Ownership structure and board effectiveness as determinants of TMT compensation in Spanish listed firms/Nuosavybes formos ir valdybos efektyvuma lemiantys veiksniai pasirinktose Ispanijos kompanijose.
Sanchez-Marin, Gregorio ; Baixauli-Soler, J. Samuel ; Lucas-Perez, M. Encarnacion 等
1. Introduction
Since the first study by Berle and Means (1932), in which the
separation of ownership and control was proposed, numerous studies have
attempted to analyze the different structures of ownership and what
effects they have on the organization. The literature provides
information on the influence ownership structure has on different
aspects of organizational governance (Shleifer and Vishny 1997; Werner
et al. 2005), and takes into account such important measures as
ownership concentration (Tosi and Gomez-Mejia 1989; Maug 1998),
proportion of ownership by the top managers (Boyd 1994; Tosi and
Gomez-Mejia 1994), and the presence of institutional investors (David et
al. 1998; Hartzell and Starks 2003).
Ownership structure may act as a natural control mechanism which
can reduce agency problems between owners and top managers and align
their interests (Hart 1995). As such, it constitutes an effective
mechanism for top manager supervision and controls their compensation
(Jensen and Meckling 1976). However, it is also important to take into
account that ownership structure indirectly influences the supervisory
effectiveness of the board of directors (Bathala and Rao 1995; Whidbee
1997; Lefort and Urzua 2008) and that top managers' compensation
depends on both these mechanisms. Coles et al. (2001) indicates that
organizations should design their control mechanisms in such a way as to
bring about an alignment of interests and thus use specific control
mechanisms to overcome or mitigate agency problems that may arise with
the use of other such mechanisms. Hence, a high level of control by the
owners may lead to a reduction in the power of the board of directors.
In turn, this may alter the effectiveness of their supervision and,
consequently, the levels of top managers' compensation (Rediker and
Seth 1995; Whidbee 1997; Bozec, Y. and Bozec, R. 2007).
The majority of previous studies in this stream either concentrate
their analysis on the effects of ownership structure without taking the
interrelationships with the board of directors into consideration, or do
not produce a clear answer in terms of the consequences these effects
have on compensation (Donnelly and Kelly 2005; Werner et al. 2005). For
example, a number of studies show that when top managers own shares,
their interests align with those of other owners (Jurkstiene et al.
2008), the board is more effective in its supervisory role, and this
brings about a reduction in the top managers' levels of pay (Tosi
and Gomez-Mejia 1994; Brick et al. 2006). However, other studies show
that ownership by top managers produces the opposite effect, increasing
their pay levels (Mangel and Singh 1993; Vafeas 2003). As a result, it
is not clear whether the presence of institutional investors makes
boards more or less effective or how this translates into higher or
lower pay levels for top managers (David et al. 1998; Hartzell and
Starks 2003; Khan et al. 2005). There is also the question of whether
placing ownership in the hands of investors who have no links to the
organization has a positive or negative influence on the board's
supervisory effectiveness and whether this produces a rise or fall in
top management team (TMT, hereafter) pay levels (Lambert et al. 1993;
Cyert et al. 2002; Ozkan 2007).
A deeper analysis of the influence of ownership structure and board
effectiveness on top managers' compensation is needed. Hence, the
main objective of the present study lies in testing Spanish listed firms
to see whether the ownership structure influences the board's
supervisory effectiveness, and whether the joint effect of both internal
control mechanisms has an impact on TMT pay level as a whole.
Spanish listed firms are attractive for several reasons. The
recently enacted Codigo Unificado de Buen Gobierno (2006), which is
similar to the Cadbury Code (1992) in the UK, requires listed firms to
disclose TMT compensation. Spanish corporate governance is characterized
by a relatively small stock market and a high level of ownership
concentration in the hands of a small number of shareholders (De Miguel
et al. 2004). In Spain, therefore, the control mechanisms rely either on
contractual clauses governing incentives between shareholders and
managers or on direct supervision by the board (La Porta et al. 1999; De
Andres et al. 2005). Thus, the importance of ownership structure and
board effectiveness in the determination of TMT pay levels is highly
significant (Sanchez-Marin et al. 2010; Baixauli-Soler and Sanchez-Marin
2011).
The present study highlights the importance of the peculiarities in
national systems of corporate governance in determining TMT pay.
Compared with other EU countries or Anglo-Saxon countries, Spain
represents a completely new and unexplored scenario for testing dynamic
relationships and this study will provide new insights into
international governance (Firth et al. 2007; Lin and Su 2009). More so
than in other countries, an understanding of how corporate governance
determines TMT pay levels in Spain can contribute to the understanding
of the effectiveness of agency control.
The structure of the study is as follows. It begins with a review
of the main theoretical positions proposed in previous literature and,
based on this, several research hypotheses are put forward. This section
is followed by an explanation of the methodology employed and the model
proposed. The penultimate section is devoted to explaining the results.
Finally, conclusions are drawn and discussed.
2. Theoretical Framework and Research Hypotheses
In order to analyze the influence of ownership structure on the
supervisory effectiveness of the board and determine the effect on TMT
pay levels, this study sets out two key contexts (Fig. 1): high and low
levels of ownership concentration. We examine the different ways in
which the significant presence of managers, institutional investors, and
external owners in the ownership structure influence the effectiveness
of the board and TMT pay levels in situtions of high ownership
concentration.
There has been extensive discussion as to whether concentrated or
dispersed ownership is more conducive to effective governance (Core et
al. 1999; Cyert et al. 2002). While greater concentration can be an
obstacle in certain cases, especially for minority interests, it can
also allow for the specialization necessary to develop complex
organizational structures and distribute the risk appropriately among
managers and owners (Melnikas 2005; Firth et al. 2007; Tvaronaviciene
and Degutis 2007). In both of these cases, the influence of owner
concentration on supervisory board effectiveness and, consecuently, on
TMT pay levels is clear. However, when higher concentrations of
ownership exist, the type of owners and the proportion of shares they
hold will determine the effectiveness of supervision over the TMT and
its pay. In the following paragraphs, we analyze the interactions in the
different contexts showed in Fig. 1 and put forward the hypotheses.
