achieved and the principal has information to verify agent behavior. In these cases, the agent is more likely to behave in the interests of the principal.[21]


From an agency theory perspective, boards of directors may be viewed as devices by which shareholders or owners (i.e., principals) monitor and reward the actions of CEOs (i.e., agents). CEOs may place their own interests over shareholder interests in a variety of ways. For example, they may shirk their work responsibilities in favor of leisure time[22] or consume excessive perquisites such as corporate jets.[23] They may also make decisions in accordance with the shorter time horizon associated with their expected job tenure rather than the longer time horizon that is optimal for the firm.[24] Further, CEOs may forego risky investments to protect their jobs. The desire to protect their employment stems from their high level of firm-specific investment in human capital. CEOs develop a variety of skills that are specific to the firm in which they serve, such as specialized training and experience, as well as knowledge of and ability to work in a specific organizational culture.[25] Although most shareholders hold diversified portfolios, most CEOs have only one job.[26] Accordingly, they may avoid risks to protect their own employment, even at the expense of shareholder return. Boards of directors are responsible for ensuring that CEOs fulfill their responsibilities to the firm. Apart from dismissal, which is generally exercised as an option only after other strategies have failed, boards have one primary means of controlling CEO performance: they may design incentive contracts that reward CEOs for good organizational performance.[27]


However, it should be noted that although the dominant theory in corporate governance research is agency theory, other theoretical frameworks have been suggested as well.[28] For example, stewardship theory suggests that managers are not motivated by self-interested behavior but are effective stewards of organizations whose goals are consistent with those of shareholders.[29] In this case there would be less need for performance-based pay. Nonetheless, the predominant position is that noncontingent composition is generally preferred by CEOs[30] because it provides a stable, less risky, income stream.[31] Thus, all else being equal, CEOs prefer a weak link between pay and performance.[32] When pay and performance are decoupled, CEOs may pursue their own interests with lower risk and greater flexibility.[33] Agency theory suggests that the more closely CEO pay reflects organizational performance, the more ably the compensation committee has fulfilled its function. [34]


In spite of the theoretical rationale for performance-based CEO pay, researchers have found little connection between CEO pay and firm performance.[35] The lack of performance-based CEO compensation has been a major source of public concern,[36] largely because CEOs are much less likely than their workers to take a cut in pay when the firm falls on hard times.[37] To shed light on the ways in which CEO pay and performance are decoupled, researchers must pay more attention to the processes underlying compensation decisions.[38] For example, the relationship between the board and the CEO is likely to impact the pay-performance link.[39] One way to evaluate that relationship is to draw from theory and research on the effects of relational demography. [40]From that perspective, compensation committee member s who are more similar in demographic characteristics to the CEO may be more likely to adopt compensation practices that CEOs prefer; that is, they are likely to establish less of a linkage between CEO pay and organizational performance.[41]


 


Statement of the Problem


This study intends to investigate the relationship of the Chief Executive Officers’ (CEO) and other board member’s remuneration to company performance. Specifically, the study intends to answer the following questions.


1.                            How do the remuneration programs of the firm affect the performance of the company?


2.                            What are the different remuneration schemes used by the firms?


3.                            How does the administrative department of every firm assess the suitable remuneration plan for a CEO and a Board Member?


4.                            What is the level of motivation of the CEOs and the board members in relation to their respective remuneration schemes?


5.                            What is the relationship of remuneration to the performance of the CEOs and other board members?


 


Hypothesis


The study seeks to test the following null hypothesis:


“The CEO and Board Members’ remuneration is inversely related to the company’s performance.”


 


Data Analysis

            The data for this study consists of the table on the average salaries, compensation, bonuses and other benefits received by CEOs. Data will be retrieved from magazines, journal articles and company websites and shall be compared using diagrams and tables. From this, a comparative analysis shall be made on the remuneration for CEOs on the average. Furthermore, the salaries of managers and ordinary employees will be diagramed for comparisons to that of CEOs.


