scispace - formally typeset
Search or ask a question
Journal ArticleDOI

Executive compensation, corporate governance and corporate performance: A simultaneous equation approach

TL;DR: In this article, the authors investigated the association between executive compensation and performance using a three-stage least squares (3SLS) simultaneous equation framework and found that the executive pay and performance sensitivity is relatively weak.
Abstract: This paper investigates the association between executive compensation and performance. It uniquely utilises a comprehensive set of corporate governance mechanisms within a three-stage least squares (3SLS) simultaneous equation framework. Results based on estimating a conventional single equation model indicate that the executive pay and performance sensitivity is relatively weak, whereas those based on estimating a 3SLS model generally suggest improved executive pay and performance sensitivity. Our findings highlight the need for future research to control for possible simultaneous interdependencies when estimating the executive pay and performance link. The findings are generally robust across a raft of econometric models that control for different types of endogeneities, executive pay and performance proxies. Copyright © 2013 John Wiley & Sons, Ltd.

Summary (3 min read)

1. INTRODUCTION

  • A number of reasons may explain the weak findings of past studies.
  • This development provides the opportunity to collect data on total pay of the Chief Executive Officer (CEO), as well as on the total pay of all executives and on CG in order to investigate the association between executive compensation and performance for a sample of SA listed companies, enabling us to make a number of contributions to the extant literature.
  • The next section discusses CG and executive pay practices within the SA institutional framework.

2. CORPORATE GOVERNANCE, EXECUTIVE PAY AND THE SOUTH AFRICAN INSTITUTIONAL FRAMEWORK

  • Attempts at improving CG practices in SA companies began with the publication of the first King Report in 1994 (King I) (Armstrong et al., 2006).
  • These domestic problems in combination with increased international attention on CG (Rossouw et al., 2002; Mangena and Chamisa, 2008), resulted in a review of King I and the subsequent publication of a second King Report (King II) in 2002.
  • An important aspect of King II is that it expects shareholders, especially institutional ones, to play an active part in setting executive pay, including the requirement that executive remuneration be approved 5 by shareholders at an annual general meeting, in which the chairperson of the RCOM should be available to answer questions.
  • Additional to the pursuance of recent CG reforms is the feature that, unlike the UK and US but similar to most Asian and some European countries, ownership of firms is highly concentrated (Firth et al., 2006, 2007; Ntim et al., 2012a, b).

3. PRIOR LITERATURE ON EXECUTIVE COMPENSATION AND CORPORATE PERFORMANCE

  • The executive compensation and performance literature has in the main developed from two major contrasting theoretical views 2 : optimal contracting and managerial power (Murphy, 1999; Bebchuk and Fried, 2003, 2004; Cheng and Firth, 2006; Van Essen et al., 2012).
  • The optimal contracting view considers 6 executive compensation packages as a result of arm‟s length dealing between independent corporate boards and executives that leads to the creation of efficient managerial contracts and incentives for minimising agency problems by aligning the interests of managers and shareholders (Jensen and Murphy, 1990; John et al., 2010; Tang, 2012; Lin et al., 2012).
  • These studies generally report a positive, but a weak, link between executive pay and performance; although US studies document a relatively stronger pay and performance sensitivity than their UK counterparts (Conyon and Murphy, 2000; Sapp, 2008).
  • Further, and of direct relevance, the results of a limited number of studies conducted in a number of developing countries are largely consistent with the non UK and US evidence.
  • Using a sample of 601 Chinese firms from 2000 to 2003, Buck et al. (2008) report a positive and higher sensitivity between CEO pay and total shareholder return than those reported for UK and US companies.

4.1. Data Considerations

  • The authors sample is drawn from all 291 non-financial firms 4 listed on the Johannesburg Securities Exchange (JSE) Ltd as at 31/12/2007.
  • Firms included in their final sample met two criteria: availability of a firm‟s executive pay data for all years from 2003 to 2007 and the accessibility to a company‟s financial and CG data from 2002 to 2006.
  • These criteria were set for a number of reasons.
  • Finally, the sample begins in 2002 because there is limited data coverage in the Perfect Information Database/Datastream on SA companies prior to that year, and crucially because King II came into effect in 2002.
  • As presented in Panel B of Table 1, the sample consists of a total of 169 firms out of the initial 291 firms 7 over five firmyears from eight industries that met the data criteria for their analysis.