[FIGURE 1 OMITTED]
A dispersed structure of ownership can lead to a lack of incentive
for owners to control the activity of top managers, leading to a passive
attitude in the defense of their interests (Grossmann and Hart 1980;
Maug 1998). The cost of obtaining information means any response by the
small shareholder will depend on the potential benefit that be may
obtained by their actions (Hart 1995). This produces a double effect
upon supervisory effictiveness (Hart 1995): (1) in terms of the votes
cast by the shareholders, the ability to control is reduced and more
power is delegated to the board of directors who, in turn, delegate to
top managers; and (2) the lower level of participation reduces
shareholder's motivation to confront the issue of supervision for
as long as the dividends continue to be paid.
A passive attitude on the part of minority shareholders and the
great difficulty they experience in coordinating their actions result in
an ownership structure that cannot act as an effective control mechanism
of TMT and its pay (Core et al. 1999). In this case, whether any control
is exercised over the TMT will depend upon the supervisory effectiveness
of the board (Soltane 2009). If the board has relatively few members,
includes a significant proportion of external or independent directors,
and is truely focused on controlling the activities of the TMT -in terms
of the activity of the several committees of which the board is
composed-, the interests of the owners and managers can be aligned. This
alignment tends to reduce TMT pay levels (Tosi and Gomez-Mejia 1989;
Boyd 1994; Conyon and Peck 1998). In Spain, due to the fact that the
characteristics of corporate governance indicate a highly limited
effectiveness of internal control mechanisms (De Miguel et al. 2004),
more effective monitoring by the board is expected to cause a greater
reduction in TMT pay levels (Sanchez-Marin et al. 2010; Baixauli-Soler
and Sanchez-Marin 2011). On the basis of these arguments we put forward
the following hypothesis.
Hypothesis 1: In a low concentration context, as supervisory board
effectiveness increases, TMT pay levels will be lower.
A concentrated structure of ownership contributes to the solution
of certain agency problems related to conflicts of interest as the
majority shareholders have an incentive to collect information and
supervise top managers (Werner et al. 2005). Thus, when ownership is
concentrated in the hands of a few major shareholders, they have greater
power to defend the capital invested and are highly motivated to control
top managers (Goldberg and Idson 1995; Faccio and Lang 2002) and, in
particular, their compensation (Tosi and Gomez-Mejia 1989).
Although these relationships are fairly clear, one of the most
important subjects to analize relates to how the type of ownership
concentration influences supervisory board effectiveness. This will
depend on whether the majority shareholders -top managers, institutional
investors or external owners--(Werner et al. 2005) can impose their own
interests and the extent to which this will influence board
effectiveness and TMT pay levels (Rediker and Seth 1995; Bozec, Y. and
Bozec, R. 2007). This is particularly important in the Spanish context,
where, in comparison to traditionally studied countries such as US or
UK, a more limited and undeveloped system of corporate governance is in
place. We detail these relationships below.
When ownership is concentrated in the hands of top managers,
divergent effects may be produced. When top managers hold a high
proportion of shares, the 'entrenchment effect' is produced
(Demsetz 1983; Fama and Jensen 1983), whereby top managers acquire
enough power to enable them to follow their own objectives whatever the
circumstances. They may fall into opportunistic behaviour in conflict
with the interests of other owners and even with the firm business
interests (Lambert et al. 1993; Dhaoui 2008). In this case, the
entrenched TMT has a major influence on board decisions, thus reducing
their supervisory function (Bathala and Rao 1995; Whidbee 1997) and
giving greater discretion to the TMT to set higher pay levels for
themselves. However, if the proportion of ownership becomes so high that
the TMT effectively become the majority shareholder, the consumption of
benefits, including those relating to compensation, is reduced (Lambert
et al. 1993; Core et al. 1999) because their personal benefits depend
upon the firm's performance (Mehran 1995; Agrawal and Knoeber
1996). This produces a 'convergence effect', which leads to a
moderation of TMT pay. This happens in spite of the fact that
supervisory board effectiveness remains low -directors relax their
monitoring activity when other control mechanisms are in place- and is
due to the policy control exercised by the TMT as majority owners
(Donnelly and Kelly 2005).
The particularity of the ownership structure in Spanish listed
firms may have a strong influence -both in a positive and a negative
sense- on setting TMT pay levels. Firm ownership is much more
concentrated in Spanish firms than in those in the US or UK (La Porta et
al. 1999). De Miguel et al. (2004) find that because of ownership
concentration, TMTs become more entrenched at higher levels of ownership
than their UK and US counterparts. As a result of this, Baixauli-Soler
and Sanchez-Marin (2011) report a high variability in TMT pay levels
depending on ownership concentration levels and the effectiveness in
board monitoring. These arguments bring us to the following hypothesis:
Hypothesis 2: In high concentration contexts, as the ownership of
top managers increases: (a) the supervisory board effectiveness will
decrease, leading to a rise in TMT pay levels -entrenchment effect-; (b)
the supervisory board effectiveness will decrease, leading to a
reduction in TMT pay levels -convergence effect-.
Considering the relationships put forward in the first two
hypotheses (see Fig. 2), we can predict a cubic association between TMT
pay level and the ownership of the firm which is conditional upon the
control exercised by the TMT (Tosi and Gomez-Mejia 1989, 1994). As
hypothesis 1 states, when ownership is dispersed, board supervision is
more effective and TMT pay levels will be lower. In this case, an
'alignment effect' is produced since the low level of shares
held by the TMT results in their lacking power and discretion. However,
if ownership is concentrated in the hands of top managers -hypothesis
2-, the entrenched TMT dominates the board and, consequently, enjoys
more discretion to set higher pay levels (Werner et al. 2005). If
ownership among TMT increases still further, there will be a convergence
with the interests of shareholders and pay levels will decrease again.
[FIGURE 2 OMITTED]
Another notable aspect that influences the supervisory board
effectiveness and TMT pay level is the concentration of ownership in the
hands of institutional investors (David et al. 1998; Hartzell and Starks
2003). Institutional investors constitute a organized group -banks,
pension funds, insurance companies and investment societies- which
characteristically holds a long term portfolio of investments in firms
and whose objective is performance maximization (Hartzell and Starks
2003). Institutional investors take the role of traditional owners and
exercise stricter control over the TMT through their presence on a more
effective board of directors (David et al. 1998; Cheng and Firth 2005).