            The survey questionnaire used for this study shall be consist of three parts- the demographic profile of the CEOs, their perception on their compensation and their perception on their performance. The items will be graded using a 5-point Likert scale format. The survey questionnaire distributed to the CEOs will be analyzed using the frequency, weighted mean, chi-square and ANOVA in testing the significance of the CEO compensation and their responses to the questions and in testing the significant correlation between remuneration and performance of CEOs. Moreover, performance shall be rated using weighted mean and ANOVA.


 


Scope and Limitations


The study intends investigate the relationship of the Chief Executive Officers’ (CEO) and other board member’s salary to company performance. For this study, primary research and secondary research will be used. Primary research will be conducted using anonymous questionnaires that will be sent to selected managers of multinational corporations based in the UK. The questionnaires will be used to collect quantitative data and the interviews will be used to provide qualitative insights into the data collected.


The data will be analyzed and compiled for the correlation of the hypothesis. The data will then be presented by means of graphical representations and illustration and the difference would be highlighted. A negative correlation between the variables would suggest that the hypothesis is null, that is, The CEO and Board Members’ salary is inversely related to the company’s performance.


Moreover, this study is subject to several limitations. The first limitation is that salary, bonus, and executive stock options are the only components of compensation that are considered. Although these components of compensation account for more than eighty-percent of total CEO compensation (Economist, 1994), it would be informative to also consider other forms of compensation such as restricted stock and payouts under long-term incentive plans. This study does not consider long-term performance. The movement toward longer-term incentive plans suggests that even stronger results could be obtained by incorporating long-term performance measures into the analysis. This study considers only a subset of short-term performance measures. Other factors, such as changes in the level of customer service and satisfaction, may have a greater influence on compensation than the measures used in this study. The ways in which compensation structure affects performance are not considered here. This study is naive in the sense that virtually no statistical study can consider all of the factors that enter into compensation decisions. Additional variables such as intra- and inter-industry comparisons, interest rates, economic growth, and executive labor market conditions play an important role in compensation decisions. To the extent possible, compensation committees should extend the regression models in this study to incorporate the additional variables that are most applicable to the executive whose compensation is being examined. Finally, although this study proposes a methodology for comparing pay levels among CEOs, it does not address the issue of the appropriateness of the level of CEO pay in comparison to that of other workers.


 


Definition of Terms Benefits: A payment or entitlement, such as one made under an insurance policy or employment agreement, or public assistance program. Or, more generally, something of value or usefulness. Board of Directors; Individuals elected by a corporation’s shareholders to oversee the management of the corporation. The members of a Board of Directors are paid in cash and/or stock, meet several times each year, and assume legal responsibility for corporate activities. 

CEO (Chief Executive Officer): The CEO (Chief Executive Officer) is often but not always also the President of a company. The CEO reports to the Chairman of the Board and board members. The CEO is usually the most important spokesperson for the company, the person who is responsible for quarterly results, and the best paid member of the company.


Chairman of the Board: The highest-ranking officer in a corporation’s board of directors. Presides over corporate meetings. Sometimes has executive authority over a firm, sometimes does not.

Remuneration: The total monetary value an employee receives.


Shareholder: One who owns shares of stocks in a corporation or mutual fund. For corporations, along with the ownership comes a right to declared dividends and the right to vote on certain company matters, including the board of directors. Salary: Wages received on a regular basis, usually weekly, bi-weekly, or monthly. Sometimes the term is used to include other benefits, including insurance and a retirement plan.

BIBLIOGRAPHY


Amihud, Y. and B. Lev. (1981) “Managerial Incentives and Corporate Investment and Financing Decisions.” Journal of Finance 42: 234-254.


 


Barkema, H.G. and L.R. Gomez-Mejia. (1998) “Managerial Compensation and Firm Performance: A General Research Framework.” Academy of Management Journal 41: 135- 145.


 


Basu, A., R. Lal, V. Srinivasin and R. Staelin. (1985). “Salesforce Compensation Plans: An Agency Theoretic Perspective.” Marketing 4: 267-291.


