Professional Documents
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Cybinski 2013
Cybinski 2013
www.emeraldinsight.com/1030-9616.htm
Remuneration
Remuneration committee committee
independence and CEO independence
remuneration for firm
197
financial performance
Patti Cybinski
Department of Accounting, Finance & Economics, Griffith University Nathan,
Brisbane, Australia, and
Carolyn Windsor
Faculty of Business, Bond University, Gold Coast, Australia
Abstract
Purpose – As a result of the Australian Government Productivity Commission’s recommendation to
mandate remuneration committee independence for ASX300 companies, this study aims to investigate
whether voluntary remuneration committee independence aligns chief executive officer (CEO) total
pay and bonuses with firm financial performance.
Design/methodology/approach – A series of hypotheses test the research question using multiple
regressions for a sample of 143 ASX300 companies during 2001. This time was prior to strengthen
corporate governance regulation, but after mandated executive remuneration disclosure, thus
capturing varying levels of voluntary remuneration committee independence.
Findings – This study shows firm size is an influential factor in the relationship under investigation.
ASX300 large firm remuneration committees link CEO total remuneration and bonuses to firm
financial performance. Smaller ASX firm remuneration committees do not link either type of CEO
remuneration to performance despite remuneration committee independence. Findings are mixed for
medium-sized ASX300 firms.
Research limitations/implications – Limitations include the necessary time restriction to 2001 for
sampling the ASX300 firms. The implication of this study’s findings is that the proposed public policy
for mandatory remuneration committee independence is not universally effective in linking CEO
remuneration to firm financial performance for ASX300 firms.
Originality/value – This study contributes to the limited research on voluntary remuneration
committee independence in relation to CEO remuneration and firm financial performance in the
Australian context.
Keywords Chief executive officer, Firm financial performance, Remuneration committee independence
Paper type Research paper
1. Introduction
Public anger about executive pay excesses has increased since corporate, regulatory,
and political leaders were implicated in the global financial crisis that harmed
community well-being (Stiglitz, 2010). Although Australian executive pay is relatively
modest by international standards, compensation for Australian executives in the
50 to 100 largest companies has increased by as much as 300 per cent in real terms Accounting Research Journal
Vol. 26 No. 3, 2013
between 1993 and 2007 (Fels, 2010). Moreover, nearly all the growth in reported pp. 197-221
executive pay for the top 300 companies is attributed to increases in incentive pay q Emerald Group Publishing Limited
1030-9616
(Fels, 2010). DOI 10.1108/ARJ-08-2012-0068
ARJ Australian governments however have been successfully persuaded to let the market
26,3 regulate corporate executive remuneration. Statements of good practice, such as the
ASX Corporate Governance Council’s (2003, 2007) Corporate Governance Principles and
Recommendations “Remunerate fairly and responsibly”, largely guide remuneration
practice for Australian executives. Further, government legislative intervention is most
prevalent for remuneration disclosure and shareholders’ binding[1] vote on
198 remuneration (Sheehan, 2009, 2012). To appease public anger, the Prime Minister
requested the Productivity Commission[2] to review the regulation of executive and
director remuneration for the following reason:
[. . .] the prime motivation for this inquiry is a widespread perception that executives have
been rewarded for failure or simply good luck. And certainly in some periods and for some
CEOs, pay outcomes appear inconsistent with a reasonably efficient executive labour market
(Australian Government Productivity Commission, 2009, p. xxvi).
Our study is motivated by the Commission’s recommendation to regulate the formation
and composition of independent remuneration committees for companies included in
the S&P ASX 300 index (hereafter referred to as ASX 300 companies). The Commission
argues that independent remuneration committees reduce conflicts of interest. These
conflicts include executive board members who are able to make decisions about their
own pay (Australian Government Productivity Commission, 2009). This key
recommendation number (2) proposes a new ASX listing rule specifying that.
The ASX Corporate Governance Council should introduce an “if not, why not”
recommendation specifying that remuneration committees:
.
have at least three members;
.
comprise (NEDIRs), a majority of whom are independent;
.
be chaired by an independent director;
.
have a charter setting out procedures for non-committee members attending; and
.
meetings (Australian Government Productivity Commission, 2009, p. 9, xxxvii).
