midwest finance association annual meeting atlanta 2016

»Hanken Svenska handelshögskolan / Hanken School of Economics www.hanken.fi

The Effect of Board Composition on CEO pay in European Companies

MFA Annual Meeting

Atlanta 2016

Laura Arranz.Hanken School of Economics, Finland

Pablo de Andrés.Autonoma Univeristy of Madrid, Spain

Objective of the Paper

» To analyse how board composition affects CEO compensation in Europe

» Ultimate goal:

» To understand how firms design their governance systems in Europe, and how board composition has an impact on firm level outcomes

Arranz /FMA, Atlanta 2016

[email protected]

[email protected]

Contribution

» Analyse the role of supervisory and independent directors separately

» US studies concentrate on independent directors

» Role of affiliated directors and major owners

» Account for the non random selection into equity linked compensation plans

» Equity granted in ca 40% obs

» Analysis of European Data

» More studies with US data; Contrast results for firms in different countries

» Pay levels /pay structure


Research Questions

Impact of board composition on level of pay? Owners in Europe influence monitor closely and influence firm governance

(Hatzell and Starks, 2003)

INCREASE MONITORING LOWER LEVELS OF COMPENSATION

Impact of boad composition on CEO incentive pay? Active owners monitor intensively and have an active role in setting firm

strategy: lower incentives

INVOLVEMENT ON STRATEGY LOWER LEVELS OF INCENTIVES

We expect firms with more non independent outsiders to give lower compensation and less equity linked compensation


Research Questions

What happens if we substitute non independent outsiders with independent

directors?

» Independent boards are considered safeguard of shareholders value and

are promoted at European level.

» Less compensation levels due to increased monitoring?

» Independent directors can substitute direct monitoring with equity pay

(Adams and Ferreira, 2009): more incentive compensation, which in turn

leads to increase compensation (compensate for risk)

» More incentive pay in more independent boards?


Importance of European Data

» Directive 2003/51/EC of the European Parliament and of the Council

» Action Plan on Modernizing Company Law and Enhancing Corporate Governance in the EU (2003)

» Promotes harmonization at European level

» Promotes the issue of Corporate Governance Codes of Best Practice (country based)

» Promotes increased transparency and board independence (comply or explain)


Importance of European Data

BOARDS

» Several CG systems coexist in the same economic space

» Some countries have strict regulations, others more freedom

» CG Codes mostly voluntary

» Ownership is concentrated , strong owners impact busines

COMPENSATION

» Equity linked compensation not so extended:

» Not granted systematically; lower amounts

» Equity linked compensation taxation varies


Data

» Representative sample of European listed firms

10 148 obs, 2 308 firms, 15 countries

» Years 1999-2007

» Boardex: governance data, compensation

» Thomsom: firm characteristics and market book values


Sample by Countries

Country Legal Origin Nr. of Obs. Percentage Nr. of Firms

Austria German 13 0.40 3

Belgium French 102 2.58 36

Denmark Scandinavian 40 0.97 11

Finland Scandinavian 30 0.41 10

France French 928 9.41 208

Germany German 256 4.54 89

Greece French 12 0.79 7

Ireland English 237 2.39 52

Italy French 238 3.24 60

Luxembourg French 7 0.37 2

Netherlands German 382 3.91 82

Portugal French 31 0.62 9

Spain French 156 2.65 45

Sweden Scandinavian 572 5.00 102

UK English 7 172 62.7 1 592

Total 10 184 100.00 2 308


Key variables

» Non-independent outsiders= non-executive-non- independent directors/board size

» Independence rate=independent directors/board size

» Direct compensation= sum of all cash based compensation for the period

» Equity linked compensation= sum of shares awarded, estimated value of options and LTIPs awarded in the period selected

» Total compensation= direct compensation plus equity linked compensation

» Equity mix= equity linked compensation/total compensation

» Equity dummy =1 if equity linked compensation >0


Data description

» CEO compensation very skewed (average and median values differ considerably).

