Scholarly article on topic 'Do Corporate Board Compensation Characteristics Influence the Financial Performance of Listed Companies?'

Do Corporate Board Compensation Characteristics Influence the Financial Performance of Listed Companies? Academic research paper on "Economics and business"

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Abstract of research paper on Economics and business, author of scientific article — Victor-Octavian Müller

Abstract As the financial performance of entities is of extreme importance to stakeholders in general and shareholders in particular (by helping to maintain a going concern and to increase the value of the business), it should appear as straightforward that identifying and analyzing those factors (determinants) that influence the financial performance is of great relevance both to practice and the academic world. It is logical (however not undisputed) to suppose that the managerial abilities of the board of directors would have a significant impact on the entity's financial performance. It is however not clear-cut whether certain board characteristics regarding its compensation would significantly influence the financial performance of the entity. Within this context, the aim of this research is to investigate (based on econometric regression models) the impact of 5 corporate governance characteristics related to board remuneration on the contemporaneous and next year's performance (measured as ROA/ROE) using a sample of large groups listed on the London Stock Exchange between 2010 and 2011. Through this study we intend to make a contribution to the academic literature on the unsettled issue concerning the relationship between corporate governance and corporate performance. The empirical results proved a significant relationship between non-executive directors’ basic fee, fees paid in shares and additional remuneration for board committee membership (as corporate board compensation characteristics) and both contemporaneous and subsequent financial firm performance.

Academic research paper on topic "Do Corporate Board Compensation Characteristics Influence the Financial Performance of Listed Companies?"

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Social and Behavioral Sciences

Procedia - Social and Behavioral Sciences 109 (2014) 983 - 988

2nd World Conference On Business, Economics And Management - WCBEM 2013

Do corporate board compensation characteristics influence the financial

performance of listed companies?

Victor-Octavian Müller a*

aBabes-Bolyai University, Cluj-Napoca 400591, Romania

Abstract

As the financial performance of entities is of extreme importance to stakeholders in general and shareholders in particular (by helping to maintain a going concern and to increase the value of the business), it should appear as straightforward that identifying and analyzing those factors (determinants) that influence the financial performance is of great relevance both to practice and the academic world. It is logical (however not undisputed) to suppose that the managerial abilities of the board of directors would have a significant impact on the entity's financial performance. It is however not clear-cut whether certain board characteristics regarding its compensation would significantly influence the financial performance of the entity. Within this context, the aim of this research is to investigate (based on econometric regression models) the impact of 5 corporate governance characteristics related to board remuneration on the contemporaneous and next year's performance (measured as ROA/ROE) using a sample of large groups listed on the London Stock Exchange between 2010 and 2011. Through this study we intend to make a contribution to the academic literature on the unsettled issue concerning the relationship between corporate governance and corporate performance. The empirical results proved a significant relationship between non-executive directors' basic fee, fees paid in shares and additional remuneration for board committee membership (as corporate board compensation characteristics) and both contemporaneous and subsequent financial firm performance.

© 2014 The Authors. Published by Elsevier Ltd.

Selection and peer review under responsibility of Organizing Committee of BEM 2013.

Keywords: Corporate Governance, board cpmpensation, financial performance, London Stock Exchange

1. Introduction

The financial performance of entities is of extreme importance to stakeholders in general and shareholders in particular, as it helps to maintain a going concern and to increase the value of the business, and offers the basis for distributing dividends, which in turn may attract investors (and their funds). Thus, it appears as straightforward that identifying and analyzing those determinants that influence financial performance is of great relevance. While on one hand it is logical (but not undisputed) to suppose that the managerial abilities of the board of directors would have a significant impact on the entity's financial performance, on the other hand it is not clear-cut whether certain board characteristics regarding its remuneration would significantly influence the company's performance.

The aim of this research is to investigate (based on econometric regression models) the impact of 5 corporate governance characteristics related to board remuneration on the contemporaneous and next year's performance (measured as ROA) using a sample of large groups listed on the London Stock Exchange between 2010 and 2011.

* Corresponding author: Victor-Octavian Müller. Tel.: +40-264418654 E-mail address: victor.muller@econ.ubbcluj.ro

1877-0428 © 2014 The Authors. Published by Elsevier Ltd.

Selection and peer review under responsibility of Organizing Committee of BEM 2013. doi: 10.1016/j.sbspro.2013.12.575

Through this research we intend to contribute to the academic literature on the unsettled issue concerning the relationship between corporate governance and corporate performance.

