The Structure of Executive Compensation: International Evidence from 1996-2004

Abstract

The primary objective of this study is to better understand the time-series and cross-sectional variation in the structure of executive compensation for non-U.S. firms. That is, has the globalization of labor markets for senior management led non-U.S. firms to design compensation contracts similar to those of U.S. firms or, are there country-specific factors that may cause compensation structures to differ? Using data from 36 non-U.S. countries over 1996-2004, we document significant cross-country differences in compensation structure (i.e., relative use of equity-based and cash-based compensation). The primary determinants of this cross-sectional variation are institutional factors related to the legal environment in each country. Specifically, firms use more equity-based compensation in countries that provide stronger protection of shareholder's rights or have English common-law legal origins. Similarly, firms in countries providing strict enforcement of the rule of law use more equity-based compensation. In addition to these institutional determinants, we find some evidence that the relative use of equity-based compensation is also affected by the firm's agency costs of debt and equity. The data indicate that non-U.S. firms with higher growth opportunities (and the resultant larger agency costs of equity) use relatively more equity-based compensation. We also find that larger firms and firms with lower free cash flow use more equity-based compensation. These findings are consistent with those documented by Yermack (1995) and Bryan et al. (2000) for U.S. firms. However, unlike in the U.S., our data indicate that the agency problems of debt have only a limited effect on compensation structure. Therefore, while the agency theory tested with U.S. compensation data is broadly portable to other markets, the explanatory power is not as significant when applied to non-U.S. firms. We also track compensation structures throughout the time period and seek to identify and explain relative differences between compensation polices of U.S. and non-U.S. firms. The data allow us to test whether compensation structure has converged (as would be suggested by the globalization of financial markets). Alternatively, cross-country institutional differences would suggest a continued divergence in compensation policies across nations. The data provide no evidence of international convergence of compensation structures. Our empirical analysis attributes these pervasive differences to institutional factors. That is, despite the substantial changes in capital market conditions throughout the sample period, institutional factors remain as significant determinants of compensation structure and appear to contribute to consistent cross-country differences in compensation structure.