4.2. Model Specification: Executive Pay-Corporate Performance Sensitivity

  • The widely used total shareholder return (TSR) is their main corporate performance proxy, but as a robustness check, the authors also employ return on assets (ROA) and Tobin‟s Q (Q) as alternative accounting and market-based corporate performance measures, respectively.
  • Table 2 contains full definitions of all the variables used.

4.3. Three-Stage Least Squares, Executive Pay, Alternative Corporate Governance Mechanisms and Possible Interdependencies

  • Firms with greater investment opportunities tend to grow faster and are more likely to receive higher market valuation (Barnhart and Rosenstein, 1998; Ghosh, 2007), and hence the authors expect sales growth (SGR) and capital expenditure (CAPX) to be positively related to TSR.
  • As larger firms are subjected to greater media and public scrutiny (Conyon, 1997; Ntim et al., 2012a), the authors hypothesise that BSIZE will be positively associated with the presence of an independent remuneration committee (RCOM) and a CG committee (see Table 2), but negatively related to CEO role duality (DUAL) and director ownership (DOWN).
  • Labelling all 12 exogenous variables together as EXOGENOUS, the second equation to be estimated in the system is specified as: ii j jii iiiii EXOGENOUSTPAYINSOWN BLKOWNLEVNEDsTSRBSIZE.
  • The authors also expect NEDs to vary across different industries and over-time (YD).

5.1. Descriptive Statistics

  • Table 3 contains descriptive statistics of the two main components of total executive pay for all firm-years, as well as for each of the five firm-years.
  • Panels A and B report statistics relating to total and average pay of all executives (TPAY), respectively, while Panel C presents similar figures for the CEO .
  • This appears to support the widely held view, especially within the SA financial press (Okeahalam, 2004; Sarra, 2004; Ntim et al., 2012a) that corporate executives continue to receive substantial pay increases that are well above the 16 average national growth rate in pay.
  • The mean institutional ownership of 74% is consistent with the 63% reported by Zheng (2010) for a sample of US firms, whereas the average block ownership 17 of 62% is considerably higher than the 20% reported by Ozkan (2011) for a sample of UK firms.
  • This supports previous evidence that CEOs, on average, tend to be matured and experienced individuals (Ozkan, 2011; Elsila et al., 2013).

5.2. Executive Pay and Corporate Performance Sensitivity

  • 2.1. Results based on estimating firm fixed-effects.
  • A major implication of this finding is that the structure rather than the levels of pay appears to be more effective in linking executive/CEO pay to corporate performance.
  • A number of minor sensitivities can be observed with regard to the magnitude of some of the coefficients, the results in both tables are essentially similar to those reported in Table 5 for TSR, suggesting that their results are fairly robust.
  • Statistically significant and positive effect of the TSR on the CEOPAY in Model 3 of Table 10 is easily discernible.

7. SUMMARY AND CONCLUSION

  • This paper investigates the association between executive pay and corporate performance, as measured by total shareholder return using a sample of South African (SA) listed firms, by uniquely taking into account a comprehensive set of corporate governance (CG) mechanisms within a three-stage least squares (3SLS) simultaneous equation framework.
  • The authors examine the link between cash and non-cash or equity-based compensation, as well as the association between both total CEO pay and corporate performance and between the total pay of all executives and corporate performance.
  • As financials and utilities are subject to different regulations and also differ in capital structure (Mangena and Chamisa, 2008; Ntim et al., 2012a), and following past studies (Blackwell et al., 2007; Dong et al., 2010), the authors exclude 111 financials and utilities, leaving us with 291 companies to be sampled.
  • As will be further explained, the authors also carried out Hausman system specification and Sargan exogeneity tests, but both tests rejected system misspecification and variable endogeneity for all seven equations.
  • The order-condition for identifying a system indicates that the number of exogenous variables excluded from any equation must be greater than or equal to the number of endogenous variables included minus one (Wooldridge, 2002; Gujarati, 2003; Beiner et al., 2004, 2006).