As a result they reduce both TMT discretion and possible agency problems
(Useem and Gager 1996). Two reasons explain these effects. First,
institutional investors have the opportunity to remove incentives for
passivity derivated from the possible situation where there are minority
shareholders in the firm (Bathala et al. 1994). Second, institutional
investors have the ability to supervise the TMT directly (Bathala and
Rao 1995), promoting an independent and effective board that protects
shareholders interests (Li et al. 2006) and that consequently moderates
TMT pay level.
Finally, when ownership is significantly concentrated in the hands
of one of a few external owners -or individuals who are not linked to
the management of the firm-, they can control strategies and supervise
TMT actions, keeping them focused on the firm's objectives
(McConnell and Servaes 1990; Donnelly and Kelly 2005). Several studies
have identified the existence of a 'substitution effect' when
external shareholders increases their ability to control the TMT while
reducing supervisory board effectiveness (Rediker and Seth 1995; Bozec
and Bozec 2007). If ownership is concentrated in the hands of external
owners, supervisory board effectiveness is reduced because the board
tends to relax its vigilance when there are other mechanisms in place;
in this case the political power of the majority external owners
(Donnelly and Kelly 2005). Thus, despite reducing supervisory board
effectiveness, the concentration of ownership in the hands of external
owners compensates for this by the more direct control that the
individuals can exercise over the TMT. This control includes setting TMT
pay levels which are effectively moderated. Based on these arguments, we
put forward the following hypotheses:
Hypothesis 3: In high concentration contexts, as ownership of
institutional investors increases, supervisory board effectiveness will
increase, leading to a reduction in TMT pay levels.
Hypothesis 4: In high concentration contexts, as ownership of
external owners increases, the supervisory boards effectiveness will
decrease, leading to a reduction of TMT pay levels--substitution
effect-.
3. Methodology
3.1. Sample and Data
Both the information on corporate governance--boards of directors
and ownership structure--and data on TMT compensation from 120 companies
that traded continuously over the four years from 2004 to 2007 were
taken from the Spanish Security Exchange Comission (CNMV). Additionally,
economic and financial information for these firms was collected from
the Osiris database (source: Bureau Van Dyck Electronic Publishing).
If we consider all the firms in the sample over the time period,
the maximum number of firm-year observations is 480. As not all the
information was in the same format or data was missing, some firms were
omitted for years where it was not possible to measure the variables
concerned. In addition, financial industry firms were removed since they
compile their accounts in accordance with different norms. Thus, the
final sample consists of a total of 308 firm-year observations.
3.2. Measurement of Variables
TMT pay level. The variable mean value of TMT pay level (TMTPL) is
calculated as the total compensation of all top managers, directors or
non-directors, divided by the number of those managers (Carpenter and
Sanders 2002). As a control variable, we consider a dummy variable to
measure duality (DUAL): the variable equals one if a CEO is also the
board chair and zero otherwise (Boyd 1994).
Supervisory board effectiveness. Four variables have been employed
to measure this concept (Sanchez-Marin et al. 2010): (1) The number of
directors (DIR) is measured as the number of non-manager directors on
the board. (2) The number of committees appointed by the board of
directors (CO) is calculated as the number of committees that the board
thought necessary to function properly. (3) The size of the compensation
committee (SRC) is the number of members of this committee. Lastly, (4)
the number of meetings of the compensation committee (MRC) is directly
measured as the number of meetings held.
Ownership structure. Following the literature operationalization
(Tosi and Gomez-Mejia 1989; Werner et al. 2005), ownership structure
(OW) -and also the control exercised by the various parties-, is
measured by means of the percentage of shares held by the largest
investor. We classify the firms in the sample as manager controlled when
the largest investor is a top manager (DMC), institutional controlled
when the largest investor is an institution (DIC) and owner controlled
when the largest investor is a private investor (DOC).
Control variables. A number of economic and other contextual
factors linked to TMT pay levels have been included as control
variables. Apart from duality, the economic factors considered are
performance, complexity and firm size (Tosi and Gomez-Mejia 1994;
Carpenter and Sanders 2002). Financial return on investment (ROE) is
used to measure firm performance; the logarithm of the value of assets
(TA) is used to measure firm size; and, finally, complexity of the
business is measured using intangible assets as a percentage of total
assets (IA).
3.3. Analysis and proposed model
In order to examine the four hypotheses, a model was proposed and
estimated using panel data. Panel data methodology makes it possible to
conduct a longitudinal study even though the data comes from a small
number of transverse samples. This technique allows us to obtain more
accurate estimations with less correlation and greater variability
(Baltagi 2001). One of the features of panel data analysis is that it
allows for the introduction of unobservable heterogeneity between
individuals. Hence, we can allow for individual characteristics, such as
the top managers' skills or the specific roles required for each
firms' activity, that may have an effect on TMT compensation but
which are impossible to control for because they are difficult to
measure. The unobservable individual differences are represented by the
individual effects, r\,, which are introduced into the model, with the
error term being the sum of the random disturbance and the individual
effects, [[eta].sub.i] + [[upsilon].sub.it]. The results may be biased
if there is no control for individual heterogeneity.
The model was estimated using the intra-group estimator and
generalized least squares. In the intra-group estimation, the variables
were standardized in relation to the mean, while in the generalized
least squares, the estimation was consistent with the
variance-covariance matrix. If the estimations produced by the two
methods are not significantly different, the estimations are consistent
but only the generalized least squares method is efficient. However, if
the estimates are significantly different, only the intra-group
estimator is consistent. Hausman's (1978) method compares the two
estimations on the null hypothesis that the estimators do not differ
significantly. Thus, the intra-group estimations are used when the null
hypothesis is rejected and the generalized least squares estimations are
used when the null hypothesis is accepted.
The present study distinguishes three patterns of ownership
structure which can affect supervisory board effectiveness and TMT pay
levels: firms controlled by top managers, firms controlled by
institutional investors, and firms controlled by external owners. Thus,
the circumstances that influence supervisory board effectiveness and its
effect on TMT pay can be represented in a single model which
distinguishes the type of owner. This model is presented in detail
below.