They found that firm size accounted for more than 40 per cent of the variance in total
CEO remuneration, while firm performance accounted for less than 5 per cent of the
variance. Merhebi et al. (2006) tested the link between firm size and CEO remuneration of
Australian companies (1990-1999) and found a significant and positive result. They
argued that some evidence exists regarding size as a proxy for performance and that
“larger firms clearly have the capacity for higher remuneration packages regardless of
performance” (Merhebi et al., 2006, p. 495). Baker et al. (1988) questioned the notion of
size as a proxy for performance when they found evidence that CEOs are able to increase
their pay by increasing the firm size, even when the size increase reduces the firm’s
market value. They further suggested this motivation “could explain some of the vast
amount of inefficient expenditures of corporate resources on diversification programs
that have created large conglomerate organizations” (Baker et al., 1988, p. 609).
Additionally, Tosi et al. (2000, p. 329) argued that their findings were consistent with:
[. . .] those theoretical explanations that emphasize organizational size as an important
determinant of total CEO remuneration; that is, indicators of firm size, taken together, explain
almost nine times the amount of variance in total CEO remuneration than the most highly
correlated performance measure. A lesser effect is demonstrated in the findings regarding
pay sensitivity as well as in the difference in the pay/performance or pay/firm growth
sensitivities. Changes in firm performance account for only 4 per cent of the variance in CEO
remuneration, while changes in firm size account for 5 per cent of the variance in CEO
remuneration. These results are consistent with Jensen and Murphy’s (1990) conclusion that
“incentive alignment” as an explanatory agency construct for CEO remuneration is weakly
supported at best.
A number of measures of firm size appear in the literature, including sales revenue, log of
net sales, net income, total assets (Hagerman and Zmijewski, 1979; Skinner, 1994), and
log of total assets (Reynolds et al., 2004). Hagerman and Zmijewski (1979) argue that no
measure of size is necessarily better than another. Therefore, we use total assets as a
proxy for firm size and partition our sample into thirds for large, medium, and smaller
firms to normalise the data (see Table III for mean total assets for each category).
3. Research design
Sample
To capture the varying levels of voluntary remuneration committee independence, we
expressly analyse data from ASX300 companies’ 2001 annual reports. The timeframe,
2001, is of interest because it is just after mandated executive remuneration disclosure,
but before the introduction of regulation to strengthen corporate governance including
the ASX recommendation for remuneration committee independence. In fact, little Remuneration
variation now exists in remuneration committee composition of ASX300 companies as
most now have independent remuneration committees. Further, Clarkson et al. (2011)
committee
concluded that extensive regulatory change between 2001 and 2009 had enhanced independence
oversight of the executive compensation process through strengthened corporate
governance regulations and increased transparency.
205
Overview of increased corporate governance regulation post-2001
We, therefore, examine ASX300 companies in a corporate governance context before the
enactment of legislation that increased regulatory scrutiny of directors’ responsibilities
in response to corporate collapses, such as Enron in December 2001. The US Congress
enhanced corporate regulation by enacting the Sarbanes-Oxley Act (SOX) (2002). These
new corporate governance rules and requirements affected US-based trading firms and
Australian companies associated with the US capital markets. Additionally, Australian
based transnational audit firms began to use elements of SOX in their audits of
Australian companies. The Australian Government’s Company Law Economic Reform
Program (CLERP), concerning corporate governance, soon followed and was enacted
as CLERP 9 in 2004. Moreover, the ASX Corporate Governance Council’s (2003, 2007)
Corporate Governance Principles and Recommendations were introduced and
encouraged firms to implement independent remuneration committees that included a
majority of NEDIRs.
Level n
REMCindep
0 Lowest proportion: firms with no remuneration 27
committee or a minority of NEDIRs – least
independent
1 Firms with a majority of NEDIRs on remuneration 42 Table II.
committees Remuneration committee
2 100 percent NEDIRs on remuneration committees – 74 independence as
most independent proportion of NEDIR at
Total 143 three levels
ARJ (operative 1 January 2005) to comply with the International Accounting Standards and
26,3 executive remuneration was specifically guided by AASB (2004) 1046 Director and
Executive Disclosures by Disclosing Entities.
remuneration (CEOtotal ) and bonuses (CEObonus) with prior year’s firm financial
performance (ROAlag1) for the period of 2001.