Did you find this useful? Give us your feedback

Content maybe subject to copyright    Report

University of Huddersfield Repository
Ntim, Collins G., Lindop, Sarah, Osei, Kofi A. and Thomas, Dennis A.
Executive Compensation, Corporate Governance and Corporate Performance: A Simultaneous
Equation Approach
Original Citation
Ntim, Collins G., Lindop, Sarah, Osei, Kofi A. and Thomas, Dennis A. (2015) Executive
Compensation, Corporate Governance and Corporate Performance: A Simultaneous Equation
Approach. Managerial and Decision Economics, 36 (2). pp. 67-96. ISSN 01436570
This version is available at http://eprints.hud.ac.uk/id/eprint/19536/
The University Repository is a digital collection of the research output of the
University, available on Open Access. Copyright and Moral Rights for the items
on this site are retained by the individual author and/or other copyright owners.
Users may access full items free of charge; copies of full text items generally
can be reproduced, displayed or performed and given to third parties in any
format or medium for personal research or study, educational or not-for-profit
purposes without prior permission or charge, provided:
The authors, title and full bibliographic details is credited in any copy;
A hyperlink and/or URL is included for the original metadata page; and
The content is not changed in any way.
For more information, including our policy and submission procedure, please
contact the Repository Team at: E.mailbox@hud.ac.uk.
http://eprints.hud.ac.uk/

Executive Compensation, Corporate Governance and Corporate Performance: A
Simultaneous Equation Approach
Collins G. Ntim
a
, Sarah Lindop
b
, Kofi A. Osei
c
, and Dennis A. Thomas
b
a
School of Management
University of Southampton
Southampton, UK
b
School of Management and Business
Aberystwyth University
Aberystwyth, UK
c
Department of Finance
University of Ghana Business School
University of Ghana
Accra, Ghana
Corresponding author. Address for correspondence: Centre for Research in Accounting, Accountability and
Governance, School of Management, University of Southampton, Southampton, SO17 1BJ, UK. Tel: +44 (0) 238
059 8612. Fax: +44 (0) 238 059 3844. E-mail: c.g.ntim@soton.ac.uk.

Executive Compensation, Corporate Governance and Corporate Performance: A Simultaneous
Equation Approach
Abstract
This paper investigates the association between executive compensation and performance. It uniquely
utilises a comprehensive set of corporate governance mechanisms within a three-stage least squares
(3SLS) simultaneous equation framework. Results based on estimating a conventional single equation
model indicate that the executive pay and performance sensitivity is relatively weak, whereas those
based on estimating a 3SLS model generally suggest improved executive pay and performance
sensitivity. Our findings highlight the need for future research to control for possible simultaneous
interdependencies when estimating the executive pay and performance link. The findings are generally
robust across a raft of econometric models that control for different types of endogeneities, executive
pay and performance proxies.
JEL Classification: G32; G34; G38
Keywords: Executive compensation; Corporate performance; Corporate governance; Simultaneous
equation; Generalised method of moments (GMM); Endogeneity

