University of Edinburgh Business School Heads I win, Tails you lose? A career analysis of executive pay and corporate performance ∗ Ian Gregory-Smith † Brian Main ‡ January 2012 Abstract The paper utilises a novel career perspective to examine managerial theories of organisa- tional control in the context of executive reward. Principal-agent theory, managerial power and neo-institutionalism are evaluated. Detailed career histories of boardroom executives in all FTSE350 companies between 1996 and 2008 are utilised. Using both a fixed effects panel and a career based approach, rival hypotheses are tested. In addition to the pay- performance relationship, the probability of job loss as a function of performance is also estimated. The evidence presented points to the importance of institutional considerations in the standard agency theory and managerial power perspectives, and lends support to a social theory of agency. The analysis is empirical in nature and an effort is made to draw on qualitative studies to further flesh out the discussion. The practical implications of the findings point to the inadequacy of existing arrangements to deliver efficient pay outcomes where performance is poor whilst highlighting dangers of relying on naive policy remedies that ignore the role played by institutional forces in their implementation. Also highlighted is the distinct advantage of boards adopting a cumulative or career-oriented approach when evaluating executive performance. From a policy perspective, the case is made for truly long term incentives, in the form of ‘Career Shares’. Key words: Career Shares; Executive Pay; Pay-for-Performance; Social Agency Theory ∗ Brian Main is grateful for research support under ESRC Grant: RES-062-23-0904. † University of Edinburgh ‡ Address for correspondence: University of Edinburgh Business School, 29 Buccleuch Place, Edinburgh, EH8 9JS. Tel +44 (0) 131 6511375. E-mail: [email protected]1
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University of Edinburgh Business School
Heads I win, Tails you lose? A career analysis of
executive pay and corporate performance∗
Ian Gregory-Smith†
Brian Main‡
January 2012
Abstract
The paper utilises a novel career perspective to examine managerial theories of organisa-tional control in the context of executive reward. Principal-agent theory, managerial powerand neo-institutionalism are evaluated. Detailed career histories of boardroom executivesin all FTSE350 companies between 1996 and 2008 are utilised. Using both a fixed effectspanel and a career based approach, rival hypotheses are tested. In addition to the pay-performance relationship, the probability of job loss as a function of performance is alsoestimated. The evidence presented points to the importance of institutional considerationsin the standard agency theory and managerial power perspectives, and lends support toa social theory of agency. The analysis is empirical in nature and an effort is made todraw on qualitative studies to further flesh out the discussion. The practical implicationsof the findings point to the inadequacy of existing arrangements to deliver efficient payoutcomes where performance is poor whilst highlighting dangers of relying on naive policyremedies that ignore the role played by institutional forces in their implementation. Alsohighlighted is the distinct advantage of boards adopting a cumulative or career-orientedapproach when evaluating executive performance. From a policy perspective, the case ismade for truly long term incentives, in the form of ‘Career Shares’.
Key words: Career Shares; Executive Pay; Pay-for-Performance; Social Agency Theory
∗Brian Main is grateful for research support under ESRC Grant: RES-062-23-0904.†University of Edinburgh‡Address for correspondence: University of Edinburgh Business School, 29 Buccleuch Place, Edinburgh,
1. Sample comprises FTSE350 executive directors serving between 1996 and 2008. The sample excludes careers less than 2 years and those careerscommencing prior to 1st January 1996.2. V alue Creators are directors who’s total shareholder return (TSR) is positive over their career. Career TSR is measured as the difference in thedirector’s company’s logged Datastream return index taken at the start of their career and at the end of their career. The annual calculation of TSRis simply the annual difference in the log of the return index. TSR is multiplied by the average Market Capitalisation over the director’s career to giveΔ Sℎareℎolder Wealtℎ (SW ) (or the market cap at the year end for the annual statistic).3. TDC realised is total compensation realised over the whole career, in Dec 2008 £M. This includes salary, bonuses, perks and the realised values fromshare options, deferred bonuses and vested equity incentives. This is our preferred measure of pay when analysing the efficiency of the remuneration contractover the director’s career.4. The Controls comprise Sales(turnover in Dec 2008 £M), Board (no. of directors at the year end), %NEDs (the percentage of the board comprisingnon-executive directors at the year end), Age (the age of the director at the year end) and Tenure (the directors’ tenure to date measured in years). Forthe career panel, the average value over the directors’ tenure was taken.