 


Belliveau, M.A., C.A. O’Reilly III and J.B. Wade. (1996). “Social Capital At the Top: Effects of Social Similarity and Status on CEO Compensation.” Academy of Management Journal 83: 1568-1593.


 


Business Week. (1992) “Executive pay.” March 30: 52-58.


 


Coffee, J.C. 1988. “Shareholders Versus Managers: The Strain In the Corporate Web.” In Knights, Raiders, and Targets: The Impact of the Hostile Takeover. Eds. J.C. Coffee, L. Lowenstein and S. Rose-Ackerman. NewYork, NY: Oxford University Press.


 


Crystal, G. (1991) In Search of Excess: The Overcompensation of American Executives. New York, NY: W. W. Norton and Co.


 


Daily, C.M., J.L. Johnson, A.E. Ellstrand and D.R. Dalton. (1998). “Compensation Committee Composition As a Determinant of CEO Compensation.” Academy of Management Journal 41: 209-220.


 


Davis, J. H., F. D. Schoorman, and L. Donaldson. (1997) “Toward a Stewardship Theory of Management.” Academy of Management Review 22: 20-47.


 


Eccles, R. (1985). “Transfer Pricing As a Problem of Agency.” In Principals and Agents: The Structure of Business. Eds. J. Pratt and R. Zeckerhauser. Boston, MA: Harvard Business School Press.


 


Economist. 1994. “Considering the Options.” (July 30): 70-71.


 


Eisenhardt, K.M.(1989). “Agency Theory: Assessment and Review.” Academy of Management Review 14: 57-74.


 


Fama, Eugene F. (1980) “Agency problems and the theory of the firm.” Journal of Political Economy, 88: 288-307.


 


Gomez-Mejia, L. R. (1994) “Executive Compensation: A Reassessment and a Future Research Agenda.” In Research in Personnel and Human Resource Management. Ed. C. K Ferris. Greenwich, CT: JAI Press.


 


Gray, S.R. and A.A. Cannella. (1997) “The Role of Risk in Executive Compensation.” Journal of Management 23: 517-540.


 


Hill, C. and P. Phan. (1991) “CEO Tenure As a Determinant of CEO Pay.” Academy of Management Journal 34: 707-717.


 


Jackson, S.E., J.F. Brett, V.I. Sessa, D.M. Cooper, J.A. Julin and K. Peyronnin. (1991). “Some Differences Make a Difference: Individual Dissimilarity and Group Heterogeneity as Correlates of Recruitment, Promotions, and Turnover. “Journal of Applied Psychology 76: 675-89.


 


Jarrell, Gregg A. (1993)”An overview of the executive compensation debate.” Journal of Applied Corporate Finance, 5: 76 82.


 


Jensen, M., and K. Murphy. (1990). “Performance Pay and Top-Management Incentives.” Journal of Political Economy (April): 225-264.


 


Jensen, M.C. W.H. Meckling. (1976) “Theory Of the Firm: Managerial Behavior, Agency Costs, and Ownership Structure.” Journal of Finance 3: 305-350.


 


Jensen, M.C.(1988). “The Takeover Controversy: Analysis and Evidence.” In Knights, Raiders, and Targets: The Impact of the Hostile Takeover. Eds. J.C. Coffee, L. Lowenstein and S. Rose-Ackerman. New York, NY: Oxford University Press.


 


Kosnik, R.D.(1987). “Greenmail: A Study in Board Performance in Corporate Governance.” Administrative Science Quarterly 32: 163-185.


 


Lazear, Edward, and Sherwin Rosen (1981) “Rank-order tournaments as optimum labor contracts.” Journal of Political Economy, 89: 841 864.


 


Murphy, Kevin J. (1986)”Top executives are worth every nickel they get.” Harvard Business Review, 64(21: 125-132.


 


O’Reilly, C. A. I., D. F. Caldwell and W. P. Barnett. 1989. “Work Group Demography, Social Integration, and Turnover.” Administrative Science Quarterly 34: 21-37.