1
1. INTRODUCTION
Jensen and Murphy (1990) suggest that through optimal contracting, executive pay, especially that
involving equity/performance-linked compensation, can limit agency problems by aligning the interests of
managers and shareholders. However, the recent global financial crisis precipitated by increased risk-taking
and pay motives of top executives of major banks (Tung, 2010; Aebi et al., 2011; Lin et al., 2012;
Paligorova, 2011; Tang, 2012; Polat and Nisar, 2013; Wesep and Wang, 2013) has reignited the debate
regarding the effectiveness of executive compensation packages in mitigating agency conflicts in modern
corporations (Goering, 1996; Murphy, 1997; Grundy and Li, 2010; Van Essen et al., 2012; Berger et al.,
2013; Cook and Burress, 2013). Whilst a number of papers have examined the link between executive pay
and corporate performance, the general conclusion is that the link is weak (Murphy, 1999; Canarella and
Nourayi, 2008; Dong et al., 2010; Elsila et al., 2013; Kabir et al., 2013; Tiani, 2013).
A number of reasons may explain the weak findings of past studies. First, since executive pay is just
one of the possible corporate governance (CG) mechanisms that companies can employ to minimise agency
conflicts (Mehran, 1995; Borisova et al., 2012; Huang et al., 2012), its effectiveness may depend on the
simultaneous use of other CG mechanisms (Agrawal and Knoeber, 1996; Chung and Pruitt, 1996; Beiner et
al., 2004, 2006; Livne et al., 2013; OConnor et al., 2013). A major implication of this is that estimating the
executive pay and corporate performance sensitivity through the use of single equation modelling
techniques can result in endogenous associations (Core et al., 1999; Larcker and Rusticus, 2010; Connelly
et al., 2012; Gil-Alana et al., 2012; Bai and Elyasiani, 2013). Existing studies, however, have mainly used
single equation modelling, and thereby crucially ignored endogeneity problems that may be posed by the
possible simultaneous use of alternative CG mechanisms in estimating the executive pay and corporate
performance sensitivity (Guest, 2009; Wintoki et al., 2012; Zhao, 2013).
Second, the extant literature has focused mostly on cash-based rather than equity-based executive
compensation (Conyon, 1997; Benito and Conyon, 1999; Kato and Long, 2006; Buck et al., 2008; Shen and
Zhang, 2013). In contrast, corporate performance is more sensitive to equity-based than cash-based
executive compensation (Jensen and Murphy, 1990; Main et al., 1996; Cosh and Hughes, 1997; Ozkan,

2
2011), and this may also explain the weak findings of past studies. Third, Main (1991), Lewellen et al.
(1992), Conyon and Murphy (2000) and Firth et al. (2006, 2007) show that executive pay differs
substantially across countries due to variations in legal, institutional, cultural and CG practices.
However, past studies are concentrated in the UK and US, presenting comparatively similar
institutional contexts (Ang et al., 2002; Anderson and Bizjak, 2003; Chen et al., 2006; Cunat and
Guadalupe, 2009; Sun et al., 2009). In developing countries with different institutional settings, with
particular regard to CG reforms, ownership structures and executive director compensation incentives, the
link between executive pay and corporate performance can be expected to differ from what has been found
in industrialised countries. As such, studying the association between executive pay and corporate
performance in developing countries, where empirical evidence has been limited, contributes to a more
complete understanding of the relationship between executive compensation and corporate performance. A
major reason for the paucity of empirical evidence in developing countries, especially African countries, is
the difficulty in obtaining data of sufficient frequency and duration for analysis (Okeahalam, 2004;
Mangena and Chamisa, 2008; Mangena et al.,2012; Ntim et al., 2012a; Fosu, 2013).
Recent CG reforms in South Africa (SA), however, provide a unique and potentially rewarding context
for such a contribution. The recent South African CG reforms incorporate the expectation that executive
pay will be strongly linked to corporate performance, and also require listed firms to fully disclose
executive compensation details in their annual reports, making available information that hitherto has been
publicly inaccessible. This development provides the opportunity to collect data on total pay of the Chief
Executive Officer (CEO), as well as on the total pay of all executives and on CG in order to investigate the
association between executive compensation and performance for a sample of SA listed companies,
enabling us to make a number of contributions to the extant literature.
The paper documents for the first time evidence on the levels of executive pay, as well as the
association between executive compensation and corporate performance in SA. Distinct from most past
studies, we provide evidence on how corporate performance is associated with both the total pay of the
CEO and that of all other executives, as well as on the link between cash (i.e., salary, performance bonus,