A higher ROA indicates management’s ability to use company assets efficiently in
serving shareholders’ economic interests. Therefore, we expect a positive association.
The link between CEO total remuneration and firm financial performance is first tested
without taking into consideration the effect of remuneration committee independence.
We use the general linear model (GLM) procedure in SPSS. This is a flexible statistical
model that incorporates normally distributed dependent variables and categorical or
continuous independent variables (McCullagh and Nelder, 1989; Nelder and
Wedderburn, 1972). GLM allows factors (and interactions of factors) as predictors,
rather than just continuous variable predictors, in the models we are estimating; and is
appropriate because this research relied on considering the interactions between factor
variables.
Model 2: regression, a two-way interaction model for CEO total remuneration on firm
financial performance and remuneration committee independence
CEOtotal ¼ b0 þ b1ðROAlag1*REMCindepÞ þ b2 Industry þ e
where: b1 is now a vector of coefficients for the various levels of the interaction term in
the model.
In Model 2, we test the effect of a two-way interaction between firm financial
performance and remuneration committee independence on CEO remuneration. This is
to investigate whether remuneration committees control CEO pay in line with firm
financial performance in at least some partitions of the group of firms characterized by
the different levels of remuneration committee independence. For theoretical reasons,
the main effects ROAlag1 and REMCindep are not included because the interaction
effect between them is significant in Model 2 ( p ¼ 0.01). To set up a model that includes
these two main effects, and interpret their coefficients and hypothesis tests as main
effects, is not theoretically justified or correct when their interaction effect is significant,
except under limited conditions (Hayes, 2005, pp. 452-456; Irwin and McClelland, 2001;
Jaccard and Turrisi, 2003, p. 24).
The two-way interaction model for CEO total remuneration is significant (F3,136 ¼ 3.7;
p ¼ 0.01, Table VI) indicating that independent remuneration committees are
significantly associated with the relationship between CEO total remuneration and
prior year’s firm financial performance. We examine the three coefficient parameter
estimates for the interaction term in Table VII to ascertain in which subgroup/s of
remuneration committee independence the association between CEO remuneration and
firm financial performance is significant, and whether it is a positive or negative one. We
find that for the most independent remuneration committees (with 100 per cent NEDIR
composition) the association between performance and CEO remuneration is significant
and positive ( p ¼ 0.06, Table VII). However, for the least independent remuneration
committees (with either no remuneration committee or a minority of NEDIRs) the
association between firm financial performance and CEO remuneration is significant and
negative ( p , 0.05, Table VII).
ARJ
Variable F p-value
26,3
Intercept 2,624.072 0.000
Industry 0.216 0.885
ROAlag1*REMCindep 3.717 0.013 * * *
Likelihood ratio x 2 ¼ 11.7, df ¼ 6 ( p ¼ 0.068)
210 Notes: Significance at: *p , 0.10, * *p , 0.05, * * *p , 0.01 and * * * *p , 0.001 (all p-values are
two-tailed):
Table VI. CEOtotal ¼ b0 þ b1 ðROAlag1* REMCindepÞ þ b2 Industry þ e
Model 2 CEO total
remuneration and CEOtotal – natural logarithm of CEO total remuneration ($) comprising base pay þ superannuation/fringe
two-way interaction benefits þ bonuses; ROAlag1 – return on assets for the prior year 2000; REMCindep is the proportion of
between firm (NEDIRs) on the remuneration committee (RC), categorised into 0 – firms with no RCs or a minority NEDIRs,
performance and the least independent RCs; 1 – a majority of NEDIRs on firm RCs but less than 100 per cent; 2 – 100 per cent
remuneration committee NEDIR composition, the most independent RCs; industry – industry groups based on GIC sectors, 1 –
independence energy and mining, 2 – industrials, 3 – consumer and 4 – services
Variable b SE t p-value
This explains the lack of significance for Model 1, since the CEO remuneration for firm
financial performance relationship is neither consistently significant nor consistently
positive for all three levels of remuneration committee independence. The model fit is
significant ( p ¼ 0.07 , 0.1), using the maximum likelihood ratio x 2 test. However,
the model fit can be improved by including firm size as a three-way interaction term with
the other two independent variables.