There are several academic papers which investigated the relationship between corporate governance characteristics and corporate performance. Gompers et al. (2003) study in their often cited paper the impact of corporate governance on firm performance during the 1990's. Using 24 governance rules, the authors construct a Governance index to proxy for the level of shareholder rights. The results the authors arrive at, indicate that companies with stronger shareholder rights had higher firm value, higher performance and higher sales growth than companies with weak shareholder rights. However in a subsequent paper, Core et al. (2006) showed that in the first decade of this century, firms with strong shareholder rights do not outperform firms with weak shareholder rights.

Another seminal paper concerning the relation between corporate governance and firm performance is that of Bhagat and Bolton (2008). Taking into consideration the endogeneity of the relationship between corporate governance, group performance, corporate structure and ownership structure, the authors found that better corporate governance is significantly positively correlated with both better contemporaneous and better subsequent operating performance (but not with stock market performance).

In her paper, Bauwhede (2009) re-examines the relationship between corporate governance and corporate performance, triggered by a prior European study (Bauer et al., 2004) which reported evidence of a negative relationship between these constructs. However, Bauwhede reports evidence of a positive relationship between the extent of compliance with international corporate governance best practices (regarding board structure and functioning) and operating performance measured by the return on assets (ROA). According to the author, it is especially the structure and functioning of the corporate board that can directly impact on the operating efficiency and operating performance of a company.

Relevant to our research is also the study of Guest (2009) who examines the influence of board size on company performance for a large sample of UK listed firms during 1981-2002. The results indicate that board size has a strong negative impact on performance (profitability), Tobin's Q and share returns.

2. Research Design and Descriptive Statistics

In this empirical research we investigated the relationship between company performance and board compensation characteristics for companies listed on the largest European stock market (London Stock exchange -FTSE100) in the period 2010-2011. The research relies on an accounting measure of company performance (return on assets) as dependent variable as a proxy for company performance.

The financial information on operating performance, total assets, shareholders equity, total sales as well as information concerning the industry in which the constituents of FTSE 100 operate, has been manually collected from the London Stock Exchange website. The data on characteristics regarding corporate board compensation have been obtained from the SpencerStuart 2011 UK Board Index. We constructed the different dependent and independent variables, including control variables (for size respectively for industry). Regarding the elimination of outliers, we truncated the observations for which the dependent variable (ROA) were below the 5th respectively above the 95th percentile.

The central hypothesis of this research, which is based on prior findings in academic research, is the following:

Hypothesis 1: There are corporate board compensation characteristics (such as chair remuneration, nonexecutive director remuneration, fees paid in shares, additional remuneration for board committee meetings) which may significantly influence the current year operating performance of companies.

In order to empirically test this research hypothesis regarding the impact of board remuneration characteristics on the contemporaneous operating performance, the following econometric model (whose parameters are to be estimated using ordinary least square OLS) has been developed:

ROAn; = a0 + a1*ChairRemi + a2* SenNExRem; + a3* NonExBasFee; + a4* FeesInShares; + a5* AddRemBComMemb; + a6*TA; + X(ai*Ind;) + s; (1)

Where:

ROAn1 =

ChairRem; =

SenNExRem1 =

NonExBasFee1 =

FeesInShares1 = AddRemBComMemb =

Ind1 =

Operating Return on Assets of company i in year n

Chairman remuneration for company i

Senior non-executive total remuneration for company i

Non-executive director basic fee for company i

Fees paid in shares (dummy: 1 - yes, 0 - no) for company i

Additional remuneration for board committee members for company i

Natural logarithm of total assets for company i

Industry dummy variable for the following industries: Basic Materials, Industrials,

Consumer Goods, Consumer Services, Utilities, Financials, Other

Moreover the research was further designed to investigate the impact of board compensation characteristics on the subsequent (i.e. next year) operating performance, thus following a research idea explored by Bhagat & Bolton (2008). Thus a second hypothesis based on the initial one has been formulated:

Hypothesis 2: There are corporate board compensation characteristics (such as chair remuneration, nonexecutive director remuneration, fees paid in shares, additional remuneration for board committee meetings) which may significantly influence the next year's operating performance of companies.

