Abstract
Orientation: Agency theory predicts that agency relationships are subject to the principal-agent problem. Other theories also suggest that executives may tend to maximise sales revenues, or expand their spans of influence through growth, at the expense of the net value of the firm or its profitability. Research purpose: The purpose of this study is to test which forms of company performance are associated with higher executive variable pay ratios or determine the proportion of variable director remuneration to total remuneration. Motivation for the study: The extent to which variable remuneration is associated with different types of firm performance is unclear. Research design, approach and method: This study applies a simple panel regression model to test the extent to which the variable ratio of total director remuneration contributes differently to increases in firm revenue, total assets, return on assets, or measures of Tobin’s Q. These relationships are tested for listed companies on South Africa’s Johannesburg Stock Exchange, South Africa, for the years 2011–2014. Main findings: Variable remuneration is found to be negatively and strongly related to total revenue and negatively and weakly related to total assets (the gross measures of performance). In contrast, variable remuneration is weakly and positively related to Tobin’s Q, a measure which better reflects the interests of shareholders than gross measures. Practical/managerial implications: Firms in this context should seek to strengthen the linkages between variable remuneration and forms of performance that reflect the interests of stakeholders. Contribution/value-add: In the wake of global and local governance failures, this study suggests that the use of the variable component of executive remuneration might be helpful in aligning stakeholder interests. Further research might seek to better understand the causal mechanisms that underlie these findings.
Highlights
Long-standing theory predicts that executives tend to maximise sales revenues, subject to a minimum profit constraint, or may seek to enlarge their spans of influence through growth, rather than maximising the net value of the firm or its profitability
Knowledge of the effectiveness of variable remuneration – remuneration that is contingent on performance – hinges on whether there is a positive relationship between variable remuneration as a ratio of total remuneration and the value of the firm measures, such as Tobin’s Q, and a negative relationship with revenue maximisation measures, such as gross revenue, as well as span of influence maximisation measures, such as total assets (TAs)
Given seminal theoretical predictions that the interests of company directors and shareholders can be aligned through the use of variable remuneration strategies, the objective of this research is to test the theoretical prediction that a higher variable component of remuneration is effective at reducing the focus on revenue maximisation at the expense of the value of the firm
Summary
Long-standing theory (see, for example, Baumol 1959; Marris 1964; Williamson 1963) predicts that executives tend to maximise sales revenues, subject to a minimum profit constraint, or may seek to enlarge their spans of influence through growth, rather than maximising the net value of the firm or its profitability. Remuneration of directors has increasingly become one of the most debated topics in the corporate governance arena, reflecting growing tensions between directors and shareholders (Deloitte 2014). These debates are especially salient with regard to publicly traded companies (Fernandes 2005). Given seminal theoretical predictions that the interests of company directors and shareholders can be aligned through the use of variable remuneration strategies, the objective of this research is to test the theoretical prediction that a higher variable component of remuneration is effective at reducing the focus on revenue maximisation at the expense of the value of the firm. Companies listed on the Johannesburg Stock Exchange (JSE) across the years 2011–2014 were the subjects of this analysis
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