 


Pearce, J., W. Stevenson and J. Perry. (1985) “Managerial Compensation Based On Organizational Performance: A Time Series Analysis of The Effects of Merit Pay.” Academy of Management Journal 28: 261-278.


 


Spence, A.M. and R Zeckhauser. (1971). “Insurance, Information, and Individual Action.” American Economic Review 61: 380-387.


 


Tosi, H. L. and L. R Gomez-Mejia. (1994). “CEO Compensation Monitoring and Firm Performance.” Academy of Management Journal 37: 1002-1016.


 


Tsui, A.S. and C.A. O’Reilly. (1989) “Beyond Simple Demographic Effects: The Importance of Relational Demography in Superior-Subordinate Dyads.” Academy of Management Journal 32: 402-423.


 


Ungson, G. and R. Steers. (1984) “Motivation and Politics in Executive Compensation.” Academy of Management Review 9: 313-323.


 


Wiseman, R.M. and L.R. Gomez-Mejia. (1998) “A Behavioral Agency Model of Managerial Risk Taking.” Academy of Management Review 23: 133-153.


 


Zajac, E.J. and J.D. Westphal.( 1995). “Accounting for Explanations of CEO Compensation: Substance and Symbolism.” Administrative Science Quarterly 40: 283-308.


 


[1] Jensen, M., and K. Murphy. (1990). “Performance Pay and Top-Management Incentives.” Journal of Political Economy (April): 225-264.


[2] Crystal, G. (1991) In Search of Excess: The Overcompensation of American Executives. New York, NY: W. W. Norton and Co.


[3] Business Week. (1992) “Executive pay.” March 30: 52-58.


[4] Jarrell, Gregg A. (1993)”An overview of the executive compensation debate.” Journal of Applied Corporate Finance, 5: 76 82.


[5] Lazear, Edward, and Sherwin Rosen (1981) “Rank-order tournaments as optimum labor contracts.” Journal of Political Economy, 89: 841 864.


[6] Supra. Jarrell (1993)


[7] Supra. Crystal (1991)


[8] Ibid. Supra, Business Week (1992)


[9] Supra. Jensen and Murphy (1990)


[10] Murphy, Kevin J. (1986)”Top executives are worth every nickel they get.” Harvard Business Review, 64(21: 125-132.


[11] Belliveau, M.A., C.A. O’Reilly III and J.B. Wade. (1996). “Social Capital At the Top: Effects of Social Similarity and Status on CEO Compensation.” Academy of Management Journal 83: 1568-1593.


 


[12] Zajac, E.J. and J.D. Westphal.( 1995). “Accounting for Explanations of CEO Compensation: Substance and Symbolism.” Administrative Science Quarterly 40: 283-308.


 


[13] Daily, C.M., J.L. Johnson, A.E. Ellstrand and D.R. Dalton. (1998). “Compensation Committee Composition As a Determinant of CEO Compensation.” Academy of Management Journal 41: 209-220.


 


[14] Eisenhardt, K.M.(1989). “Agency Theory: Assessment and Review.” Academy of Management Review 14: 57-74.; Jensen, M.C. W.H. Meckling. (1976) “Theory Of the Firm: Managerial Behavior, Agency Costs, and Ownership Structure.” Journal of Finance 3: 305-350.


[15] Ibid. Supra, Daily (1998).


[16] Spence, A.M. and R Zeckhauser. (1971). “Insurance, Information, and Individual Action.” American Economic Review 61: 380-387.


[17] Fama, Eugene F. (1980) “Agency problems and the theory of the firm.” Journal of Political Economy, 88: 288-307.


[18] Basu, A., R. Lal, V. Srinivasin and R. Staelin. (1985). “Salesforce Compensation Plans: An Agency Theoretic Perspective.” Marketing 4: 267-291.


[19] Kosnik, R.D.(1987). “Greenmail: A Study in Board Performance in Corporate Governance.” Administrative Science Quarterly 32: 163-185.


[20] Eccles, R. (1985). “Transfer Pricing As a Problem of Agency.” In Principals and Agents: The Structure of Business. Eds. J. Pratt and R. Zeckerhauser. Boston, MA: Harvard Business School Press.