Model 3: regression – a three-way interaction model for CEO total remuneration on Remuneration
firm financial performance, remuneration committee independence and firm size committee
Prior research by Tosi et al. (2000) and Merhebi et al. (2006) examined firm size and
financial performance separately in relation to CEO remuneration. These studies suggest independence
that large firms generously pay their CEOs and executives and size was found to be a
more important criterion than financial performance alone. Recall that our study
contributes to corporate governance research and associated public policy by examining 211
whether varying levels of remuneration committee independence align CEO total
remuneration with firm financial performance for ASX 300 companies in an essentially
voluntary context. Although we examine ASX300 firms, these firms vary in size and are
not homogeneous. Firm size (Size) is categorised into the following three levels (described
in Table III): smaller firms (n ¼ 46, mean 148, SD 77 in $m), medium firms (n ¼ 49, mean
787, SD 373 in $m), and large firms (n ¼ 48, mean 18,980, SD 47,950 in $m). This
categorisation of size allows analysis of the model with a three-way interaction below:
CEOtotal ¼ b0 þ b1ðSize*ROAlag1*REMCindepÞ þ b2 Industry þ e
where: b1 is a vector of coefficients for the various levels of the interaction term in the
three-way interaction model (Friedrich, 1982; Jaccard and Turrisi, 2003). For Model 3,
Table VIII reports a significant high-order relationship (F12,130 ¼ 8.94, p ¼ 0.001)
between the dependent variable, CEO total remuneration (CEOtotal ) and the three-way
interaction with firm size (Size), prior year’s firm financial performance (ROAlag1), and
remuneration committee independence (REMCindep). Model 3 is a much better fit than
Model 2, as indicated by the maximum likelihood x 2 test ( p , 0.001). Table IX reports
further analysis of this three-way interaction revealing that firm size matters, with very
significant positive associations for large firms ( p , 0.01) between CEOtotal and firm
financial performance (ROAlag1) for all three levels of remuneration committee
independence (REMCindep).
The results for the three-way interaction are particularly strong ( p , 0.001),
especially for large firms with remuneration committees comprising 100 per cent
Variable F p-value
NEDIRs and for firms with a majority of NEDIRs ( p ¼ , 0.001). Results are weaker
( p , 0.005) for firms with no remuneration committees or a minority NEDIRs. For
medium and smaller size firms, the only significant positive association between CEO
total pay and prior year’s firm financial performance occurred for medium-sized firms
with remuneration committees comprising a majority of NEDIRs ( p , 0.05).
Interestingly, a significant negative relationship between CEOtotal and prior year’s
firm financial performance was found for smaller firms with no remuneration
committees or remuneration committees with a minority of NEDIRs (the lowest level of
remuneration committee independence). This last result suggests that smaller firms
with the least independent remuneration committees recompense their CEOs even when
these firms are not performing financially. The results also show the ineffectiveness of
remuneration committees to align CEO total pay with firm financial performance for
smaller firms regardless of the composition of the remuneration committee.
Model 5: regression – a two-way interaction model for CEO bonuses on firm financial
performance and remuneration committee independence
CEObonus ¼ b0 þ b1 ðROAlag1*REMCindepÞ þ b2 Industry þ e
In Model 5 we test CEO bonuses and the two-way interaction between firm financial
performance and remuneration committee independence. The result was not
significant ( p ¼ 0.238), as shown in Table XI. The two-way interaction shows only
marginal significance ( p ¼ 0.1). We conclude that our sample of firms, when
partitioned by the independence level of their remuneration committee, show no
evidence of aligning CEO bonuses with prior year’s firm financial performance within
any subgroup of remuneration committee categorised at three levels of independence.