For empirically testing this research hypothesis regarding the impact of board related corporate governance characteristics on the next year's operating performance, a second similar econometric model (whose parameters are to be estimated using ordinary least square OLS) hase been developed:

ROAn+1i = a0 + a1*ChairRemi + a2* SenNExRemi + a3* NonExBasFeei + a4* FeesInSharesi + a5* AddRemBComMembi + a6*TA + £(ai*Indi) + Si (2)

Where:

ROAn+1i = Operating Return on Assets of company i in year n + 1

As in other previous studies (see Vafeas & Theodorou, 1998, Guest, 2009) the regression models include a control variable for the company size (natural logarithm of total assets) and dummy variables which control for the industry family the company primarily operates in (Basic Materials, Industrials, Consumer Goods, Consumer Services, Utilities, Financials, Other). These control variables are used to capture the influence of size and sector on company's performance, thus improving the explanatory power of the elaborated regression models. In order to confirm a research hypothesis, the coefficient of at least one variable concerning the specific board remuneration characteristic has to be statistically significant at the 0,1 level and has to record a Variance Inflation Factor (which tests the degree to which the independent variable is correlated with other independent variables) below 5. Otherwise the respective hypothesis is considered to be infirmed. Regarding the existent associations between the variables employed in the econometric models (see Pearson correlation matrix in table 1), there are two significant (at least at the 5% level) correlations between the dependent variable (ROA) and the independent variables ChairRem (Chair remuneration), respectively SenNExRem (Senior non-executive remuneration).

Table 1. Pearson Correlat1on Matrix

Variable ROA n ROA n+1 ChairRem SenNExRem NonExBasFee FeesInShares

ROAn+1 0,878**

ChairRem -0,219* -0,192

SenNExRem -0,257* -0,195 0,529**

NonExBasFee -0,098 -0,086 0,528** 0,589**

FeesInShares -0,098 -0,018 0,196 0,162 0,038

AddRemBComMemb_-0,015_0,031_0,278**_0,278**_0,135_0,166

**. Correlation is significant at the 0.01 level (2-tailed) *. Correlation is significant at the 0.05 level (2-tailed).

One can also observe the existence of significant correlations between some independent variables used in the same econometric models. We are referring to the correlation between ChairRem and SenNExRem, NonExBaseFee respectively AddRemBComMemb, and the correlations between FoSenNExRem and NonExBaseFee, respectively AddRemBComMemb. These correlations are small or moderate and indicate the existence of a certain multicollinearity between variables. To examine if multicollinearity generates instability of empirical results, we computed, for each coefficient of the independent variables from the econometric models, the variance inflation factor (VIF), which quantifies to what extent the variance for a coefficient is increased due to collinearity (Andrei & Bourbonnais, 2008: 274). When variables are not correlated, the variance inflation factor is 1. VIF values of more than 5 (see Jermakowicz et al., 2007) or even 10 (see Kutner et al., 2004) are regarded in the specialty literature as indication of (seriouss) autocorrelation problems between independent variables.

3. Empirical Results

The main results for the relationship between the operating performance measured as return on assets (for the current period) and the board compensation characteristics are summarized in table 2. These results are consistent with a statistically significant relationship (at least at 0,1 level) between the contemporaneous operating performance (measured as ROA) and some of the corporate governance characteristics regarding board remuneration, namely the non-executive director basic fee, the fees paid in shares and the additional remuneration for board committee members.

Table 2. Empirical results for regression model 1

Variable Coefficients (a) t Sig. VIF

(Constant) 0,238** 2,147 0,036

ChairRem 0,000 -0,474 0,637 2,833

SenNExRem 0,000 -1,48 0,144 3,213

NonExBasFee 0,002*** 3,375 0,001 3,222

FeesInShares 0,025* 1,697 0,095 1,564

AddRemBComMemb 0,037*** 3,674 0,001 1,611

TAn -0,033*** -5,628 0,000 4,943

IndBasMat 0,045 2,596 0,012 2,814

IndInd -0,048 -2,770 0,008 2,796

IndConsGoods -0,008 -0,428 0,67 2,004

IndConsServ 0,000 -0,032 0,975 2,21

IndUtilities 0,028 1,349 0,183 2,012

IndFinancials 0,012 0,648 0,519 3,353

IndOther 0,020 0,973 0,334 1,684

Model Summary ROAn AdjR2 0,561 F 4,879 Durbin-Watson 1,972

The relatively strongest (and statistically significant) impact on ROA can be observed for the additional remuneration for board committee members. Noticeable is also the relationships involving ROA and the variable for the fees paid in shares. As concerns the potential problem of multicollinearity between independent variables included in the two models, which generates instability of empirical results, we computed, for each coefficient of the independent variables from the econometric models, the variance inflation factor.

