4 th BIENNIAL IMTERNATIONAL CONFERENCE ON BUSINESS, BANKING & FINANCE

EXECUTIVE COMPENSATION, FIRM PERFORMANCE AND RISK IN THE FINANCIAL CRISIS PERIOD Mr. Quinn Trimm

Introduction  US CEO/worker pay gap stood at 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). 23/06/2011 3

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. 23/06/2011 4

Literature Review  The Agency Theory.  Jensen and Meckling (1976)  Smith (1776) 23/06/2011 5

Literature Review  The Managerial Power Theory.  Bebchuk and Fried, (2004); Grabke-Rundell and Gomez-Mejia, (2002).  Finkelstein (1992) 23/06/2011 6

Research 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. 23/06/2011 7

Research Methodology  Hypothesis Development  Hypothesis One:  H o =  3 (ROA),  4 (ROE),  5 (EPS) and  6 (PE) = 0  Hypothesis Two:  H o :  1 (MKTR) and  2 (UNSYSR) = 0 23/06/2011 8

Research Methodology  Regression Models  Compensation= a +  1 (MKTR) +  2 (UNSYSR) +  3 (ROA) +  4 (ROE) +  5 (EPS) +  6 (PE) + ε i 23/06/2011 9

Research Methodology  Base Pay= a +  1 (MKTR) +  2 (UNSYSR) +  3 (ROA) +  4 (ROE) +  5 (EPS) +  6 (PE) + ε i  Annual Bonus= a +  1 (MKTR) +  2 (UNSYSR) +  3 (ROA) +  4 (ROE) +  5 (EPS) +  6 (PE) + ε i  Long term Compensation= a +  1 (MKTR) +  2 (UNSYSR) +  3 (ROA) +  4 (ROE) +  5 (EPS) +  6 (PE) + ε i  Stock Options= a +  1 (MKTR) +  2 (UNSYSR) +  3 (ROA) +  4 (ROE) +  5 (EPS) +  6 (PE) + ε i 23/06/

Research 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). 23/06/

Empirical Results 23/06/

Pre-financial crisis period January 03, 2006 to December 29, 2006 Model Standardized Coefficients tSig. Beta TOTAL COMPENSATION (Constant) EPS BASE PAY (Constant) ROE EPS PE MKTR UNSYSR BONUS PAY (Constant) EPS MKTR LONG TERM COMPENSATION (Constant) STOCK (Constant) EPS /06/

23/06/ The financial crisis period January 08, 2007 to December 28, 2007 Model Standardized Coefficients tSig. Beta TOTAL COMPENSATION (Constant) EPS BASE PAY (Constant) ROE EPS MKTR BONUS (Constant) -8.98E ROA EPS E-08 LONG TERM COMPENSATION (Constant) STOCK (Constant) EPS

23/06/ The financial crisis period January 08, 2008 to December 29, 2008 Model Standardized Coefficients tSig. Beta TOTAL COMPENSATION (Constant) MKTR BASE PAY (Constant) MKTR BONUS (Constant) MKTR LONG TERM COMPENSATION (Constant) STOCK (Constant) MKTR

23/06/ The post-financial crisis period January 05, 2009 to December 27, Model Standardized Coefficients tSig. Beta TOTAL COMPENSATION (Constant) -8.74E ROA MKTR BASE PAY (Constant) MKTR BONUS (Constant) ROA ROE UNSYSR LONG TERM COMPENSATION (Constant) MKTR STOCK (Constant) ROA ROE UNSYSR

Conclusions  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. 23/06/

Conclusions  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. 23/06/

Conclusions  The Agency Theory  The Managerial Power Thoery 23/06/

Conclusions  The Managerial Power Theory points the way for the apparent deviation from the Agency Theory during the period 2006 – /06/