» Equity linked compensation not always present (40 % observations; 20 % of CEO Pay)

» Equity linked compensation and CEO pay varies accross time (cross sectional and time variation)

» Board size and composition very constant accross time (cross sectional variation)


Data Description

Year 1999 2000 2001 2002 2003 2004 2005 2006 2007

Direct compensation 739.27 652.71 580.79 632.14 683.96 777.3 680.10 761.21 879.82

Equity linked compensation 606.29 729.93 586.40 437.15 547.34 548.2 595.17 623.17 681.14

Total compensation 1345.6 1382.7 1167.2 1069.3 1231.3 1325.5 1275.3 1384.4 1560.96

Equity mix 0.22 0.244 0.227 0.19 0.214 0.206 0.229 0.22 0.22

Equity dummy 0.546 0.53 0.5138 0.50 0.50 0.469 0.469 0.45 0.47

Board size 9.22 8.85 8.77 8.69 8.43 8.15 8.00 7.9 7.83

Non Indep Outs 0.19 0.22 0.22 0.22 0.22 0.22 0.23 0.24 0.24

Indep 0.36 0.34 0.35 0.36 0.36 0.35 0.35 0.34 0.35

Number of obs. 337 576 796 937 1370 1306 1561 1776 1763


Evolution of CEO Pay

0

200

400

600

800

1000

1200

1400

1600

1999 2000 2001 2002 2003 2004 2005 2006 2007

Direct compensation Equity Linked Compensation Total Compensation


Board Composition and Compensation

0.3

0.35

0.4

0.45

0.5

0.55

0.6

0.65

0.7

0.75

1999 2000 2001 2002 2003 2004 2005 2006 2007

Outsider rate ODB Equity dummy Equity proportion


Research Strategy

Two analyses

Analisys of the level of pay:

» Simultaneous Equation to control for endogeneity of board design and unobserved heterogeneity

Analysis of the structure of pay

» Heckman to control for the fact that equity is not granted every year systematically

For every analysis : Study non indep-outsiders and independent (=number of independent directors/board size) separately


Board composition and the level of pay

1st equation: - Three dependent variables measuring different components of CEO compensation (equity mix, direct and total). -CEO and firm characteristics as explanatory variables 2sd equation: - Outsider as a dependent variable - CG and firm characteristics as explanatory variables

𝐶𝑜𝑚𝑝𝑒𝑛𝑠𝑎𝑡𝑖𝑜𝑛 𝑖𝑡 = 𝛿0 + 𝛿1𝑜𝑢𝑡𝑠𝑖𝑑𝑒𝑟𝑠𝑖𝑡 + 𝛿2𝑎𝑔𝑒𝑖𝑡 + 𝛿3𝐶𝐸𝑂𝑤𝑒𝑎𝑙𝑡ℎ𝑖𝑡 + 𝛿4𝑡𝑖𝑚𝑒𝑖𝑛𝑟𝑜𝑙𝑒𝑖𝑡 +

𝛿5𝐶𝐸𝑂𝑜𝑤𝑛𝑒𝑟𝑠ℎ𝑖𝑝𝑖𝑡 + 𝛿6𝑎𝑠𝑠𝑒𝑡𝑠𝑖𝑡 + 𝛿7𝑣𝑜𝑙𝑎𝑡𝑖𝑙𝑖𝑡𝑦𝑖𝑡 + 𝛿8𝑜𝑤𝑛𝑒𝑟𝑠ℎ𝑖𝑝𝑖𝑡 + 𝛿9𝑦𝑒𝑎𝑟𝑑𝑖𝑡 + 휀𝑖𝑡 (5)