Supervisory board effectiveness in firms controlled by top
managers. For firms controlled by top managers (DMC = 1), hypothesis 1
and hypothesis 2 predict a cubic relationship between the pay level and
the percentage of the firm owned by top managers (as shown in Fig. 2).
To test the hypotheses, the model has to include the following equation:
[TMTPL.sub.it] = [[beta].sub.1] + [[[beta].sub.2] x [OW.sub.it] +
[[beta].sub.3] x [BOARD.sup.2.sub.it] + [[beta].sub.4] x
[OW.sup.3.sub.it]] [DMC.sub.it] + ... + [[eta].sub.i] +
[[upsilon].sub.it]. (1)
The proposed cubic relation has two turning points, a minimum
[OW.sup.*.sub.1] and a maximum [OW.sup.*.sub.2], which can be found by
differentiating in relation to the ownership of the top managers, and
equating to zero. The values of the turning points are given by
(-2[[beta].sub.3] [+ or -] [square root of 4[[beta].sup.2.sub.3] -
12[[beta].sub.2][[beta].sup.4])]/6[[beta].sub.4]. Given that hypothesis
1 and hypothesis 2 imply that the first value is a minimum and the
second a maximum, [[beta].sub.3] and [[beta].sub.4] must have opposite
signs, so the second derivative, 2[[beta].sub.3] + 6[[beta].sub.4]OW,
should be positive for [OW.sup.*.sub.1] and negative for
[OW.sup.*.sub.2]. Once the coefficients are estimated we can obtain the
cut-off levels for managerial ownership by substituting them in
(-2[[beta].sub.3] [+ or -] [square root of 4[[beta].sup.2.sub.3] -
12[[beta].sub.2][[beta].sub.3])]/6[[beta].sub.4].
Supervisory board effectiveness in firms controlled by
institutional investors. According to hypothesis 3, in firms where
institutional investors predominate (DIC = 1), the supervisory board
effectiveness is greater, the board is strengthened by the substitution
effect, thus leading to a reduction in TMT pay levels. Thus, we expected
the variable OW x DIC to have a negative effect. The product of the OW x
DIC by the board characteristics (BOARD) is introduced to measure the
marginal effect that each has on the other.
[TMTPL.sub.it] = [[beta].sub.1] x [BOARD.sub.it] + [[beta].sub.2] x
[OW.sub.it] + [[beta].sub.3] x [BOARD.sub.it] x [OW.sub.it]]
[DIC.sub.it] + ... + [[eta].sub.i] + [[upsilon].sub.it]. (2)
If we differentiate in relation to BOARD, we obtain [[beta].sub.2]
+ [[beta].sub.3] OW x DIC, which means that [[beta].sub.3] gives an
indication of the marginal effect which institutional ownership has on
the TMT pay level.
Supervisory board effectiveness in firms controlled by external
owners. In firms controlled by outside owners (DOC = 1), the owners
exercise supervision that substitutes that of the board. Even though
their supervision reduces the effectiveness of the board, their
interventions are effective in controlling the TMT. In this context, the
TMT pay level is reduced because of the improved supervision of the
board (hypothesis 1). At the same time, the board can reduce its
vigilance, because of the substitution effect related to supervision
exercised by the owners (hypothesis 4). Thus, we expected a negative
coefficient for OWN x DOC variable. The model also introduces the
product BOARD x OWN x DOC to examine the possible marginal effect of the
variables on the TMT pay level.
[TMTPL.sub.it] = [[beta].sub.1] x [BOARD.sub.it] + [[beta].sub.2] x
[OW.sub.it] + [[beta].sub.3] x [BOARD.sub.it] x [OW.sub.it]]
[DOC.sub.it] + ... + [[eta].sub.i] + [[upsilon].sub.it]. (3)
To avoid model misspecification we add equations (1), (2) and (3)
into one model and we include the control variables. The model is
expressed in the following equation.
[MATHEMATICAL EXPRESSION NOT REPRODUCIBLE IN ASCII]. (4)
4. Results
Table 1 presents the descriptive statistics for all the firms in
the sample, giving the values for each type of firm according to the
ownership structure and the type of largest investor. Table 2 shows the
correlations between the variables used in the models. As can be seen,
the signs are in accordance with those expected from the theoretical
discussion set out above. The biggest correlation is between the four
variables: board size (DIR), number of board committees (CO), size of
the compensation committee (SRC) and number of meetings (MRC), which
measure the supervisory board effectiveness (BOARD). Since their values
range from 0.42 to 0.58, we estimate the model with each variable
separately to avoid multicollinearity problems.
Table 3 presents results for equation (4) and shows the influence
of ownership on supervisory board effectiveness and TMT pay levels. In
the first estimation, where the board size is taken into account, as
supervisory board effectiveness goes up, TMT pay levels go down, as was
suggested in Hypothesis 1, [[beta].sub.1] < 0. The same result is
obtained in the second estimation where the number of committees is
considered. In the other estimations, when size of compensation
committee or number of meetings is introduced, we observe that the
coefficient becomes statistically non-significant. Therefore, unlike
board size or the number of committees, compensation committees do not
have an effect on TMT pay levels.
The proposed cubic relation between the managerial ownership and
TMT pay levels is significant at different levels in the four
estimations. Given the values of the estimated coefficients, we obtain
the turning points using (-2[[beta].sub.3] [+ or -] [square root of
4[[beta].sup.2.sub.3] -
12[[beta].sub.2][[beta].sub.4])]/6[[beta].sub.4]. The values obtained in
each estimation are: 1.48 and 23.71 -estimation 1-, 1.62 and 17.75
-estimation 2-, 3.43 and 18.67 -estimation 3-, 1.26 and 19.92
-estimation 4-. These turning points give an estimation of the levels of
managerial ownership at which alignment, entrenchment and convergence
effects occur.
When the percentage owned by the TMT is below 1.48% -estimation 1-,
1.62% -estimation 2-, 3.43% -estimation 3-, 1.26% -estimation 4- the low
concentration of ownership in the hands of the TMT allows an alignment
of interests through supervisory board effectiveness (hypothesis 1). In
contrast, when the participation of top managers is between 1.48% and
23.71% -estimation 1-, 1.62% and 17.75% -estimation 2-, 3.43% and 18.67%
-estimation 3-, or 1.26% and 19.92% -estimation 4- there is an
entrenchment effect: the greater concentration of ownership in the hands
of top managers leads to a reduction in supervisory board effectiveness
and a rise in TMT pay levels (hypothesis 2a). However, ownership
participation above 23.71% -estimation 1-, 17.75% -estimation 2-, 18.67%
-estimation 3-, or 19.92% -estimation 4- produces a convergence effect
because the high concentration of ownership in the hands of top managers
aligns their interests with those of the other owners, which in turn
lowers TMT pay levels (hypothesis 2b).
