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An institution-based view of executive compensation: A multilevel meta-analytic test

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Abstract

We offer a multilevel meta-analytic study of the firm performance – executive compensation relationship, comprising prior tests derived from 332 primary studies nested in 29 countries. Although our work modestly supports the optimal contracting theory-based expectation that compensation is positively associated with performance, it also reveals considerable cross-country variability in this relationship. We trace this variance to differences in the level of development of the formal and informal institutions protecting investors against managerial overcompensation and underperformance. In terms of intentionally devised and enforced formal institutions, we find significant positive moderating effects on the focal relationship of the rule of law and strength of investor protection variables. For self-enforcing informal institutions, we find similar effects for concentrated ownership and compensation-related entries in codes of good corporate governance. We also find that formal and informal institutions function in a complementary manner in shaping the performance sensitivity of executive compensation. The focal relationship becomes stronger when concentrated owners have access to well-functioning courts, and when informal norms of good governance are supported by shareholder protection laws. Our study thus suggests that optimal contracting theory must be supplemented with an institution-based view, to account for the conditioning effects of institutions on national contracting environments.

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Notes

  1. Peng and Khoury (2008: 261) call them “compensatory structures.”

  2. Partial correlations are computed as follows: √[t2/(t2+df)], where t is the t-statistic and df is degrees of freedom. Note that this will always produce a positive number, so it is necessary to convert it to a negative number if the regression coefficient is negative (Greene, 2008: Chapter 3). t-values result from the scaling of primary coefficients by their respective standard errors. They are by definition standardized, and defined on a dimensionless scale.

  3. In econometrics, the problem of endogeneity occurs when the independent variable is correlated with the error term in a regression model, or when the dependent variable (i.e., the executive compensation measure) simultaneously affects the independent variable (i.e., firm performance) (Bhagat & Jefferis, 2002). There are several accepted methods of controlling for endogeneity. Endogeneity-conscious researchers usually use a fixed- or random-effects panel data model, and calculate instrumental variables using two- or three-stages least squares (2/3SLS) or the generalized method of moments (GMM) (Bhagat & Jefferis, 2002).

  4. Fisher's Zr transformed correlations are calculated as follows: z r =1/2 ln[(1+r)/1−r], where r and r xy.z are the untransformed correlation coefficients.

  5. w is calculated as follows: w i =1/(s.e. i 2+v̂ θ ), where s.e. is the standard error of the effect size and v̂ θ is the random-effects variance component. s.e. is in turn calculated as , and the formula for random effect variance is

  6. The meta-analytic mean is calculated as , with its standard error , and with its 95% confidence interval computed as ,

  7. Raudenbush and Bryk (2002: 207) therefore label HiLMMA as a “level-1 variance-known (or V-known) application”.

  8. A point is added to a given country's score on our soft law index when its code of good governance calls for: (1) separation of the CEO and Chair functions; (2) majority of independent directors on the BoD; (3) majority of non-executive directors on the BoD; (4) performance evaluations of executives by an independent committee and/or externals; (5) disclosure of the firm's executive remuneration policy; (6) an independent nominating committee; (7) an independent remuneration committee; (8) disclosure of the rules of operation of the remuneration committee; (9) disclosure of the total compensation received by each executive; (10) a direct link between firm performance criteria and executive compensation; (11) proportionality between the fixed and variable components of executive compensation; (12) disclosure of the principles of the retirement plan for executives; (13) disclosure of the principles for setting the exit bonus in case of premature contract termination; (14) disclosure of stock options granted to executives; (15) a minimum exercise window of 3 years for stock options. Country score data are available from the authors.

  9. To establish the fraction of firms with a blockholder in their ownership structures, we performed an exhaustive search of the ownership concentration literature (e.g., see Heugens et al., 2009, for the Asian countries in our dataset). We computed the fraction of concentratedly owned firms by taking the sample size-weighted average of all unique datasets available for a given nation. Country score data are available from the authors.

  10. We thank an anonymous reviewer for alerting us to the issue of omitted variable bias.

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Authors and Affiliations

  1. Faculty of Law, Economics and Governance, Utrecht University, Utrecht, The Netherlands

    Marc van Essen

  2. Rotterdam School of Management, Erasmus University, Rotterdam, The Netherlands

    Pursey PMAR Heugens, Jordan Otten & J (Hans) van Oosterhout

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  1. Marc van Essen
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  2. Pursey PMAR Heugens
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Correspondence to Pursey PMAR Heugens.

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Accepted by Ishtiaq Mahmood, Area Editor, 19 December 2011. This paper has been with the authors for two revisions.

APPENDIX

APPENDIX

Table A1

Table A1 Studies included in the meta-analysisab
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van Essen, M., Heugens, P., Otten, J. et al. An institution-based view of executive compensation: A multilevel meta-analytic test. J Int Bus Stud 43, 396–423 (2012). https://doi.org/10.1057/jibs.2012.6

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