[21] Supra. Eisenhardt (1989).


[22] Supra. Jensen and Meckling (1976)


[23] Jensen, M.C.(1988). “The Takeover Controversy: Analysis and Evidence.” In Knights, Raiders, and Targets: The Impact of the Hostile Takeover. Eds. J.C. Coffee, L. Lowenstein and S. Rose-Ackerman. New York, NY: Oxford University Press.


[24] Supra. Jensen and Meckling (1976).


[25] Coffee, J.C. 1988. “Shareholders Versus Managers: The Strain In the Corporate Web.” In Knights, Raiders, and Targets: The Impact of the Hostile Takeover. Eds. J.C. Coffee, L. Lowenstein and S. Rose-Ackerman. NewYork, NY: Oxford University Press.


[26] Amihud, Y. and B. Lev. (1981) “Managerial Incentives and Corporate Investment and Financing Decisions.” Journal of Finance 42: 234-254.


[27] Supra. Walsh and Seward. (1990)


[28] Supra. Davis (1998); Davis, J. H., F. D. Schoorman, and L. Donaldson. (1997) “Toward a Stewardship Theory of Management.” Academy of Management Review 22: 20-47.; O’Reilly, C. A. I., D. F. Caldwell and W. P. Barnett. 1989. “Work Group Demography, Social Integration, and Turnover.” Administrative Science Quarterly 34: 21-37.


[29] Ibid. Davis (1997).


[30] Supra Daily (1998); Tosi, H. L. and L. R Gomez-Mejia. (1994). “CEO Compensation Monitoring and Firm Performance.” Academy of Management Journal 37: 1002-1016.


[31] Gomez-Mejia, L. R. (1994) “Executive Compensation: A Reassessment and a Future Research Agenda.” In Research in Personnel and Human Resource Management. Ed. C. K Ferris. Greenwich, CT: JAI Press.; Gray, S.R. and A.A. Cannella. (1997) “The Role of Risk in Executive Compensation.” Journal of Management 23: 517-540.


[32] Supra Gray and Canella (1997); Daily (1998): Hill, C. and P. Phan. (1991) “CEO Tenure As a Determinant of CEO Pay.” Academy of Management Journal 34: 707-717.


[33] Supra (Daily et al., 1998; Tosi and Gomez-Mejia, 1989)


[34] Supra. Gray and Canella (1997); Barkema, H.G. and L.R. Gomez-Mejia. (1998) “Managerial Compensation and Firm Performance: A General Research Framework.” Academy of Management Journal 41: 135- 145.; Wiseman, R.M. and L.R. Gomez-Mejia. (1998) “A Behavioral Agency Model of Managerial Risk Taking.” Academy of Management Review 23: 133-153.


[35] Supra. Barkema and Gomez-Mejia (1998) and Jensen and Murphy (1990)


[36] Ungson, G. and R. Steers. (1984) “Motivation and Politics in Executive Compensation.” Academy of Management Review 9: 313-323.; Pearce, J., W. Stevenson and J. Perry. (1985) “Managerial Compensation Based On Organizational Performance: A Time Series Analysis of The Effects of Merit Pay.” Academy of Management Journal 28: 261-278.


[37] Supra. Crystal (1991)


[38] Supra. Tosi and Gomez-Mejia, 1989


[39] Supra. Ungson and Steers (1984)


[40] Jackson, S.E., J.F. Brett, V.I. Sessa, D.M. Cooper, J.A. Julin and K. Peyronnin. (1991). “Some Differences Make a Difference: Individual Dissimilarity and Group Heterogeneity as Correlates of Recruitment, Promotions, and Turnover. “Journal of Applied Psychology 76: 675-89.; Tsui, A.S. and C.A. O’Reilly. (1989) “Beyond Simple Demographic Effects: The Importance of Relational Demography in Superior-Subordinate Dyads.” Academy of Management Journal 32: 402-423.


[41] Supra. Daily (1998).



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