As can be seen, where the firm is controlled by institutional
investors (DIC = 1), supervisory board effectiveness results in a
reduction of TMT pay levels. In this case, the board's control
mechanisms are effective, irrespective of ownership concentration, thus
supporting hypothesis 1. This occurs in much the same way where
ownership is dispersed as when it is concentrated in the hands of
institutional investors. However, hypothesis 3 must be rejected since
the coefficients of the variable institutional ownership by board,
[[beta].sub.6], are not statistically significant. It should be noted
that there are no observable effects of institutional ownership on
supervisory board effectiveness: as the ownership of institutional
investors increases, the board maintains its supervisory effectiveness.
Where the firm is controlled by external owners (DOC = 1),
coefficient [[beta].sub.7] -ownership by external owners- is negative
and significant in estimations 1, 2 and 3. This implies that when
ownership is concentrated in the hands of external owners, it produces
an additional supervision to that of the board. Hence, as the ownership
of external owners increases, this increase will produce a reduction in
TMT pay levels. The fact that coefficient [[beta].sub.7] is bigger than
[[beta].sub.1] indicates that, as predicted in hypothesis 4, when the
concentration of ownership by external owners increases, there is a
substitution effect with the board of directors. Furthermore, we can
observe that the product of board characteristics and external owners
ownership is significant in estimations 1 and 2. This indicates that
when the concentration of ownership by external owners increases, there
is a positive marginal effect on the actions of the board of directors
([[beta].sub.8] < 0).
5. Conclusions and discussion
The present study attempts to develop an understanding of the
interactive effect of ownership structure and board effectiveness on TMT
pay levels in order to examine whether they complement or substitute
each other. More specifically, the study examines whether any particular
ownership structure in Spanish listed firms can be conducive to an
improvement or deterioration in board effectiveness, and how these two
internal mechanisms contribute, either positively or negatively, to the
appropriate supervision of the TMT and the setting of its compensation
levels.
The corporate governance system in Spanish listed firms is
characterized by a high concentration of ownership in the hands of a few
majority shareholders, with significant cross-holdings between firms,
and a moderate involvement of institutional investors (De Miguel et al.
2004). This implies a reduced diversity of interests on boards, which in
principle could provide a favorable context for high TMT pay in relation
to other countries such as US or UK where board monitoring is much more
developed (Baixauli-Soler and Sanchez-Marin 2011).
In general, the results confirm our hypotheses, indicating that
when ownership is dispersed, TMT pay level is dependent on supervisory
board effectiveness, and when ownership is concentrated, TMT pay level
depends upon whether control by the majority owners complements or
substitutes the board of directors' monitoring activity. We detail
our findings in the following paragraphs.
When ownership is dispersed, the incentives for shareholders to
supervise the managers are reduced as they have little power and are
poorly motivated, and are likely to be passive when it comes to
defending their interests, leaving monitoring responsabilities to the
board of directors (Hart 1995). In these cases, the board are seen to be
effective in their supervision and TMT pay levels are lower. As opposed
to this, when there is a concentration of ownership, the results
indicate that supervisory board effectiveness over TMT and its pay level
depends upon the type of owner that predominates (Tosi and Gomez-Mejia
1989).
As we expected, if the firm is controlled by top managers, the
extent to which supervisory board effectiveness is affected depends on
the percentage of their ownership. When top managers own a small
proportion of the firm, there is an alignment of their interests with
those of the other owners. Effective board supervision is maintained and
TMT pay, which remains at low levels, is moderated. However, if top
managers own a greater share of the firm, it produces an entrenchment
effect, which gives them greater power and reduces supervisory board
effectiveness. This results in TMT having a greater influence over its
own pay levels, which tend to be higher. Finally, if top managers own so
much of the firm that they become majority shareholders, a convergence
effect is produced whereby, in spite of the lack of effective
supervision of the board, the interests of top managers coincide with
those of other shareholders and TMT pay levels are reduced.
When ownership is concentrated in the hands of individuals who have
no other links to the company, supervisory board effectiveness, as
expected, decreases. The substitution effect found suggests that an
increase in the direct control that these investors have over the TMT
will be matched by a reduction in the control exercised by the board of
directors. Nevertheless, the overall consequence of this is a reduction
in TMT pay levels.
Finally, contrary to what was expected, if institutional
shareholders own a significant part of the company, the results indicate
that the supervisory board effectiveness does not increase. However, the
TMT pay level decreases due to the direct control exerted by
institutional investors as a result of the 'social' pressures
of those investors. This result could be explained by the
particularities of Spanish corporate governance (De Miguel et al. 2004):
institutional investors have members on the board that commonly have
direct affiliations with management and who are likely to be more
sympathetic to high compensation for the TMT. The moderate involvement
of institutional investors implies a reduced diversity of interests on
boards and may provide a favorable context for high pay for TMTs
(Baixauli-Soler and Sanchez-Marin 2011).
As a whole, our findings show significant relationships that
determine TMT pay levels: characterized by high concentration and little
legal protection for minority shareholders, the structure of ownership
of Spanish listed firms tends to lead to higher TMT pay levels,
particularly in firms controlled by top managers and institutional
investors. Only external owner controlled firms or firms with dispersed
ownership have a more moderate level of compensation for their top
managers.
In summary, in line with other recent research (Werner et al. 2005;
Firth et al. 2007), the results of the present study highlight the
importance of the peculiarities of national systems of corporate
governance in determining TMT pay. In particular, this paper contributes
to an understanding of how Spanish corporate governance characteristics
give a fundamental importance to board and ownership structures in the
determination and adjustment of TMT pay levels. This influence is even
stronger than that found in other Western European countries and North
American countries.
As a key moderator of TMT pay levels, future research should study
organizational governance in depth, extending the models to other
samples and scenarios. Such research will be of importance in order to
refine our understanding of the influence of ownership structure and
board effectiveness on the design of top managers' compensation.
