4th BIENNIAL IMTERNATIONAL CONFERENCE ON BUSINESS, BANKING &

FINANCE

EXECUTIVE COMPENSATION, FIRM PERFORMANCE AND RISK IN THE FINANCIAL

CRISIS PERIOD 2006-2009

Mr. Quinn Trimm

Introduction Introduction US CEO/worker pay gap stood at 301-1 in 2003, as

compared to only 42-1 in 1982 (Matsumura & Shin, 2005).

Executive compensation has become synonymous with the ‘agency problem’ (Quinn, 1999), scholars have concluded that agency costs can be reduced by aligning the risk preferences of CEOs and shareholders, by awarding equity-based incentives i.e. stock options and restricted stock (Core et al. 2003).

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Introduction Introduction The application of performance-linked remuneration

has been viewed as a tool for aligning the interests of directors and shareholders (Dalton et al, 2007).

The uncertainty surrounding the Agency Theory, executive compensation, unsystematic risk, and firm accounting performance motivates this study and attempts to explore the underlying relationship between them, if any.

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Literature ReviewLiterature Review The Agency Theory.

Jensen and Meckling (1976)

Smith (1776)

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Literature ReviewLiterature Review The Managerial Power Theory.

Bebchuk and Fried, (2004); Grabke-Rundell and Gomez-Mejia, (2002).

Finkelstein (1992)

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Research MethodologyResearch Methodology A cross sectional study was employed to examine the

effect of firm performance and total risk on executive compensation.

Multiple regression analysis was used to analyze the relationship between the variables . The data was duly treated using the first difference transformation to achieve normality.

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Research MethodologyResearch Methodology Hypothesis Development

Hypothesis One: Ho = 3(ROA), 4 (ROE), 5(EPS) and 6 (PE) = 0

Hypothesis Two: Ho: 1(MKTR) and 2(UNSYSR) = 0

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Research MethodologyResearch Methodology Regression Models

Compensation= a + 1(MKTR) + 2(UNSYSR) + 3(ROA) + 4 (ROE) + 5(EPS) + 6 (PE) + εi

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Research MethodologyResearch Methodology Base Pay= a + 1(MKTR) + 2(UNSYSR) + 3(ROA) + 4

(ROE) + 5(EPS) + 6 (PE) + εi  

Annual Bonus= a + 1(MKTR) + 2(UNSYSR) + 3(ROA) + 4 (ROE) + 5(EPS) + 6 (PE) + εi  

Long term Compensation= a + 1(MKTR) + 2(UNSYSR) + 3(ROA) + 4 (ROE) + 5(EPS) + 6 (PE) + εi

Stock Options= a + 1(MKTR) + 2(UNSYSR) + 3(ROA) + 4 (ROE) + 5(EPS) + 6 (PE) + εi

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Research MethodologyResearch Methodology The dependent variable total executive compensation, base

pay, annual bonus, long-term compensation and equity based incentives/stock options) was analyzed (Murphy, 1999).

The first independent variable is firm performance. ROA, ROE, EPS & PE were used (Murphy, 1985).

The second independent variable is firm risk. Considering the Market Model as posed by Harry Markowitz, risk was represented by market risk (MKTR) and unsystematic risk (UNSYSR).

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Empirical ResultsEmpirical Results

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Pre-financial crisis period January 03, 2006 to December 29, 2006

Model

Standardized Coefficients

t Sig.BetaTOTAL COMPENSATION

(Constant)   0.038 0.97

EPS 0.403 4.003 0.000

BASE PAY (Constant) 0.158 0.875

ROE -0.415 -3.139 0.002

EPS 0.536 6.098 0.000

PE -0.242 -2.824 0.006

MKTR 0.275 3.329 0.001

UNSYSR -0.192 -2.41 0.018

BONUS PAY(Constant) 0.003 0.997

EPS 0.254 2.532 0.013

MKTR 0.216 2.288 0.024

LONG TERM COMPENSATION (Constant) 0.065 0.949

STOCK(Constant) 0.006 0.995

EPS 0.454 4.477 0.000

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The financial crisis period January 08, 2007 to December 28, 2007

Model

Standardized Coefficients

t Sig.BetaTOTAL COMPENSATION

(Constant) 0.03 0.976

EPS 0.739 4.926 0.000

BASE PAY(Constant) 0.107 0.915

ROE 0.699 2.02 0.046

EPS 0.546 4.115 0.000

MKTR 0.263 3.307 0.001

BONUS(Constant) -8.98E-04 0.999

ROA 0.975 2.567 0.012

EPS 0.847 5.761 8.12E-08

LONG TERM COMPENSATION(Constant) 0.096 0.923

STOCK(Constant) 0.005 0.996

EPS 0.712 4.634 0.000

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The financial crisis period January 08, 2008 to December 29, 2008

Model

Standardized Coefficients

t Sig.BetaTOTAL COMPENSATION

(Constant) 0.04 0.968

MKTR 0.405 4.648 0.000

BASE PAY

(Constant) 0.078 0.938

MKTR 0.243 2.667 0.009

BONUS

(Constant) 0.012 0.991

MKTR 0.336 3.708 0.000

LONG TERM COMPENSATION

(Constant) 0.008 0.994

STOCK

(Constant) 0.026 0.98

MKTR 0.399 4.567 0.000

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The post-financial crisis period January 05, 2009 to December 27, 2009.

Model

Standardized Coefficients

t Sig.BetaTOTAL COMPENSATION

(Constant) -8.74E-01 0.384

ROA 0.787 3.059 0.003

MKTR 0.304 3.262 0.002

BASE PAY(Constant) -1.327 0.188

MKTR 0.418 4.569 0.000

BONUS(Constant) -0.109 0.914

ROA 0.646 2.31 0.023

ROE -0.537 -2.238 0.028

UNSYSR -0.269 -2.148 0.034

LONG TERM COMPENSATION(Constant) -0.222 0.825

MKTR 0.296 2.873 0.005

STOCK(Constant) -0.787 0.433

ROA 1.13 4.489 0.000

ROE -0.968 -4.483 0.000

UNSYSR -0.31 -2.751 0.007

ConclusionsConclusions Managers were contracted based on the perceived value they can add to

a company. This is reflected in their base salary – their worth at the face value. Upon evidence of additional efforts (increased firm accounting performance) they were endowed with bonuses, stock options and other long term benefits.

However, for the years 2006 and 2007 this study did not provide the evidence to fully support the dictum of the Agency Theory.

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ConclusionsConclusions Managers did nothing to overtly jeopardize that which mattered

most – their base salary. With the bullish market of 2007 managers did not appear to be “risk-seeking” and their base salaries increased. In 2008 however, the financial crisis took full effect.

This caused the level of executive compensation to decline, and in 2009 managers tried to rebuild the market by taking more risk.

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ConclusionsConclusions The Agency Theory

The Managerial Power Thoery

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ConclusionsConclusions The Managerial Power Theory points the way for the

apparent deviation from the Agency Theory during the period 2006 – 2009.

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