The effect of board composition and managerial pay on Saudi firm performance

Mamdouh Abdulaziz Saleh Al-Faryan

doi:10.1007/s11156-021-00959-4

Abstract

Using five empirical methodologies to account for endogeneity issues, this study investigates the effects of board independence and managerial pay on the performance of 169 Saudi listed firms between 2007 and the end of 2014. Studying board independence and managerial pay utilises the main internal governance mechanism in relation to firm performance; therefore, the effect of the 2009 exogenous regulatory shock on board independence was also examined to learn whether it impacted firm performance. The empirical results show that the board composition–performance relationship is endogenous. Strong evidence is found through the dynamic generalised method of moments estimation, which indicates that board composition has a positive relationship with return on assets, and poor past performance of listed firms has a negative impact on the current level of performance. The difference-in-differences approach results show a positive relationship between board composition, stock returns, and Tobin’s Q. The findings also reveal that managerial pay has a positive relationship with firm performance, although when endogeneity is considered, there is a smaller positive relationship and a decrease in significance levels. Thus, pay-for-performance in Saudi Arabia matters, and firms are not simply controlled by the government. The results of this study have implications for both policy makers and investors. In particular, policy makers and Saudi regulators can evaluate the impact of Saudi corporate governance arrangements and, in so doing, highlight changes in corporate governance arrangements that need to be made to achieve their economic objectives, such as Vision 2030. This study also contributes to the literature by showing the importance of considering endogeneity in studies.

Highlights

In corporations, the board of directors’ main responsibility is to protect and promote the interests of shareholders
The role of outside directors is to offer an alternative and objective approach to managerial decision making and, since their role is mandated by corporate law and corporate governance codes in countries with strong and well-established corporate governance systems, they are considered an important governance mechanism
Industry average compensation is not expected to have a direct effect on individual firm performance

Summary

Introduction

The board of directors’ main responsibility is to protect and promote the interests of shareholders (i.e. owners). Fama and Jensen (1983) argue that the reason for including outside directors on a board is to help mitigate the potential conflicts of interest between managers and shareholders, thereby mitigating agency costs. This is because corporations with outside directors on their boards are more likely to be well governed and generate better profits, as their managers are less likely to engage in activities that threaten the corporation’s reputation. Studies have found that firms in countries with weak legal systems have lower values than those in countries with strong legal systems, but this value discount can be offset by improving firm-level governance quality. An independent board is a vital governance mechanism that substitutes for the weak legal protection of minority shareholders and enhances value even in the presence of dominant shareholders, according to Dahya et al (2008) and Claessens and Yurtoglu (2013)

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