This present paper takes the first step in this direction.
doi: 10.3846/16111699.2011.555371
References
Agrawal, A.; Knoeber, C. R. 1996. Firm performance and mechanisms
to control agency problems between managers and shareholders, Journal of
Financial and Quantitative Analysis 31: 377-397. doi:10.2307/2331397
Baixauli-Soler, J. S.; Sanchez-Marin, G. 2011. Organizational
governance and TMT pay level adjustment, Journal of Business Research.
doi:10.1016/j.jbusres.2010.09.011
Baltagi, B. H. 2001. Econometric Analysis of Panel Data. Wiley.
Chichester.
Bathala, C. T.; Moon, K. P.; Rao, R. P. 1994. Managerial ownership,
debt policy and the impact of institutional holdings: An agency
perspective, Financial Management 23: 38-50. doi:10.2307/3665620
Bathala, C. T.; Rao, R. P. 1995. The determinants of board
composition: An agency theory perspective, Managerial and Decision
Economics 16: 59-69. doi:10.1002/mde.4090160108
Berle, A. A.; Means, G. C. 1932. The modern corporation and private
property. MacMillan. New York.
Boyd, B. K. 1994. Board control and CEO compensation, Strategic
Management Journal 15: 335-344. doi:10.1002/smj.4250150502
Bozec, Y.; Bozec, R. 2007. Ownership concentration and corporate
governance practices: Substitution or expropriation effects?, Canadian
Journal of Administrative Sciences 24: 182-195. doi:10.1002/cjas.23
Brick, I. E.; Palmon, O.; Wald, J. K. 2006. CEO compensation,
director compensation, and firm performance: Evidence of cronyism,
Journal of Corporate Finance 12: 403-423.
doi:10.1016/j.jcorpfin.2005.08.005
Cadbury, A. 1992. Report of the committee on the financial aspects
of corporate governance. Gee. London.
Carpenter, M. A.; Sanders, W. G. 2002. Top management team
compensation: The missing link between CEO pay and firm performance?,
Strategic Management Journal 23: 367-375. doi:10.1002/smj.228
Cheng, S.; Firth, M. 2005. Ownership, corporate governance and top
management pay in Hong Kong, Corporate Governance: An International
Review 13: 291-302.
Codigo Unificado de Buen Gobierno. 2006. Informe del grupo especial
de trabajo sobre el buen gobierno de las sociedades cotizadas. CNMV.
Madrid.
Coles, J. W.; McWilliams, V. B.; Sen, N. 2001. An examination of
the relationship of governance mechanism to performance, Journal of
Management 27: 23-50. doi:10.1177/014920630102700102
Conyon, M. J.; Peck, S. I. 1998. Board control, remuneration
committees, and top management compensation, Academy of Management
Journal 41: 146-151. doi:10.2307/257099
Core, J. E.; Holthausen, R. W.; Larcker, D. F. 1999. Corporate
governance, chief executive officer compensation, and firm performance,
Journal of Financial Economics 51: 371-406.
doi:10.1016/S0304-405X(98)00058-0
Cyert, R.; Kang, S.; Kumar, P. 2002. Corporate governance,
takeovers, and top-management compensation: Theory and evidence,
Management Science 48: 453-469. doi:10.1287/mnsc.48.4.453.205
David, P.; Kochhar, R.; Levitas, E. 1998. The effect of
institutional investors on the level and mix of CEO compensation,
Academy of Management Journal 41: 200-208. doi:10.2307/257102
De Andres, P.; Azofra, V.; Lopez, F. J. 2005. Corporate boards in
OECD countries: Size, composition, functioning and effectiveness,
Corporate Governance: An International Review 13: 197-210.
De Miguel, A.; Pindado, J.; De La Torre, C. 2004. Ownership
structure and firm value: New evidence from Spain, Strategic Management
Journal 25: 1199-1207. doi:10.1002/smj.430
Demsetz, H. 1983. The structure of ownership and the theory of the
firm, Journal of Law and Economics 26: 375-390. doi:10.1086/467041
Dhaoui, A. 2008. R&D diversification in Mncs: Between earnings
management and shareholders increasing wealth, Journal of Business
Economics and Management 9: 199-205.
doi:10.3846/1611-1699.2008.9.199-205
Donnelly, R.; Kelly, P. 2005. Ownership and board structures in
Irish plcs, European Management Journal 23: 730-740.
doi:10.1016/j.emj.2005.10.016
Faccio, L.; Lang, L. 2002. The ultimate ownership of Western
European corporations, Journal of Financial Economics 65: 365-395.
doi:10.1016/S0304-405X(02)00146-0
Fama, E. F.; Jensen, M. C. 1983. Separation of ownership and
control, Journal of Law and Economics 2: 301-325. doi:10.1086/467037
Firth, M.; Fung, P. M. Y.; Rui, O. M. 2007. How ownership and
corporate governance influence chief executive pay in China's
listed firms, Journal of Business Research 60: 776-785.
doi:10.1016/j.jbusres.2007.01.014
Goldberg, L.; Idson, T. 1995. Executive compensation and agency
effects, The Financial Review 30: 313-335.
doi:10.1111/j.1540-6288.1995.tb00835.x
Grossmann, S. J.; Hart, O. D. 1980. Takeover bibs, the free rider
problem and the theory of the corporation, Bell Journal of Economics 2:
42-64. doi:10.2307/3003400
Hart, O. 1995. Corporate governance: Some theory and implications,
The Economic Journal 105: 678-689. doi:10.2307/2235027
Hartzell, J. C.; Starks, L. T. 2003. Institutional investors and
executive compensation, The Journal of Finance 58: 2351-2374.
doi:10.1046/j.1540-6261.2003.00608.x
Hausman, J. A. 1978. Specification tests in econometrics,
Econometrica 46: 1251-1271. doi:10.2307/1913827
Jensen, M. C.; Meckling, W. H. 1976. Theory of the firm: Managerial
behavior, agency cost and ownership structure, Journal of Financial
Economics 3: 305-360. doi:10.1016/0304-405X(76)90026-X
Jensen, M. C. 1993. The modem industrial revolution, exit, and the
failure of internal control systems, Journal of Applied Corporate
Finance 6: 4-23. doi:10.1111/j.1745-6622.1994.tb00244.x
Jurkstiene, A.; Darskuviene, V.; Duda, A. 2008. Management control
systems and stakeholders interests in Lithuanian multinational
companies: Cases from the telecommunications industry, Journal of
Business Economics and Management 9: 97-106.
