Executive Compensation, Firm Performance and Corporate Governance: Evidence from Pakistan

Abstract

Executive Compensation, Firm Performance and Corporate Governance: Evidence from Pakistan The study aims at examining how compensation of chief executive officer (CEO) is influenced by firm performance and corporate governance mechanisms such as concentrated/family ownership and board structure in Pakistan. It further extends its scope to analyzing the motivation aspects of CEO compensation towards future firm performance and earnings management. The study uses a sample of 1508 firm-year observations from 225 non-financial listed companies in Karachi Stock Exchange (KSE) for period 2005 to 2012. Robust methodological procedures that control for heteroskedasticity, serial correlation and endogeneity issues are used. The study finds that current and previous year firm accounting performance as measured by return on assets has significant influence on CEO compensation. However, firm market performance does not have positive influence on CEO compensation. Ownership concentration appears to have positive influence on CEO compensation, indicating some sort of collusions between management and largest shareholder to get personal benefits. CEOs who are also chairman board of directors receive lower compensation as compared to their counterparts. Board size and board independence have no convincing influence on CEO compensation in any direction, indicating irrelevance of these mechanisms in CEO compensation decisions making. There is weak evidence that CEOs in family firms receive lower pay as compared to their counterparts. Further, it is found that CEOs are not rewarded for expected future firm performance. Similarly, CEOs do not appear to induce earnings management to receive higher compensations. The study indicates that incentive based CEO compensation does not exist in Pakistan. In addition, behavior of corporate governance variables in setting CEO compensation appears to be pretty different from what is expected. Therefore, all the stakeholders should be concerned and need to notice the decision-making process within the boards in addition to ensuring the effective internal control system to align the CEO interests with that of shareholders and restrain the possible expropriation of minority shareholders’ interests. Keywords: Executive Compensation, CEO Pay, Corporate Governance, ROA, Stock Returns, Earnings Management, Fixed Effects, Endogeneity, Non-Financial Firms.