Model 6: regression model – a three-way interaction model for CEO bonus on firm
financial performance, remuneration committee independence and firm size
Next, in Model 6, we investigate the association between the dependent variable CEO
bonus, and the three-way interaction between firm size, prior year’s firm financial
performance, and remuneration committee independence. Table XII Model 6 reports a
significant three-way interaction (F9,129 ¼ 2.24, p , 0.05), but not as strong as for
Model 3 that shows CEO total remuneration ( p , 0.001). Just as for CEO total
remuneration, Table XIII reports further analysis of Model 6 interaction and shows a
strong positive relationship between CEO bonuses and prior year’s financial
performance (ROAlag1) for large firms at all three levels of remuneration committee
independence (REMCindep). The relationship is strongest ( p , 0.002) for large firms
Variable F p-value
Variable F p-value
with remuneration committees comprising 100 per cent NEDIRs. This result shows
that the largest firms with the most independent remuneration committees consistently
paid CEO bonuses in line with firm financial performance, thus demonstrating that
CEO bonuses are somewhat controlled by independent remuneration committees for
this subgroup of firms.
We find a weaker result for large firms with remuneration committees having a majority
of NEDIRs or mid-level independence ( p , 0.05); while, those firms with no remuneration
committees or a minority of NEDIRs were weaker still ( p , 0.01). Table XIII also reports a
positive significant result for medium-sized firms with 100 per cent NEDIRs ( p ¼ ,0.05).
These results suggest that large and medium firm groups with 100 per cent NEDIRs on
their remuneration committees are the most effective in controlling CEO bonus incentives
in line with prior year’s firm financial performance. The results also show the
Remuneration
Variable b SE t p-value
committee
Intercept 8.019 1.025 7.820 0.000 independence
Energy and mining 2 0.510 1.357 2 0.376 0.708
Industrials 2 2.613 1.490 2 1.754 0.082
Consumer 2 2.983 1.246 2 2.394 0.018
Services 0a 215
[Size ¼ 0 smaller]*[REMCindep ¼ 0]*ROAlag1 2 0.016 0.078 2 0.202 0.840
[Size ¼ 0 smaller]*[REMCindep ¼ 1]*ROAlag1 0.067 0.154 0.434 0.665
[Size ¼ 0 smaller]*[REMCindep ¼ 2]*ROAlag1 0.022 0.092 0.243 0.808
[Size ¼ 1 med]*[REMCindep ¼ 0]*ROAlag1 0.042 0.220 0.190 0.849
[Size ¼ 1 med]*[REMCindep ¼ 1]*ROAlag1 0.187 0.184 1.016 0.311
[Size ¼ 1 med]*[REMCindep ¼ 2]*ROAlag1 0.423 0.180 2.345 0.021 * *
[Size ¼ 2 large]*[REMCindep ¼ 0]*ROAlag1 1.015 0.374 2.718 0.007 * * *
[Size ¼ 2 large]*[REMCindep ¼ 1]*ROAlag1 0.359 0.184 1.948 0.054 * *
[Size ¼ 2 large]*[REMCindep ¼ 2]*ROAlag1 0.523 0.166 3.158 0.002 * * *
Notes: Significance at: *p , 0.10, * *p , 0.05, * * *p , 0.01 and * * * *p , 0.001 (all p-values are two-
tailed); athis parameter is set to zero because it is redundant:
CEObonus ¼ b0 þ b1 ðSize*ROAlag1* REMCindepÞ þ b2 Industry þ e Table XIII.
Model 6 CEO total
CEObonus – natural logarithm of CEO bonuses; Size – total assets ($ value) categorised into thirds: 0 bonuses, parameter
– smaller firms, 1 – medium firms, 2 – larger firms; ROAlag1 – return on assets for the prior year estimates for three-way
2000; REMCindep is the proportion of NEDIRs on the remuneration committee (RC), categorised into 0 interaction between firm
– firms with no RCs or a minority NEDIRs, the least independent RCs; 1 – a majority of NEDIRs on size remuneration
firm RCs but less than 100 per cent; 2 – 100 per cent NEDIR composition, the most independent RCs; committee independence
Industry – industry groups based on GIC sectors, 1 – energy and mining, 2 – industrials, 3 – and firm financial
consumer and 4 – services performance
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Corresponding author
Carolyn Windsor can be contacted at: cwindsor@bond.edu.au