doi:10.3846/1611-1699.2008.9.97-106
Khan, R.; Dharwadkar, R.; Brandes, P. 2005. Institutional ownership
and CEO compensation: A longitudinal examination, Journal of Business
Research 58: 1078-1088. doi:10.1016/j.jbusres.2004.02.002
La Porta, R.; Lopez-de-Silanes, F.; Shleifer, A. 1999. Corporate
ownership around the world, Journal of Finance 54: 471-517.
doi:10.1111/0022-1082.00115
Lambert, R.; Lacker, D. F.; Weiglet, K. 1993. The structure of
organizational incentives, Administrative Science Quarterly 38: 438-461.
doi:10.2307/2393375
Lefort, F.; Urzua, F. 2008. Board independence, firm performance
and ownership concentration: Evidence from Chile, Journal of Business
Research 61: 615-622. doi:10.1016/j.jbusres.2007.06.036
Li, J.; Lam, K.; Quian, G.; Fang, Y. 2006. The effects of
institutional ownership on corporate governance and performance: An
empirical assessment in Hong Kong, Management International Review 46:
259-276. doi:10.1007/s11575-006-0047-0
Lin, C.; Su, D. 2009. Does state control affect managerial
incentives? Evidence from China's publicly listed firms, Journal of
Business Economics and Management 10: 291-311.
doi:10.3846/1611-1699.2009.10.291-311
Mangel, R.; Singh, H. 1993. Ownership structure, board relations
and CEO compensation in Large U.S. corporations, Accounting and Business
Research 23: 339-350.
Maug, E. 1998. Large shareholders as monitors: Is there a trade-off
between liquidity and control?, Journal of Finance 53: 65-97.
doi:10.1111/0022-1082.35053
McConnell, J. J.; Servaes, H. 1990. Additional evidence in equity
ownership and corporate value, Journal of Financial Economic 27:
595-612. doi:10.1016/0304-405X(90)90069-C
Mehran, H. 1995. Executive compensation, structure ownership, and
firm performance, Journal of Financial Economics 38: 163-184.
doi:10.1016/0304-405X(94)00809-F
Melnikas, B. 2005. Management specialists in the knowledge based
society: Life-long learning oriented human resource development, Journal
of Business Economics and Management 6: 155-170.
Ozkan, N. 2007. Do corporate governance mechanisms influences CEOS
compensation? An empirical investigation of UK companies, Journal of
Multinational Financial Management 17: 349-364.
doi:10.1016/j.mulfin.2006.08.002
Rediker, K.; Seth, A. 1995. Board of directors and substitution
effects of alternative governance mechanisms, Strategic Management
Journal 16: 85-99. doi:10.1002/smj.4250160202
Sanchez-Marin, G.; Baixauli-Soler, J. S.; Lucas-Perez, M. E. 2010.
When much is not better? Top management compensation, board structure
and performance in Spanish firms, The International Journal of Human
Resource Management 21: 2778-2797. doi:10.1080/09585192.2010.528660
Shleifer, A.; Vishny, R. W. 1997. A survey of corporate governance,
The Journal of Finance 52: 737-783. doi:10.2307/2329497
Soltane, B. 2009. Governance and performance of microfinance
institutions in Mediterranean countries, Journal of Business Economics
and Management 10: 31-43. doi:10.3846/1611-1699.2009.10.31-43
Tosi, H. L.; Gomez-Mejia, L. R. 1989. The decoupling of CEO pay and
performance: An agency theory perspective, Administrative Science
Quarterly 34: 169-189. doi:10.2307/2989894
Tosi, H. L.; Gomez-Mejia, L. R. 1994. CEO compensation monitoring
and firm performance, Academy of Management Journal 37: 1002-1016.
doi:10.2307/256609
Tvaronaviciene, M.; Degutis, M. 2007. If approach to innovations
differs in locally and foreign owned firms: Case of Lithuania, Journal
of Business Economics and Management 8: 195-202.
Useem, M.; Gager, C. 1996. Employee shareholders or institutional
investors? When corporate managers replace their stockholders, Journal
of Management Studies 33: 613-632.
doi:10.1111/j.1467-6486.1996.tb00811.x
Vafeas, N. 2003. Further evidence on compensation committee
composition as a determinant of CEO compensation, Financial Management
32: 53-70. doi:10.2307/3666336
Werner, S.; Tosi, H. L.; Gomez-Mejia, L. R. 2005. Organizational
governance and employee pay: How ownership structure affects the
firm's compensation strategy, Strategic Management Journal 26:
377-384. doi:10.1002/smj.452
Whidbee, D. A. 1997. Board composition and control of shareholder
voting rights in the banking industry, Financial Management 26: 27-41.
doi:10.2307/3666125
Gregorio Sanchez-Marin (1), J. Samuel Baixauli-Soler (2), M.
Encarnacion Lucas-Perez (3)
Department of Management and Finance, University of Murcia, 30100
Murcia, Spain E-mails: (1) gresanma@um.es (corresponding author); (2)
sbaixaul@um.es; (3) me.lucas@um.es
Received 29 September 2009; accepted 16 November 2010
Gregorio SANCHEZ-MARIN is an Associate Professor of Human Resource
Management in the Department of Management and Finance at the University
of Murcia, Spain. He received his Ph.D in Management from the University
of Murcia, Spain. He has been research visitor at the Department of
Management of Arizona State University, USA. His current research
interests focus on executive compensation, family firms'
compensation, and international human resource management. He has
published his works in several journals, such as Journal of Business
Research, Family Business Review, Journal of Small Business Management,
and International Journal of Human Resource Management.
J. Samuel BAIXAULI-SOLER is an Associate Professor of Finance in
the Department of Management and Finance at the University of Murcia,
Spain. He received his Ph.D in Finance from the University of Valencia,
Spain. He has been research visitor at the Department of Economics at
the University of York, UK. His main research areas include corporate
finance and financial modeling. He has published on these topics in
international journals such as Journal of Business Research, European
Journal of Operational Research, Journal of Financial Research,
International Journal of Human Resource Management, and European Journal
of Finance.