Citations
More filters
Journal ArticleDOI
TL;DR: In this paper, the authors investigate the association among trustee board diversity (TBD), corporate governance (CG), capital structure (CS) and financial performance (FP) by using a sample of UK charities.
Abstract: This paper aims to investigate the association among trustee board diversity (TBD), corporate governance (CG), capital structure (CS) and financial performance (FP) by using a sample of UK charities. Specifically, the authors investigate the effect of TBD on CS and ascertain whether CG quality moderates the TBD–CS nexus. Additionally, the authors examine the impact of CS on FP and ascertain whether the CS–FP nexus is moderated by TBD and CG quality.,The authors use a number of multivariate regression techniques, including ordinary least squares, fixed-effects, lagged-effects and two-stage least squares, to rigorously analyse the data and test the hypotheses.,First, the authors find that trustee board gender diversity has a negative effect on CS, but this relationship holds only up to the point of having three women trustees. The authors find similar, but relatively weak, results for the presence of black, Asian and minority ethnic (BAME) trustees. Second, the authors find that the TBD–CS nexus depends on the quality of CG, with the relationship being stronger in charities with higher frequency of meetings, independent CG committee and larger trustee and audit firm size. Third, the authors find that CS structure has a positive effect on FP, but this is moderated by TBD and CG quality. The evidence is robust to different econometric models that adjust for alternative measures and endogeneities. The authors interpret the findings within explanations of a theoretical perspective that captures insights from different CG and CS theories.,Existing studies that explore TBD, CG, CS and FP in charities are rare. This study distinctively attempts to address this empirical lacuna within the extant literature by providing four new insights with specific focus on UK charities. First, the authors provide new evidence on the relationship between TBD and CS. Second, the authors offer new evidence on the moderating effect of CG on the TBD-CS nexus. Third, the authors provide new evidence on the effect of CS on FP. Finally, the authors offer new evidence on the moderating effect of TBD and CG on the CS–FP nexus.

34 citations

Journal ArticleDOI
TL;DR: In this paper, the authors investigate the relationship between chief executive officers' (CEOs) compensation and corporate governance practices of publicly listed companies in New Zealand for the period 2005-2010, and examine whether ownership structure, board structure, CEO and director compensation have an effect on company performance.
Abstract: Purpose – The purpose of this paper is to investigate the relationship between Chief Executive Officers’ (CEOs) compensation and corporate governance practices of publicly listed companies in New Zealand for the period 2005-2010. Design/methodology/approach – Prior literature argues that corporate governance systems and structures are heterogeneous, that is, corporate governance mechanisms that are important tend to be specific to a country and its institutional structures. The two corporate governance mechanisms most important for monitoring CEO compensation are ownership structure and board structure. The authors use a generalised least squares regression estimation technique to examine the effect ownership structure and board structure has on CEO compensation, and examine whether ownership structure, board structure, CEO and director compensation have an effect on company performance. Findings – After controlling for size, performance, industry and year effects, the authors report that internal feature...

33 citations

Journal ArticleDOI
TL;DR: In this article, the determinants of poverty and vulnerability of smallholder farmers in the rural areas in the face of climate change were analyzed through a cross-sectional survey conducted between December 2009 and January 2010 covering 240 households in six villages of Morogoro region, Tanzania.
Abstract: This paper analyses the determinants of poverty and vulnerability of smallholder farmers in the rural areas in the face of climate change. The data were collected through a cross-sectional survey conducted between December 2009 and January 2010 covering 240 households in six villages of Morogoro region, Tanzania. Descriptive and the econometric approaches involving three-stage least squares (3SLS) and generalized methods of moments (GMM) regressions were used to analyse poverty and vulnerability. Results indicate that income poverty was prevalent in the study area—based on a daily income per capita poverty line of US$ 1.25. The income poverty was relatively higher in agro-climatically less-favourable area than in favoured areas. Over three quarters of the sample households were vulnerable. The pattern of future vulnerability tended to overlap with poverty rates. Ageing of the household head tended to increase the level of vulnerability. Large-sized households were more income-poor than their counterpart small-sized households. Farming experience reduced the probability of future vulnerability. Increased farm size enhanced the level of income, and further increase in farm size reduced future vulnerability. Higher income contributed to wealth formation through improved access to assets and housing amenities. Farmers who perceived that climate change is human-induced tended to have significantly higher income than otherwise. The following conclusions with policy implications are drawn from the findings: (1) addressing poverty and vulnerability of farmers is critical particularly in relatively agro-ecologically less-favoured areas that are prone to climate change impacts, (2) old-age-related vulnerability must be addressed through dedicated policies and programmes, (3) increasing farm size would enhance smallholder farm income, (4) awareness creation among farmers on climate change drivers and processes by highlighting anthropogenic contribution is important in order to influence local adaptation and mitigation practices, and (5) improving rural income will advance wealth creation and foster local livelihood resilience to shocks including climate change.