Pr 𝑜𝑢𝑡𝑠𝑖𝑑𝑒𝑟𝑠𝑖𝑡 =

𝜑0 + +𝜑1𝑜𝑤𝑛𝑒𝑟𝑠ℎ𝑖𝑝𝑖𝑡 + 𝜑2 𝑏𝑜𝑎𝑟𝑑𝑠𝑖𝑧𝑒𝑖𝑡 + 𝜑3 𝑡𝑖𝑚𝑒𝑖𝑛𝑟𝑜𝑙𝑒𝑖𝑡 + 𝜑4 𝑡𝑜𝑡𝑎𝑙 𝑎𝑠𝑠𝑒𝑡𝑠 𝑖𝑡 + 𝜑5𝑙𝑒𝑣𝑒𝑟𝑎𝑔𝑒𝑖𝑡 +

𝜑6𝑚𝑎𝑟𝑘𝑒𝑡 − 𝑡𝑜 − 𝑏𝑜𝑜𝑘 𝑖𝑡 + 𝜑7 𝑓𝑜𝑟𝑒𝑖𝑔𝑛 𝑎𝑠𝑠𝑒𝑡𝑠 𝑖𝑡 + +𝜑8𝑀𝐷𝑖𝑡 + 𝜑9𝐶𝐸𝑂 𝐼𝑛𝑡𝑒𝑟𝑙𝑜𝑐𝑘𝑖𝑡 +

𝜑10−13𝑙𝑒𝑔𝑎𝑙 𝑜𝑟𝑖𝑔𝑖𝑛𝑖𝑡 + 𝜑14−22𝑦𝑒𝑎𝑟𝑖𝑡+ 𝜑23−63𝑠𝑒𝑐𝑡𝑜𝑟 𝑖𝑡 + 𝜇𝑖𝑡 (6)


(1) (2) (3) (4)


Total

Compensation

Direct

Compensation

Equity Linked

Compensation

Equity Mix

NON INDEP OUTS -1.294*** -0.491*** -1.638*** -0.187***

(-10.88) (-5.07) (-4.99) (-3.30)

Ownership -0.004*** -0.00310*** -0.00209 0.000

(-5.44) (-5.23) (-1.20) (1.15)

CEO age -0.00680*** -0.000934 -0.0135** -0.002***

(-3.55) (-0.59) (-3.10) (-3.42)

Time in role 0.00422 0.0108*** -0.000471 -0.003***

(1.54) (4.87) (-0.07) (2.80)

CEO wealth -0.00104 -0.00131 0.00979 0.001

(-0.45) (-0.69) (1.32) (1.21)

CEO ownership 0.00183 -0.000205 0.0599*** 0.015***

(0.52) (-0.07) (3.94) (5.83)

Log Assets 0.383*** 0.298*** 0.519*** 0.035***

(46.80) (44.23) (30.00) (12.02)

Volatility 0.00602*** 0.00345** 0.00860** 0.001***

(4.47) (3.10) (2.97) (2.77)

R2 0.4795 0.4858 0.3581 0.2198

N 3961 3907 2474 2474



Total

Compensation

Direct

Compensation

Equity Linked

Compensation

Equity Mix

INDEP 0.868*** -0.03 2.01*** 0.291***

(4.87) (-0.22) (4.96) (4.11)

Ownership -0.00632*** -0.005*** -0.00366* -0.000

(-8.92) (-8.25) (-2.33) (1.04)

CEO age -0.00770*** -0.00139 -0.0142** -0.002***

(-3.99) (-0.88) (-3.28) (0.001)

Time in role 0.00688* 0.0116*** 0.00175 -0.002***

(2.53) (5.22) (0.28) (-2.56)

CEO wealth 0.000630 -0.000585 0.00844 0.001

(0.27) (-0.31) (1.14) (0.94)

CEO ownership 0.00242 0.0000415 0.0626*** 0.015***

(0.68) (0.01) (4.10) (5.94)

Log Assets 0.345*** 0.289*** 0.460*** 0.028***

(40.34) (41.45) (23.62) (8.29)

