Global Corporate Governance Colloquia Stockholm, 10-11 June 2016 Executive Remuneration and Controlling Shareholders Roberto Barontini Scuola Superiore Sant’Anna, Pisa Stefano Bozzi Università Cattolica, Rome Guido Ferrarini University of Genoa, University of Nijmegen and ECGI Global Corporate Governance Colloquia Stockholm, 10-11 June 2016 ,

Paper’s Purpose We analyse the relationship between conformity to executive remuneration standards, corporate ownership, and the level and structure of CEO compensation for large European listed companies Our results show that controlled corporations follow the relevant standards less than widely- held ones We interpret this ‘conformity gap’ from the perspective of individual corporations and of society as a whole

2. Corporate governance reform Two waves of reform in Europe: post-Enron and post-great financial crisis The first wave targeted remuneration governance (including say on pay) and disclosure The second wave switched focus on pay structures and their alignment with long-term sustainability At national level, reforms have been mainly implemented through private codes, but there is presently a move towards formal law

3. Our data Unique database, comprising governance and compensation data: hand-collected for compensation and governance variables (Annual reports, CG reports, Notes to the financial statements) financial data from Thompson Reuters FTSE Eurofirst 300 Index constituents 192 non-financial firms in 2007 and 2010 largest European non-financial companies from 16 European countries: UK, France, Germany, Italy, Spain and Switzerland Continental countries (CONT): Austria, Belgium, Denmark, and Netherlands Nordic countries (NORD): Finland, Norway, and Sweden PIG (Portugal, Ireland, and Greece)

Governance & Disclosure Variables Area Category Variable Criteria to research GOVERNANCE Remuneration governance Y1 RemCo Existence Y2 RemCo Independence Y3 Consultant Existence Y4 Consultant Independence DISCLOSURE Remuneration Policy Y5 Policy overview (fin.year in review) Y6 Forward-looking policy (future fin. years) Y7 Proportion fixed-variable pay Y8 Performance criteria for bonus Y9 Performance criteria for share plans Y10 Information on termination payments Individual disclosure Y11 Breakdown of pay components for each executive director Y12 Breakdown of pay components for each non- Y13 N. of share-based granted Y14 N. of share-based exercised Y15 N. of share-based unexercised Y_all -------Mean of all variables

Area Category Variable Explanation   GOVERNANCE Remuneration governance Compliance_gov The average for the compliance to each of the criteria Y1-Y4 DISCLOSURE Remuneration policy Compliance_rem The average for the compliance to each of the criteria Y5-Y10 Individual disclosure Compliance_discl The average for the compliance to each of the criteria Y11-Y15 OVERALL COMPLIANCE SCORE Compliance_Score The average for the compliance to all criteria Y1-Y15

4. CEO compensation Level of compliance We study the impact of the ownership type on the level of compliance with respect to the 4 dependent variables (Y_gov, Y_rem, Y_dis, Y_all) On average, State and Family ownership have a negative impact on the level of all dependent variables. In particular State and Family firms have lower levels of disclosure and governance of remuneration policy. The 2007 results are confirmed for 2010, even though their magnitude is lower Why are controlled firms less compliant than widely held ones?

Levels of CEO compensation We study the relationship between the level of CEO compensation, the type of ownership and the level of compliance to best practices On average, when compared to widely-held firms, State owned and Family firms firms pay lower Total Compensation (regression 1). The effect for Family firms is smaller, but still significant (regression 2)

Levels of CEO compensation We study the relationship between the level of CEO compensation, the type of ownership and the level of compliance to best practices On average, when compared to widely-held firms, State owned and Family firms firms pay a lower level of Total Compensation (regression 1). The effect for Family firms is smaller, but still significant, in regression 2 The level of compliance Y_all is strongly correlated to the level of compensation (regression 3), also when combined with the type of ownership (regression 4) These results are not sensible to the alternative parameters of firm performance used as control variables (ROA, Qratio and stock returns)

Level of CEO total compensation, ownership and disclosure

Structure of CEO compensation We then study the correlation between the structure of CEO compensation, the type of ownership and the level of compliance to best practices On average, the percentage of cash compensation (over Total compensation) is higher in State and Family firms than in widely held firms (for family firms it is significant for 2010)

Structure of CEO compensation and ownership

Structure of CEO compensation We then study the correlation between the structure of CEO compensation, the type of ownership and the level of compliance to best practices On average, the percentage of cash compensation (over Total compensation) is higher in State and Family firms than in widely held firms (for family firms it is significant for 2010) Incentive-based compensation (Bonus+stock-based) is lower for state-owned firms, while family firms reveal no significant differences vs. WH firms. This evidence is stronger for 2010.