31 citations

Journal ArticleDOI
TL;DR: In this article, the interactive effect of executive compensation, firm performance and corporate governance in different institutional and governance settings of an emerging market economy was examined, and the authors found evidence of a reciprocal positive significant relationship between compensation and performance, as well as between corporate governance and performance.
Abstract: Much of the management compensation literature focuses either on the level and structure of executives’ pay or the pay-for-performance sensitivity in a set of corporate governance structure in the Western economies. In this study, we examine the interactive effect of executive compensation, firm performance and corporate governance in different institutional and governance settings of an emerging market economy. Capturing monitoring and incentive alignment aspects as suggested in agency theory, we argue that in a markedly different executive compensation system in Thailand, the interrelationships between executive compensation, firm performance and corporate governance would exhibit some similarities to those found in developed economies. While there remains sparse research on how these relationships operate in Thailand, using data for 432 publicly listed Thai firms between 2000 and 2011, we find evidence of a reciprocal positive significant relationship between compensation and performance, as well as between corporate governance and performance. However, a reciprocal relationship is not found between corporate governance and compensation, which shows a mono-directional positive significant relationship running from corporate governance to compensation. These findings show similarities with those of developed economies and provide support for the need for an effective governance system to determine optimal executive compensation that will enhance firm performance and value. Our findings thus add some potentially noteworthy dimensions to the compensation literature that are especially important to policy makers and other stakeholders, and aiming to shape an optimal governance system in the emerging markets around the world.

30 citations

Journal ArticleDOI
TL;DR: In this article, the causal relationship between CEO pay and firm performance in Nigeria for the period 1998-2010, using annual data of 63 non-financial listed firms was examined, and it was shown that CEO pay acts both as a reward and a performance motivator.
Abstract: This study examines the causal relationship between CEO pay and firm performance in Nigeria for the period 1998–2010, using annual data of 63 non-financial listed firms. We adopt a two-step dynamic generalized method of moments to explore the causal relationship. The study establishes a bi-directional relationship between CEO pay and firm performance. While CEO pay Granger-causes firm performance, firm performance also Granger-causes CEO pay. It implies that CEO pay acts both as a reward and a performance motivator. This study therefore suggests that CEO pay effectively aligns shareholders’ interests with those of CEOs; hence stakeholders should focus more on CEO pay as a corporate governance mechanism to reduce agency problem in non-financial listed firms in Nigeria.

25 citations

References
More filters
Journal ArticleDOI
TL;DR: In this paper, a theoretical valuation formula for options is derived, based on the assumption that options are correctly priced in the market and it should not be possible to make sure profits by creating portfolios of long and short positions in options and their underlying stocks.
Abstract: If options are correctly priced in the market, it should not be possible to make sure profits by creating portfolios of long and short positions in options and their underlying stocks. Using this principle, a theoretical valuation formula for options is derived. Since almost all corporate liabilities can be viewed as combinations of options, the formula and the analysis that led to it are also applicable to corporate liabilities such as common stock, corporate bonds, and warrants. In particular, the formula can be used to derive the discount that should be applied to a corporate bond because of the possibility of default.

