1 The relationship between Financial Participation Plans and Company Financial Performance Evidence from a Dutch Longitudinal Panel Paper for the Mid Year Fellows Conference, SMLR, Rutgers University NJ, 25 February 2011 DRAFT, Please do not quote Any comments highly appreciated ! 16 February 2011 Geert BRAAM and Erik POUTSMA Institute for Management Research, Nijmegen School of Management Radboud University, PO Box 9108 HK Nijmegen, Netherlands Tel. +31 24 3611608 / Fax. +31 24 3611933 Correspondence: [email protected]Abstract This study investigates the relationship between several forms of financial participation (profit sharing, stock options and shares) and company financial performance for the period of 1992 – 2009 comprising 2216 observations. Using a unique dataset of a panel of companies listed on the Euronext Amsterdam Stock Exchange, we are not only able to distinguish between forms of participation but also to what extend these plans are narrow- based, directed to top management and executives only, or broad-based, targeted to all employees. The panel data allows us also to take into account time lag effects, as profit sharing is usually said to have short term effects while stock options and share plans are more targeted to longer term impact. We used accounting and market-based indicators for company financial performance such as ROE, ROA, earnings per share and dividend yield. The results of the econometric panel analysis using STATA 10 show that when firm size, period and fixed firm effects, or industry and random firm effects are controlled for, in comparison with companies with no plan, broad-based profit sharing and share plans and combinations of these plans show systematically significant higher positive relationships with many performance indicators than narrow-based plans. We discuss the findings in light of future directions of research, in particular also by adding more employment, qualitative and social performance data.
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1
The relationship between Financial Participation Plans and Company Financial Performance Evidence from a Dutch Longitudinal Panel
Paper for the Mid Year Fellows Conference,
SMLR, Rutgers University NJ, 25 February 2011
DRAFT, Please do not quote
Any comments highly appreciated!
16 February 2011
Geert BRAAM and Erik POUTSMA Institute for Management Research, Nijmegen School of Management
Radboud University, PO Box 9108 HK Nijmegen, Netherlands Tel. +31 24 3611608 / Fax. +31 24 3611933
(72-73) and Mining (10-17).1 Among these industry groups manufacturing is well
represented with 1025 observations (55%), trade with 335 observations (18%) and services
with 298 observations (16%). ICT has 197 observations (11%), while mining represents two
companies (1%).
[Insert Table 1]
3.2 Variable measurement
3.2.1 Dependent variables
1 Our sample is composed of publicly traded firms operating in a variety of different industries, including 34
different two-digit standard industrial classification (SIC) codes,. However, because for 5 industries we had less than ten observations, we reclassified our sample in these five main groups.
9
To measure firm financial performance we used six different measures of performance that
we classified in three groups: accounting-based, accounting and market-based, and market-
based measures. The accounting-based performance measures Return on equity (ROE) and
Return on assets (ROA) were based on the information disclosed in a company’s (annual)
financial report. The accounting and market-based performance indicators Earnings per
share (Eps) and Shareholders’equity per share (Seps) were calculated using information
disclosed in a company’s financial statements and information on the number of outstanding
shares. Finally, the market-based performance indicators Dividend Yield and Exchange rate
per AEX point reflected a firm’s performance on the stock market. The dividend yield
indicates how high the dividend per share price is, while the exchange rate per AEX-point
indicates the outperformance of the share compared to the AEX index. Please note that
these performance indictors measured different aspects of firm performance. For example,
dividend payments are usually because relatively stable, while share price fluctuate more.
An increase in a firm’s stock exchange price leads to an increase in the exchange rate per
AEX point, but to decreases of the dividend yield, ceteris paribus. Table 2 provides an
overview of the performance indicators.
3.2.1 Independent variables
To assess companies’ use of the different forms of financial participation plans we used
dummy variables. Two independent raters with a background in business administration and
economics used content analysis to code the information disclosed per firm per year. Using
data from Company.info, the raters read the entire contents of the corporate annual reports
to assess whether a company used share plans, profits sharing plans and/or stock option
plans for each year that the company was stock exchange listed. In addition, they assessed
whether these financial plans were narrow-based (top management only) or broad-based
(financial participation plans for management and employees). During these content
analyses some judgment was exercised. To control for subjectivity, in the event of
differences in judgment between the raters, the best interpretation was discussed in a
meeting of the raters and the authors of this paper.
10
Table 1, Panel C presents the distribution of the sample firms across industry and use
of share plans, profit sharing plans and/or stock option plans. As far as the data were
available, 17%, 14% and 65% of the sample firms used respectively share, profit sharing and
option plans. In addition, Panel C shows whether these financial participation plans used
were narrow- or broad-based. Respectively 8%, 2% and 45% of the firms used narrow-based
share, profit sharing and option plans, while respectively 9%, 12% and 21% of the firms used
broad-based share, profit sharing and option plans.