Structure of CEO compensation and ownership

Structure of CEO compensation We then study the correlation between ownership type and composition of CEO compensation On average, the percentage of cash compensation (over Total compensation) is higher in State and Family firms than in widely held firms (for family firms it is significant for 2010) Incentive-based compensation (Bonus+stock-based) is lower for state-owned firms, while family firms reveal no significant differences vs. WH firms. This evidence is stronger for 2010. Within incentive-based compensation, the percentage of bonus pay is higher in family and state-owned firms than in widely-held firms.

Structure of CEO compensation and ownership

Structure of CEO compensation We then study the correlation between ownership type and composition of CEO compensation On average, the percentage of cash compensation (over Total compensation) is higher in State and Family firms than in widely held firms (for family firms it is significant for 2010) Incentive-based compensation (Bonus+stock-based) is lower for state-owned firms, while family firms reveal no significant differences vs. WH firms. This evidence is stronger for 2010. Within incentive-based compensation, the percentage of bonus pay is higher in state-owned firms Within stock-based compensation, there are no significant differences among the types of ownership as to stock grant/stock options. These results suggest that, in paying their CEOs, Family and state- owned firms rely more on cash after the crisis and make less use of bonuses and incentive compensation

Structure of CEO compensation and ownership

On average, when the overall level of compliance (Y_all) is higher: Remuneration structure and level of compliance On average, when the overall level of compliance (Y_all) is higher: the percentage of cash compensation (over Total compensation) is lower the percentage of incentive compensation (Bonus+stock-based) over Total compensation is higher the incidence of bonus within incentive-based compensation is lower Overall, a better quality of disclosure, governance and remuneration policy (proxied by Y_all) is associated with more incentive-based compensation, mainly driven by stock-based pay. These results are robust to the inclusion of ownership dummy variables

5. Discussion of the conformity gap Why a conformity gap? Controlled corporations pay smaller remuneration packages and rely more on fixed pay and cash-based incentives. Possible reasons: Controlling shareholders monitor the managers more effectively Incentive pay is less needed or more efficiently managed The lower pressure to provide CEOs with financial incentives leads to Less emphasis on remuneration governance Less attention to the disclosure of remuneration

Moreover, controlling shareholders are less interested to appease investor concerns for excessive pay: They dominate the AGM They are less worried about minority shareholders’ criticism Possible alternative explanation: Lower compliance as a means to facilitate the extraction of PBC However, the level of compensation at controlled corporations is lower than in dispersed ones (and their performance is better, at least in family-controlled firms)

ii. An enforcement problem? Does the conformity gap derive from weak enforcement or from society’s tolerance of non-compliance by controlled corporations? Weak enforcement has limited explanatory power: Public enforcement depends on mandatory rules (e.g. disclosure requirements), but remuneration standards are often subject to ‘comply or explain’ Private enforcement is rare for remuneration issues, which are largely covered by the business judgment rule Weak enforcement would concern both controlled corporations and dispersed ones

2. We would rather explain the conformity gap by assuming that society tolerates deviations from executive remuneration standards. Possible reasons: Controlled corporations pay their managers less than widely-held firms Controlled corporations often perform better than widely-held ones The appropriation of some PBC is tolerated in most legal systems to compensate controlling shareholders for the costs of their monitoring; what really matters is that PBC consumption is limited to efficient levels (where the gains from better monitoring and management exceed the PBC costs to minority shareholders: Gilson and Schwartz 2013)

6. Conclusions Two main interrelated results Interpretation Controlled corporations on average comply less than widely-held ones (conformity gap) Less compliant firms pay their CEOs less and rely more on cash-based compensation Interpretation The conformity gap is a consequence of the tighter monitoring by controlling shareholders Such monitoring reduces the need for financial incentives and therefore the pressure to comply with remuneration best practices An alternative (but less likely) explanation is that the conformity gap makes the appropriation of PBC easier