M. Encarnacion LUCAS-PEREZ is an Assistant Professor of Management
in the Department of Management and Finance at the University of Murcia,
Spain. She received her Ph.D in Management from the University of
Murcia, Spain. At present, her research interests focus on executive
compensation and corporate governance. She has published on these topics
in International Journal of Human Resource Management.
Table 1. Descriptive statistics
TOTAL Institutional Owner Control
(N = 308) Control (N = 151)
(N = 112)
Mean Dev. Mean Dev. Mean Dev.
PAY LEVEL TMTPL 872.9 5322.1 424.1 429.4 524.2 1404.8
BOARD DIR 8.844 3.646 8.642 3.663 9.145 3.839
CO 2.538 0.955 2.589 0.800 2.576 1.073
SRC 3.279 1.717 3.258 1.637 3.377 1.738
MRC 3.613 3.175 3.517 2.687 3.741 3.437
OWNERSHIP OW 28.58 23.78 21.91 23.08 34.66 24.46
CONTROL ROE 13.70 28.48 10.01 29.65 17.21 24.48
TA 14.07 1.88 13.99 1.858 14.26 1.952
IA 0.096 0.117 0.087 0.120 0.101 0.118
DUAL 0.577 0.494 0.696 0.461 0.456 0.499
Manager
Control
(N = 45)
Mean Dev.
PAY LEVEL TMTPL 3160.6 9570.4
BOARD DIR 8.333 2.828
CO 2.288 0.869
SRC 3.000 1.846
MRC 3.422 3.421
OWNERSHIP OW 24.81 17.56
CONTROL ROE 11.06 36.28
TA 13.61 1.629
IA 0.101 0.110
DUAL 0.688 0.468
Note: TMTPL: average pay of TMT (thousands of euros); DIR: number of
independent directors; CO: number of committees appointed by board;
SRC: size of remuneration committee; MRC: number of meetings of
remuneration committee; OWN: percentage of shares owned by the largest
investor; ROE: financial return on equity; TA: logarithm of total
assets; IA: intangible assets over total assets; DUAL: takes value one
if CEO is also the board chair.
Table 2. Correlations between variables used in the models
TMTPL DIR CO SRC MRC OW
TMTPL 1.00
DIR -0.04 1.00
CO -0.02 0.44 1.00
SRC -0.01 0.42 0.58 1.00
MRC -0.04 0.43 0.48 0.46 1.00
OW 0.03 0.01 -0.08 -0.02 0.01 1.00
ROE 0.01 0.09 0.01 -0.01 -0.08 0.05
TA 0.04 0.64 0.53 0.40 0.52 0.01
IA 0.05 0.07 0.20 0.19 0.17 -0.08
DUAL 0.06 0.01 0.03 -0.02 -0.04 -0.22
ROE TA IA DUAL
TMTPL
DIR
CO
SRC
MRC
OW
ROE 1.00
TA 0.15 1.00
IA 0.04 0.16 1.00
DUAL 0.05 -0.02 0.06 1.00
Note: TMTPL: average pay of TMT (thousands of euros); DIR: number of
independent directors; CO: number of committees appointed by board;
SRC: size of remuneration committee; MRC: number of meetings of
remuneration committee; OWN: percentage of shares owned by the largest
investor; ROE: financial return on equity; TA: logarithm of total
assets; IA: intangible assets over total assets; DUAL: takes value one
if CEO is also the board chair.
Table 3. Panel data analysis in the relationship between TMT pay
level, supervisory board effectiveness, and ownership concentration
Model (1) (2)
Constant 5.008 ** 5.827 **
(2.157) (2.463)
BOARD DIR -0.050 *
(0.027)
CO -0.059 *
(0.033)
SRC
MRC
MANAGER OW -1.437 * -1.372 *
CONTROL (0.823) (0.760)
(DMC = 1) [OW.sup.2] 0.514 ** 0.462 **
(0.250) (0.223)
[OW.sup.3] -0.014 * -0.016 *
(0.008) (0.009)
INSTITUTIONAL OW 0.009 0.002
CONTROL (0.019) (0.005)
(DIC = 1) OW*DIR -0.001
-0.001
OW*CO -0.004
-0.012
OW*SRC
OW*MRC
OWNER OW -0.067 * -0.066 *
CONTROL (0.038) (0.038)
(DOC = 1) OW*DIR -0.006 **
-0.003
OW*CO -0.007 **
(0.003)
OW*SRC
OW*MRC
CONTROL ROE 0.014 0.010
VARIABLES (0.017) (0.013)
TA 0.035 0.012
(0.115) (0.036)
IA 0.126 ** 0.075 **
(0.058) (0.037)
DUAL 0.133 ** 0.154 **
(0.059) (0.069)
Hausman test 0.533 0.531
Model (3) (4)
Constant 5.170 ** 5.168 **
(2.440) (2.383)
BOARD DIR
CO
SRC 0.021
(0.015)
MRC -0.039
(0.030)
MANAGER OW -1.461 * -1.191 *
CONTROL (0.861) (0.689)
(DMC = 1) [OW.sup.2] 0.252 ** 0.502 **
(0.123) (0.264)
[OW.sup.3] -0.008 * -0.016 *
(0.004) (0.009)
INSTITUTIONAL OW 0.001 -0.003
CONTROL (0.002) -0.013
(DIC = 1) OW*DIR
OW*CO
OW*SRC -0.004
(0.009)
OW*MRC 0.001
(0.001)
OWNER OW -0.061 * -0.050
CONTROL (0.036) (0.036)
(DOC = 1) OW*DIR
OW*CO
OW*SRC -0.003
(0.002)
OW*MRC -0.001
(0.001)
CONTROL ROE 0.017 0.053
VARIABLES (0.023) (0.076)
TA 0.030 0.018
(0.099) (0.058)
IA 0.134 ** 0.068 **
(0.064) (0.032)
DUAL 0.163 *** 0.156 **
(0.061) (0.067)
Hausman test 0.642 0.129
***, ** and * significant at 1%, 5% and 10% respectively. Hausman is
the p-value of the Hausman (1978) comparison test.