Volatility 0.00628*** 0.00354** 0.00855** 0.001***

(4.62) (3.17) (2.95) (2.67)

R2 0.4955 0.4884 0.3701 0.2210

N 3961 3907 2474 2474


A closer look at incentives

»



SELECTION EQUATION. DEPENDENT VARIABLE : EQUITY DUMMY

NON INDEP OUTS -1.135*** -1.135***

(-10.94) (-10.94)

INDEP DTORS 0.983*** 0.983***

(9.08) (9.08)

Ownership -0.0146*** -0.0146*** -0.0156*** -0.0156***

(-14.82) (-14.82) (-16.03) (-16.03)

Leverage -0.459** -0.459** -0.466*** -0.466***

Board size -0.000 -0.000325 -0.0109 -0.0109

Time in role -0.00943* -0.00943* -0.00623 -0.00623

CEO interlocking -0.0131 -0.0131 -0.0261 -0.0261

MD -0.668*** -0.668*** -0.611** -0.611**

Log Assets 0.210*** 0.210*** 0.184*** 0.184***

Market-to-book 0.0102* 0.0102* 0.00932 0.00932

Foreign assets 0.000365 0.000365 -0.001 -0.000

Year dummies Yes Yes Yes Yes

Industry dummies Yes Yes Yes Yes

Rho 0.0577 -0.451 0.15 -0.311

Sigma 0.2152 1.33 0.218 1.30

Lambda 0.0124*** -0.602 0.033* -0.404***

N 5006 5006 5006 5006



» Heckman regression model

» OUTCOME EQUATION

» Dep var. The proportion of equity in total CEO pay

» Explanat. Var. Measure how powerful incentive pay is

»OUTSIDERS : key

CEO AGE; CEO wealth; to control individual risk aversion

»CEO ownership, to control alignment of interest

»Time in role: asymmetry of inform. about CEO abilities

»Total assets: larger firms, larger returns to effort

»Price volativity: more volatile firms, incentives more expensitve


A close look at incentives

Dep. Variable Equity Mix Log Equity Equity Mix Log Equity

NON INDEP OUTS 0.175** 0.972**

(5.19) (4.83)

INDEPENDENT -0.048 0.219

(-0.088) (1.20)

CEO age -0.002** -0.019** -0.002** -0.0125**

(-3.31) (-3.01) (-3.17) (-2.91)

Time in Role -0.003* 0.0069 -0.0028* 0.0058

(-2.52) (1.09) (-2.63) (0.92)

CEO wealth 0.014*** 0.057*** 0.014*** 0.060***

(5.47) (3.80) (5.57) (3.95)

CEO ownership 0.001 0.009 0.000 0.006

(1.00) (1.25) (0.79) (0.90)

Log Assets 0.039*** 0.452*** 0.038** 0.465***

(10.87) (21.06) (11.24) (23.54)

Volatility 0.0027*** 0.016*** 0.0027*** 0.01634***

(6.51) (6.57) (6.59) (6.62)

Year dummies Yes Yes Yes Yes

Country FE Yes Yes Yes Yes


Key Results

» We find that the presence of non independent outsiders moderates the levels of pay

» Non-independent outsiders pay incentives less often.

» Independent directors on average more compensation (specially equity linked compensation), and pay incentives more often.

» The proportion of incentives to total pay is not related to the proportion of independent directors (but it is related to the proportion of non-independent directors)


Robustness tests

Panel data analysis

» Resutls robust

Split the sample by ownership concentration

» Resutls robust

Split the sample by institutional settings:

» In countries with German and Scandinavian legal origins, board composition not related to level or structure of pay

» In countries with English and French legal origin, strong relation.


Conclusions

» Outside directors relevant- CG Codes independent

» CG instruments interact -CG Codes additive

» Harmonization in Europe- Institutional constraints are relevant

THANK YOU !!!


midwest finance association annual meeting atlanta 2016

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