As the VIF values are less than 5, there is no indication of (serious) autocorrelation problems between independent variables. Based on this statistical results for the first regression model, we consider confirmed the hypothesis 1,

regarding a significant relationship between corporate board compensation and contemporaneous company performance.

As mentioned in the research design, we also investigated the impact of board compensation characteristics on the subsequent (i.e. next year) operating performance, thus following a research idea explored by Bhagat & Bolton (2008). The existence of statistically significant coefficients for the board related independent variables in the regression model based on subsequent ROA would definitely strengthen a presumable conclusion regarding the existence of an impact which certain board remuneration characteristics might have on company performance. The empirical results obtained from this regression model are synthesized in table 3.

Table 3. Empirical results for regression model 2

Variable Coefficients (a) t Sig. VIF

(Constant) 0,327*** 2,837 0,006 0

ChairRem 0,000 -1,34 0,186 3,026

SenNExRem 0,000 -0,419 0,677 3,536

NonExBasFee 0,001* 1,977 0,053 3,36

FeesInShares 0,021 1,31 0,195 1,536

AddRemBComMemb 0,043*** 4,086 0,000 1,601

TAn -0,028*** -4,299 0,000 5,857

IndBasMat 0,050 2,965 0,020 2,814

IndIndustrials -0,048 -2,77 0,008 2,796

IndConsGoods -0,037 -1,759 0,084 2,616

IndConsServ -0,049 -2,683 0,01 2,805

IndUtilities -0,055 -2,57 0,013 2,219

IndFinancials -0,079 -3,765 0 3,505

IndOther 0,005 0,215 0,83 2,272

Model SummaryROAn+1 AdjR2 0,561 F 4,887 Durbin-Watson 1,983

These results indicate a statistically significant relationship (at least at 0,1 level) between next year's operating performance (measured as ROA) and the corporate governance characteristics regarding de non-executive basic fee and the additional remuneration for board committee members. It should be noticed that the coefficient for the the additional remuneration for board committee members has even a higher positive value as compared to model 1 (based on contemporaneous ROA), which might indicate that this compensation component has a stronger influence on the performance on the longer term.

Concerning the potential problem of multicollinearity between independent variables included in the second model (which generates instability of empirical results), the computed variance inflation factor (VIF) values are less than 5, thus not indicating (serious) autocorrelation problems between independent variables.

Based on these empirical results obtained from the second regression model which contains statistically relevant coefficients we confirm the hypotheses 2, regarding a significant link between corporate board compensation and subsequent operating performance.

4. Summary and Conclusions

The aim of this study was to investigate (based on econometric regression models) the impact of several board compensation characteristics on contemporaneous and subsequent (next year's) performance using a sample of large groups listed on the largest European capital market (namely London Stock Exchange) between 2010 and 2011. The selected companies are the constituents of FTSE 100.

The study has used an accounting measure of operating performance, namely the operating return on assets (ROA). In order to investigate the profoundness of a potential impact of corporate board remuneration

characteristics on company performance, we explored the influence of these characteristics both on contemporaneous and on subsequent (next year's) operating performance.

As hypothesized and in accordance with some previous researches (for example Vafeas & Theodorou, 1998, Gompers et al, 2003, Guest, 2009, Bhagat & Bolton, 2008) we found a statistically significant relationship between some corporate governance characteristics and firm performance (both contemporaneous and subsequent). The empirical results proved a statistically significant relationship between non-executive directors' basic fee, fees paid in shares and additional remuneration for board committee membership (as corporate board compensation characteristics) and both contemporaneous and subsequent financial firm performance. However, the chair remuneration and the senior non-executive remuneration seem not to significantly influence company performance.

In the end, at least two limitations are worth mentioning. First, it is possible to raise the problem of sample representativeness (and implicitly of the results obtained) for the large European capital markets and respectively for the whole European capital market. In this respect, future research could extend the analysis (and the sample) to other capital markets in Europe, as well as to companies that are not included in the main index of the stock market they are listed on. Second, the obtained results do not take into account the possibile endogeneity of the relationships among corporate governance (including board remuneration), operating performance, corporate structure and ownership structure.

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