28,434 citations

Journal ArticleDOI
TL;DR: In this article, the generalized method of moments (GMM) estimator optimally exploits all the linear moment restrictions that follow from the assumption of no serial correlation in the errors, in an equation which contains individual effects, lagged dependent variables and no strictly exogenous variables.
Abstract: This paper presents specification tests that are applicable after estimating a dynamic model from panel data by the generalized method of moments (GMM), and studies the practical performance of these procedures using both generated and real data. Our GMM estimator optimally exploits all the linear moment restrictions that follow from the assumption of no serial correlation in the errors, in an equation which contains individual effects, lagged dependent variables and no strictly exogenous variables. We propose a test of serial correlation based on the GMM residuals and compare this with Sargan tests of over-identifying restrictions and Hausman specification tests.

26,580 citations

Report SeriesDOI
TL;DR: In this paper, two alternative linear estimators that are designed to improve the properties of the standard first-differenced GMM estimator are presented. But both estimators require restrictions on the initial conditions process.

19,132 citations

Journal ArticleDOI
TL;DR: In this paper, a framework for efficient IV estimators of random effects models with information in levels which can accommodate predetermined variables is presented. But the authors do not consider models with predetermined variables that have constant correlation with the effects.

16,245 citations

Posted Content
TL;DR: In this paper, the benefits of debt in reducing agency costs of free cash flows, how debt can substitute for dividends, why diversification programs are more likely to generate losses than takeovers or expansion in the same line of business or liquidationmotivated takeovers, and why the factors generating takeover activity in such diverse activities as broadcasting and tobacco are similar to those in oil.
Abstract: The interests and incentives of managers and shareholders conflict over such issues as the optimal size of the firm and the payment of cash to shareholders. These conflicts are especially severe in firms with large free cash flows—more cash than profitable investment opportunities. The theory developed here explains 1) the benefits of debt in reducing agency costs of free cash flows, 2) how debt can substitute for dividends, 3) why “diversification” programs are more likely to generate losses than takeovers or expansion in the same line of business or liquidationmotivated takeovers, 4) why the factors generating takeover activity in such diverse activities as broadcasting and tobacco are similar to those in oil, and 5) why bidders and some targets tend to perform abnormally well prior to takeover.

14,368 citations

Frequently Asked Questions (8)
Q1. What are the contributions in this paper?

This paper investigates the association between executive compensation and performance. Results based on estimating a conventional single equation model indicate that the executive pay and performance sensitivity is relatively weak, whereas those based on estimating a 3SLS model generally suggest improved executive pay and performance sensitivity. 

Their results appear to justify their research design, as well as highlighting the need for future research to take into account a comprehensive set of CG mechanisms within a simultaneous 30 equation framework, which permits each mechanism to affect executive pay, but also allows executive pay to affect each mechanism when estimating the executive pay and corporate performance sensitivity. As data coverage improves, future studies may need to consider other CG mechanisms, such as data on the market for corporate control, 31 in estimating the executive pay and corporate performance sensitivity. Therefore, future research may improve their findings by investigating how different types of institutional owners influence the pay-for-performance elasticity. Incorporating such changes in CEO wealth in the total CEO pay package by future researchers may enhance their findings. 

The theory that larger firms are more complex to manage, implies the need for higher quality managers capable of making frequent and significant decisions, but such talented managers are both scarce and highly mobile who can largely be attracted with competitive pay packages (Murphy, 1999; Sapp, 2008). 

Apart from regulatory enforcement, their results further indicate that greater activism by institutional shareholders may help strengthen the executive pay and corporate performance link. 

Evidence of a stronger link between corporate performance and equity-based compensation provides support to the recommendations of King II that non-cash pay should form a substantial portion of total executive compensation in order to align executive interests with those of shareholders. 

It is also consistent with tournament theory (Sapp, 2008; Lee et al., 2008; Zhao, 2013), which suggests that CEOs are paid more to stimulate healthy competition among lower placed executives for the position of the CEO, ultimately resulting in the exertion of greater effort and improved corporate performance. 

During the late 1990s, the country experienced a number of high profile corporate failures, such asthe collapse of the Macmed, Leisurenet and Nedbank companies, which were attributed mainly to poor CG practices, including increased executive compensation (Okeahalam, 2004; Sarra, 2004). 

As data coverage improves, future studies may need to consider other CG mechanisms, such as data on the market for corporate control,31in estimating the executive pay and corporate performance sensitivity.