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Board compensation and ownership structure: empirical evidence for Italian listed companies

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Abstract

This paper investigates the relationships among corporate ownership, the level of board compensation, and firms’ future performance within Italian listed companies. Board compensation could be related to corporate ownership characteristics, like the type of controlling shareholder, ownership concentration, the separation between cash flow and voting rights, and the presence of shareholders’ agreements. The evidence of high levels of board compensation associated with certain governance characteristics could signal, in a principal-agent framework, rent extraction by entrenched managers or by controlling shareholders versus minority shareholders; high board compensation, however, could be related to the need to hire directors with higher professional standing and also to the desire to create a network with other companies through the enlargement of the board, according to a social network view. In this paper we disentangle this issue showing the relationship between excess board compensation and future performance: examining firms listed on the Milan Stock Exchange over the period 1995–2002, we show that board compensation is linked to many governance characteristics, but excess compensation is never positively related to future performance. For founder family firms, in particular, high board compensation is associated with (a) smaller board size; (b) higher proportion of family members on the board; (c) lower future performance. The whole evidence therefore doesn’t support the hypothesis suggested by the social network view, but is consistent with a rent extraction hypothesis. These results could add new empirical evidence to the recent debate on the need for global remuneration reform. According to our results, some control mechanism and an increase in transparency of executive compensation schemes could be appropriate.

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Notes

  1. A non exhaustive listing of available papers includes Angel and Fumás (1997), Crespi and Gispert (1998), Gomez-Mejia et al. (2003), and Carrasco Hernandez and Sanchez-Marin (2007) for Spain; Duffhues and Kabir (2008) for the Netherlands; Haid and Yurtoglu (2006) for Germany; Randøy and Nielsen (2002) for Norway and Sweden; Sraer and Thesmar (2006), and Llense (2008) for France; Fernandes (2008) for Portugal.

  2. The paper by Brunello et al. (2001) is based on a selection of 107 listed and non-listed firms and is limited to the 1993–1996 period. The sample account for 2996 observations, reduced to 623 observations when the focus is only on executives. The main findings of the paper are that Italian firms show a low fraction of incentive pay over total compensation and a low sensitivity to firm performance. The paper of Zona (2001) focuses exclusively on 1999 and to changes in executive compensation with respect to 1998 for all listed companies. This paper focuses on size and performance as the main determinants for the level of executive compensation. The paper of Barucci and Falini (2007) is based on a sample of Italian listed firms over the 2000–2003 period. Their findings with respect to the determinants of board compensation are that remuneration does not depend on performance measures and growth opportunities, while the wedge is positively related to compensation, even if not highly significant with respect to the board. The difference with our findings could be related to the smaller sample.

  3. We proxy monitoring activity by using the percentage of share ownership of the ultimate shareholder. However a number of other variables, not considered here, impact on the intensity of monitoring activity, such as the presence of institutional investors (Hartzell and Starks 2003); or the presence of non-executive directors (Fama and Jensen 1983; Cadbury 1992; Cheng and Firth 2005). Managerial compensation is also affected by concentration of ownership in the hands of the CEO, i.e. the owner-manager (Core et al. 1999; Ramaswamy et al. 2000; Cheung et al. 2003; Cohen and Lauterbach 2008).

  4. Evidence of the reduced agency problem between owners and managers within family firms is provided by Carrasco Hernandez and Sanchez-Marin (2007), through the analysis of under-the-top employee compensation: pay level is the lowest in family owned and managed firms, given the relative ability of the owner-manager to prevent agency problems, is higher in professionally managed family firms, because of the lower degree of CEO’s discretionary capacity, and is the highest in non-family firms.

  5. However, the rent-extraction hypothesis associated with family ownership doesn’t necessarily imply that family ownership negatively affects firm’s value and performance, given the other positive effects that are also associated with family ownership. As pointed out by Barontini and Caprio (2006), in continental Europe family control is positive for firm value and operating performance.

  6. For example, Gianfrate (2007) shows that, on average, a voting trust owning 52% of the total company's cash-flow rights is able to exercise up to 87% of the total board rights.