Data on share plans were collected with a one-year lag effect because share plans
have a longer term effect on firm performance relatively to profit sharing plans. As a
consequence of institutional constraints (tax regulation), options plans have the relatively
longest term impact on firm performance. Data on option plans were collected with a four-
year lag effect. For robustness reasons we also examined the relationships between firm
performance and profit share plans with a one-year lag, share plans with a two-year lag, and
option plans with a three-year and five-year lag. Additional analysis showed that the results
were qualitatively similar when using different time lags for the different forms of financial
participation. We reports the results with profit-sharing plans with no time lag, share plans
with one-year lag and option plans with a four-year lag.
3.2.1 Control variables
We included company size and year dummies, and firm fixed effects as control
variables. The natural logarithm of total assets was included to proxy for the size of the
company. The year dummies were included to control for omitted variables that vary over
time but are constant between the firms. Finally the fixed firm effects were included to
control for omitted variables that differ between the firms but are constant over time. When
the results the Hausman test showed that we could use random effects estimators, we also
included a time-invariant vector of industry dummies to control for industry effects on
company performance.
3.3 Analysis
11
Our hypotheses were tested using panel data regression techniques with Stata 10. Panel
data regression techniques have the advantage to incorporate both the cross-sectional
information reflected in the differences between the firms, and information in the time-
series or within-subject information reflected in the changes within the firms over time
(Wooldridge, 2002). As a consequence, panel data analysis makes it possible to control for
some types of omitted variables, i.e. firm fixed and year effects.
To test our hypotheses, we estimated the following general panel data model:
PERFi,j,t = performance of firm i in year t measured by performance indictor j;
with j = Return on equity (ROE); Return on assets (ROA); Earnings per share (Eps); Shareholders’equity per share (Seps); Dividend Yield (DY); Exchange rate per AEX point (EXPAEX).
STMi,t = dummy variable coded as 1 if firm i has narrow-based (top management only) share plans in year t and 0 otherwise;
SBBi,t = dummy variable coded as 1 if firm i has broad-based share plans in year t and 0 otherwise;
PSTMi,t = dummy variable coded as 1 if firm i has narrow-based (top management only) profit sharing plans in year t and 0 otherwise;
PSBBi,t = dummy variable coded as 1 if firm i has broad-based profit sharing plans in year t and 0 otherwise;
OTMi,t = dummy variable coded as 1 if firm i has narrow-based (top management only) option plans in year t and 0 otherwise;
OBBi,t = dummy variable coded as 1 if firm i has broad-based option plans in year t and 0 otherwise;
LNTAi,t = company size measured by its natural logarithm of total assets of firm i in year t;
FFEi = fixed effect of firm i.
YEAR = a vector of year dummies.
12
We applied a Hausman test to test whether the random effects estimators were
unbiased. The results of this test showed that when using our dependent variables EPS, SEPS
and Expaex we had to use fixed effect estimators, while random effects estimators could be
used for ROE, ROA and DY. If random effects are present, then the random effects estimator
is preferred for its greater precision. In addition, the random effects estimator permits to
estimate the effects of time-invariant variables. For this reason, we included a vector
industry dummies when using random effects estimators.
13
4. Results
Table 2 reports the results of the regression analyses for the hypothesized
relationships between share, profit sharing and option plans, the combinations of profit
sharing plans and share or option plans, and firm performance.
[Insert Table 2]
H1 predicts a positive longer term relationship between share plans for top
management (1a) and broad-based share plans (1b) and firm performance. Table 2 showed
that the relationships between share plans for top management and company performance
were mixed. The results showed a positive association between narrow-based share plans
and firm performance when the performance was measured with market-based measures
Dividend yield and Exchange rate per AEX point. The coefficients which estimated the
difference between expected performance for firms with and without share plans for top
management once variation in performance related to profit sharing and option plans, firm
size, period and fixed firm effects, or industry and random firm effects had been partialed
out showed that share plans for top management were positively and significantly
associated with Exchange rate per AEX point (β = 1.06, p.<0.01), while its association with
Dividend yield was also positive but not significant. These finding suggest that firms with
narrow-based share plans perform on average significantly better on the stock market than
firms without narrow-based share plans, controlling for all other factors specified in the
model. However, contrary to the expectation, share plans for top management were
significantly negatively related to Shareholders’ equity per share (β = .05, p.<0.10), whereas
its associations with ROE, ROA and Earnings per share were also negative but not significant.
In addition, broad-based share plans were positively related to firm performance
when the performance was measured using the measures Earnings per share, Dividend yield
and Exchange rate per AEX point. The positive association with Dividend yield was significant
(β = 0.62, p.<0.05), while the positive relationships between broad-based employee share
plans and Earnings per share and Exchange rate per AEX point were not significant. Contrary
to the expectations, broad-based share plans were marginally significantly negatively related
to ROE (β = -2.09, p.<0.10), while its association with ROA and Shareholders’ equity per
share were also negative but not significant. Together these results show partial support for
14
H1 suggesting a positive longer term relationship between narrow- and broad-based share
plans and market-based firm performance.
