Abstract
Motivated by recent ethical concern regarding astronomical Chief Executive Officer (CEO) compensation worldwide and calls for more research on the role of institutional investors in reducing agency costs, this study examines whether institutional investors affect the alignment of firm performance and CEO compensation measured by CEO pay-performance sensitivity (PPS) of Malaysian firms. Using a sample of 3,584 firms from 2003 to 2012, we find that overall total institutional investor ownership has a negative effect on CEO PPS. However, we find that these negative results are driven by local institutional ownership; foreign institutional investors, on the other hand, show a positive effect on CEO PPS. This suggests that local institutional investors as a result of being backed by government funds are subject to more conflicts of interests compared to foreign investors. Our results provide some insights on the role of government backed funds and foreign institutional investors in ensuring that CEO pay is justified by firm performance.
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