  7. CONSOB communication n. 11580 released on 15 February 1998 and substituted by the regulation n. 11971 released on 14 May 1999.

  8. The same adjustment has been applied to Total Assets, our proxy for firm size.

  9. Given that the information provided by the companies on these very different types of payments is poor, in a limited number of cases we were not able to break up the item Other Compensation; in this case, we included the whole amount, without other refinements.

  10. As a robustness check, we run regressions excluding compensation granted by controlled companies from Total Compensation. Results are highlighted when they differ from those reported in the paper.

  11. We also classify according to this criterion firms whose largest direct shareholder owns less than 20% of capital, in order to define a classification not related to ownership concentration, directly captured by the variable ownership (O).

  12. We included in this class firms without a first direct shareholder or whose first direct shareholder is a widely held company. Firms with ultimate owners that are institutional investors are included in widely held corporations, as well as a small group of co-operative banks (“banche popolari”), in which shareholders have voting rights not related to the number of shares held. Foreign ultimate owners are classified according to the type of controlling owner.

  13. Cyert et al. (1997) and Core et al. (1999) measure firm’s risk as the standard deviation of the firm’s common equity returns.

  14. We also considered stock Beta as a measure of firm’s risk, but results didn’t change significantly. However we think that standard deviation of returns is a more appropriate risk measure, since board members could hardly diversify the risk of the firm.

  15. For example, Hall and Murphy (2002) find that 94% of S&P 500 companies granted options to their top executives in 1999, and the value of these option grants at the date of grant accounted for nearly 50% of CEOs total compensation. .

  16. This result could be determined by greater problems of communication and coordination as group size increases, and less ability to control management, in a typical agency framework focusing on the separation of management and control. Yermack (1996) and Eisenberg et al. (1998) obtain results consistent with this hypothesis.

  17. In more detail, the mean is influenced by the very large compensation paid by Fiat and Pirelli to their CEOs.

  18. The coefficients are always significant at least at 10% level (5% in some specifications). .

  19. Through a logit regression, not reported in the paper for brevity, we analyze the determinants of stock option plans adoption. The results show that, coherently with agency theory, the probability of the adoption of stock option plans is positively related to the firms’ size and to growth opportunities (Tobin’s Q).

  20. We explore the impact of shareholder agreements in more detail, by considering four groups, divided by the percentage (X) of voting rights within the agreement (X ≤ 30%, 30% ≤ X < 50%; 50% ≤ X < 70%; X ≥ 70%). The results show a positive and strong impact when the percentage of voting rights within the agreement is under 50%; the magnitude is lower for 50% ≤ X < 70%, but the coefficients are still significant, while the impact on compensation is not significant for X ≥ 70%.

  21. In more detail, we group the firms of the sample in three classes of wedge (0, 1 and 2) and found that the percentage of family members on the board decreases as the wedge increases. Moreover, the difference in family participation on the board between these classes is statistically significant.

  22. In an unreported test, on a sample of family firms we regress the individual compensation of each member of the board versus a number of control variables plus a dummy that takes the value one for family members. The positive and statistical significant coefficient for this dummy means that family members get higher compensation compared to their non-family counterparts.

  23. Own_1 takes the value 1 if the ultimate shareholder owns less than 20% of voting rights and 0 otherwise; Own_2 takes the value 1 if the ultimate shareholder owns more than 20% but less than 50% of voting rights, and 0 otherwise; Own_3 takes the value 1 if the ultimate shareholder owns more than 50% of voting rights and 0 otherwise.

  24. Wedge_1 takes the value 1 if W = 0% and 0 otherwise; Wedge_2 takes the value 1 if 0% < W < 8% and 0 otherwise; Wedge_3 takes the value 1 if W > 8% and 0 otherwise.

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Barontini, R., Bozzi, S. Board compensation and ownership structure: empirical evidence for Italian listed companies. J Manag Gov 15, 59–89 (2011). https://doi.org/10.1007/s10997-009-9118-5

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