H2 predicts a short term positive relationship between profit sharing plans for top
management (2a) and broad-based profit sharing plans (2b) and firm performance. The
results showed that profit sharing plans for top management were significantly positively
related to Shareholders’ equity per share (β = .55, p.<0.01) and Exchange rate per AEX point
(β = .42, p.<0.01), while its association with ROE and ROA were also positive but not
significant. However, contrary to the expectation, these narrow-based financial participation
plans were negatively related to Earnings per share and Dividend Yield, whereas its
association with Dividend Yield was also significant (β = -1.54, p.<0.05). These findings lead
to rejection of H2a.
Broad-based profit sharing plans were consistently positively related to firm
performance. The associations with Earnings per share (β = .85, p.<0.05), Shareholders’
equity per share (β = .98, p.<0.10) and Exchange rate per AEX point (β = .10,p.<0.01) were
significant, while the relationships with ROE, ROA and Dividend Yield were also positive but
not significant. These findings suggest that, when the other independent variables in the
equations are controlled for, firms with broad-based profit sharing plans on average have a
better short-term performance than firms that do not have these profit sharing plans. It
provides support for H2b suggesting that broad-based profit sharing plans positively
influence company performance.
H3 predicts a neutral impact of option plans for top management (3a) and broad-
based option plans (3b) on firm performance on the longer term. In spite of the fact that we
expected neutral relationships between narrow- and broad-based options plans and firm
performance, our findings consistently showed negative associations between narrow- and
broad-based options plans and the accounting- and market-based firm measures of firm
performance. Option plans for top management were significantly negatively related to
Earnings per share (β = -.38, p.<0.10), Shareholders’ equity per share (β = -.70, p.<0.10) and
Dividend Yield (β = -.53, p.<0.01), while the negative relationship between these narrow-
based participation plans and ROE, ROA and Exchange rate per AEX point were not
significant. Broad-based option plans were significantly negatively associated with Earnings
per share (β = -.70, p.<0.05), Shareholders’ equity per share (β = -.85, p.<0.10) and Exchange
rate per AEX point (β = -.99, p.<0.01). The relationships between broad-based option plans
15
and ROE, ROA and Dividend yield were also negative but not significant. Contrary to our
expectations, these findings thus consistently show negative associations suggesting that
both the option plans for top management and the broad-based option plans have a
negative impact on firm performance on the longer term. As a consequence, we have to
reject H3a and H3b.
Finally, to test whether the existence of these combinations of plans may have
synergic impacts on performance since one type of plan may compensate for disadvantages
of the other plan, H4 predicts that profit sharing plans in combination with narrow- and
broad-based share plans (4a) or option plans (4b) are positively associated with firm
performance on the short and longer term. Table 2 shows the results to test whether the
existence of these combinations of plans may have synergic impacts on performance since
one type of plan may compensate for disadvantages of the other plan. The findings in Table
2 show that profit sharing plans in combination with share plans for top management were
significantly positively associated with Dividend yield (β = 2.158, p.<0.10). At the same time,
the interaction effects of these combinations of narrow-based participation plans are
positively but not significantly related to ROE, ROA, Earnings per share and Exchange rate
per AEX point. However, the interaction effect of profit sharing and share plans for top
management on Shareholders’ equity per share was negatively but relatively small and not
significant. In addition, the results consistently show positive relationships between broad-
based profit sharing plans in combination with share plans and firm performance. The
positive association with Earnings per share (β = 1.03, p.<0.10) and Exchange rate per AEX
point (β = 2.86, p.<0.05) were also significant. These findings suggest that the subset of firm
having both broad-based profit sharing and share plans on average perform better than
firms that do not have these plans, while controlling for all other factors specified in the
model. Together these results provide support for H4a. It suggests that the combinations of
narrow- and broad-based profit sharing and share plans have a positive short and longer
term effect on firm performance.
Finally, table 2 shows the results to test hypothesis H4b, which predicts a positive
association between profit sharing plans in combination with option plans and firm
performance on the short and longer term. Contrary to the expectations, the interaction
effects of the narrow-based combinations of profit sharing and option plans on firm
16
performance were consistently negative. The negative associations between the
combinations of profit sharing and option plans for top management and Shareholders’
equity per share (β = -63, p.<0.05) and Exchange rate per AEX point (β = -.49, p.<0.01) were
also significant.
