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Incentive pay for non-executive directors: The direct and interaction effects on firm performance

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Abstract

To improve corporate governance and firm performance, institutional investors and influential activists in the US recommend the use of incentive pay for non-executive directors. Policy makers in the UK and Australia, however, recommend against it. Motivated by stark contrast in the recommendations from these Anglo-Saxon countries, this paper investigates the impacts of incentive pay for non-executive directors on firm performance. The findings based on data from 178 listed Australian companies support both recommendations. Firm performance tends to be better when no incentive or high-power incentives are offered to non-executive directors than when low-power incentives are offered. This paper also investigates how incentive pay interacts with monitoring by large shareholders and debtholders to influence firm performance. This paper shows that large shareholder monitoring interacts negatively while debtholder monitoring interacts positively with incentive pay for non-executive directors to affect firm performance. Overall, the findings suggest that governance mechanisms recommended by agency theorists such as performance-contingent pay and monitoring can backfire if they are not designed properly. Both the direct and interaction effects should be considered when practitioners design corporate governance systems.

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Notes

  1. We thank the anonymous reviewer for raising the point that we need to provide a rationale for using psychology theory as another explanation in the paper.

  2. Incentive pay for directors includes long-term incentive plan, options and shares. We calculate an incentive ratio for each NED and calculate an average ratio (of all NEDs) for each firm-year. We calculate MgtIncentive in the same manner.

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Acknowledgements

The authors gratefully acknowledge financial support for this research from the School of Accounting, Curtin University of Technology.

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  1. Curtin University of Technology, GPO Box U1987, Perth, WA, 6845, Australia

    Pattarin Adithipyangkul

  2. Open University of Hong Kong, 30 Good Shepherd Street, Ho Man Tin, Kowloon, Hong Kong

    T. Y. Leung

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  1. Pattarin Adithipyangkul
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Correspondence to Pattarin Adithipyangkul.

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Adithipyangkul, P., Leung, T.Y. Incentive pay for non-executive directors: The direct and interaction effects on firm performance. Asia Pac J Manag 35, 943–964 (2018). https://doi.org/10.1007/s10490-017-9534-z

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