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Table II: Pay-performance Elasticities. Career & AnnualCareer estimates
Full sample Value Creators Value Destroyers Asymmetric Test
Robust t-statistics in parentheses*** p<0.01, ** p<0.05, * p<0.1
1. The first panel estimates the pay-performance elasticity on a career basis. The dependent variable is the loggedvalue of career TDC realised and TSRc is measured as the difference in the director’s company’s logged return indextaken at the start of their career and at the end of their career. The second panel estimates the pay-performanceelasticity on an annual basis, again using a realised measure of TDC (for comparability the realised measure ispresented here, but qualitatively similar results were obtained using a grant date based measure, results available onrequest).2. The benefit of including a career perspective can be seen by contrasting the career-based elasticities with thosewhich result from a year-on-year approach. Under the latter approach, the estimated pay-performance sensitivity onthe full sample appears as 0.11, versus 0.06 in the career estimates.3. The asymmetric test column tests whether pay is more sensitive to performance when the performance is positive.TSR+ is TSR when TSR>0. This variable is positive, suggesting the relationship between pay and performance isstronger when TSR is positive. Further, when this variable is included with the career estimates, the coefficient onTSRc returns as insignificantly different from zero. This suggests that on a career basis, a director who destroysmore value than her counterpart experiences no financial penalty relative to her counterpart.4. In addition to the controls reported above, industry and time dummies were included in the estimating equations.The industry dummies (and the tenure variable) were omitted in the annual panel as these are eliminated in the fixedeffects regression. Likewise, the age variable merely captures the within director time trend and hence was omittedfrom the annual panel.
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Table III: Cumulative Pay-performance ElasticitiesFull Sample Value Creators Value Destroyers
Robust t-statistics in parentheses*** p<0.01, ** p<0.05, * p<0.1
1 The above table reports OLS estimates using the company-specific pay accumulated to date by theexecutive director as the dependent variable. TSRcum is cumulative TSR, which measures the log differencein the return index starting at the director’s appointment date and ending at each year end until theirexit. TSRcum‡ interacts TSRcum with the average %NEDs to the year end. This allows us to capturethe potential increase in pay-performance sensitivity imposed by boards with a greater proportion of boarddirectors. Best practice introduced during the period has encouraged a steady increase in both non-executivemembership on the board and pay-performance sensitivity (PPS). As such there is a time component tothe relationship between %NEDs and PPS. Nevertheless, the table above explicitly controls for this timecomponent with year dummies (output omitted) in addition to the director tenure variable.
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Table IV: Exit likelihood and cumulative payFull Sample Value Creators Value Destroyers
Robust z-statistics in parentheses*** p<0.01, ** p<0.05, * p<0.1
1 The above tables reports probit coefficients (not marginal effects) where Pay is the log of cumulativeTDC realised. This captures the emerging connection between pay and the likelihood of exit. Directorswho have accumulated more during their tenure to date, are more likely to exit. The difference is greaterfor the value destroyers but the difference is not statistically significant (Wald test post biprobit in Stata11 (�2=0.67). The equivalent coefficient for column 1 if using log annual TDC realised is .066***2 TSRcum is cumulative TSR. The expected inverse relationship between exit likelihood and performance isfound and this is stronger for the value destroyers. Here the difference is statistically significant (�2=52.92).The TSR‡ interacts TSR with %NEDs and is not significant suggesting more non-executives do not tightenexit-performance relationship, rejecting H5.
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Figure 1: Distribution of Career Pay and Performance
Banke
r 2
Banke
r 1
HPD
020
4060
80P
erce
nt
0 10 20 30 40 50 60 70 80
£M
Career Realised Pay
Banke
r 1HPD
Banke
r 205
1015
20P
erce
nt
−8 −4 0 4 8
Career TSR
Banker 1
Banker 2HPD
020
4060
80P
erce
nt
−50 −25 0 25£BN
Delta Shareholder Wealth
1. Distribution of CEO pay and shareholder returns from a career based perspective.2. Excludes careers commencing prior to 1st January 19963. Careers less than 2 years dropped4. HPD signifies the Highest Paid Director observed in our sample
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Figure 2: Heads I win, tails you lose Value creators vs Value Destroyers
−2
−1
0
1
2
3
£M
1 3 5 7 9Tenure (years)
Value Creators Value Destroyers
Median Realised Pay
−2
−1
0
1
2
3
£100
M
1 3 5 7 9Tenure (years)
Value Creators Value Destroyers
Median delta Shareholder Wealth
1. Δ Sℎareℎolder Wealtℎ (SW ) is TSR is multiplied by the average Market Capitalisation over thedirector’s career2. Excludes careers commencing prior to 1st January 19963. Careers less than 2 years dropped
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Figure 3: Pay-performance sensitivity and percentage of non-executive directors on the board.
−.1
0.1
.2.3
PP
S
.3 .4 .5 .6 .7% Non−executive directors
All directors Value CreatorsValue Destroyers
1. %NEDs is the percentage of non-executive directors that served on the board during the financial year,excluding the chairman. Best practice introduced during the period has encouraged a steady increase inboth non-executive membership on the board and pay-performance sensitivity (PPS). As such there is atime component to the relationship between %NEDs and PPS. Nevertheless, the graph above explicitlycontrols for this time component with year dummies and a variable capturing the length of the directorstenure (see table III )2. Excludes careers commencing prior to 1st January 19963. Careers less than 2 years dropped
33
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