The relationships between broad-based combinations of profit sharing and option
plans and firm performance were inconsistent. The interaction effect of the combination of
broad-based profit sharing and option plans on Exchange rate per AEX point was positive
and significant (β = 1.83, p.<0.01). However, the interaction effect of the combination of
broad-based profit sharing and option plans on shareholders’ equity per share was
significant but negative (β = -2.47, p.<0.05). The relationships between the combination of
broad-based profit sharing and option plans and ROA, ROA, Earnings per share and Dividend
Yield were not significant.
These findings suggest that narrow-based combinations of profit sharing and option
plans have a negative impact on firm performance on the short and longer term relative to
firms that do not have profit sharing and option plans for top management, while the broad-
based combinations of profit sharing and option plans do not have differential effects on
firm performance. Together these findings lead to the rejection of H4b.
In sum, the results support H2b and H4a and provide partial support for H1. These
findings suggest that broad-based profit sharing and share plans and combinations of these
plans positively affect firm performance relative to firms that do not have these financial
participation plans. Narrow-based share plans and combinations of profit sharing and share
plans for top management positively affect market-based firm performance relative to firms
that do not have these financial participation plans.
5. Conclusion and discussion
This paper assessed the relationship between financial participation and firm
performance using a longitudinal panel of companies with narrow and broad-based financial
participation plans (profit sharing, share plans and option plans). The results show that when
firm, period, size and industry effects are controlled for, in comparison with companies with
no plan, broad-based profit sharing and share plans show systematically significant higher
17
positive relationships with many performance indicators than narrow-based plans. In
addition, both the option plans for top management and the broad-based option plans are
negatively related with firm performance in comparison with companies with no plan.
However, broad-based option plans in combination with broad-based profit sharing plans
have the opposite effect on firm performance, suggesting synergic impacts since one type of
plan may compensate for disadvantages of the other plan.
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Table 1 Summary statistics of sample firms (1992-2009)
Explanation 0 = absence of type of financial participation plan. 1= narrow-based financial participation plans (directed to top management and executives only). 2 = broad-based financial participation plan (targeted to all employees).
22
Table 2 Regression of company financial performance on financial participation plans, company size,
year, industry and fixed firm controls
Independent variables Dependent variables
Accounting Accounting & market-
based
Martket-based
ROE ROA EPS SEPS DY Expaex
Intercept -18.659
(-1.02)
-27.283***
(-3.82)
.853
(.40)
-20.834***
(-5.24)
1.287*
(1.41)
-.992
(-.47)
Shares management only
(STM)
-1.530*
(-1.40)
-2.108*
(-1.51)
-.144
(-.60)
-.058*
(-1.30)
.089
(.49)
1.068***
(4.41)
Shares broad-based
(SBB)
-2.092*
(-1.30)
-.885
(-.30)
.234
(.63)
-.760
(-1.08)
.625**
(2.27)
.093
(.25)
Profitsharing
management only
(PSTM)
.427
(.09)
.935
(.11)
-.261
(-.25)
.515**
(2.66)
-1.544**
(-2.02)
.422***
(4.06)
Profitsharing broad-
based (PSBB)
.361
(1.22)
.573
(1.19)
.857**
(2.20)
.938*
(1.29)
.188
(1.03)
.102***
(2.59)
Options management
only (OTM)
-1.196
(-1.13)
-.746
(-1.04)
-.388*
(-1.48)
-.701*
(-1.41)
-.523***
(-2.75)
-.296
(-1.12)
Options broad-based
(OBB)
-.608
(-.45)
-2.140
(-.86)
-.707**
(-2.11)
-.856*
(-1.35)
-.205
(-.85)
-.993***
(-2.93)
STM * PSTM 3.723
(.49)
2.843
(.65)
1.754
(.85)
-.156
(-.04)
2.158*
(1.60)
.303
(.14)
SBB * PSBB 2.790
(0.95)
2.843
(0.53)
1.036*
(1.58)
2.864**
(2.31)
.392
(.81)
.271
(.41)
PSTM * OTM -.706
(-.12)
-.621
(-.58)
-1.210
(-1.02)
-.638**
(-2.85)
-.592
(-1.07)
-.496**
(-4.13)
PSBB * OBB 1.793
(.56)
2.058
(.34)
.214
(.32)
-2.471**
(-1.96)
-.601
(-1.20)
1.83***
(2.71)
Firm size (LNTA) 3.594***
(2.95)
2.268***
(4.57)
.198
(1.13)
2.406***
(8.16)
.188*
(1.57)
.498***
(3.16)
YEAR dummies
1 Y Y Y Y Y Y
INDUSTRY dummies
1 Y Y N N Y N
Fixed firm effects1 Y Y Y Y Y Y
F-statistic 4.22*** 6.81*** 9.73***
Wald-
2 65.82*** 81.02*** 93.31***
R² .066 .103 .104 .157 .143 .187
N 1158 1158 934 933 934 933
23
Table 2a [FE] Regression of company financial performance on financial participation plans,