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Executive Compensation, Business Size and Business Productivity

Executive Compensation, Business Size and Business Productivity

Abstract

Current paper is an outline of a proposed research study on executive compensation. The research will seek to determine the existence and strength of a relationship between executive compensation, business productivity and business size using data from 200 companies listed in the London Stock Exchange (LSE) from 2009 to 2013.The objectives that the proposal formulate relate to determination of the influence of business size, business productivity and executive powers on executive compensation among the L.S.E listed companies. The relevance of the proposed research includes facilitating the understanding of the variables influencing executive cash compensation, exploring the executive cash compensation systems and adding to the existing few academic literature on the topic. The literature review uses the agency theory to argue that for businesses with weak governance structures, executives influence the boards to set high remuneration packages. The study will maintain a positivist research paradigm and, as such, adopt a quantitative research methodology. Historical-based methods will be used to obtain data from past records of companies. The survey-based methods will employ structured qualitative and quantitative questionnaires to obtain data from the Chief Payroll Officers of the selected companies. The methods based on inferential statistics will facilitate the computation of survey and historical data to form conclusions.

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Introduction

For a long time, the executives’ pay has caused large controversy and public scrutiny. In Britain, the compass organization formed the High Pay Commission inquire the public criticism of the high and increasing executive pay. The report of the commission termed the executive pays as corrosive (Lalanne and Seabright 2011). The investor groups, institutional shareholders and the public continue to express their dissatisfaction with the pay perks companies offer to CEOs and directors, even when the productivity of the corporates fall below expectations (Fattorusso 2006). Such increasing discontent causes the need for further research on the fundamental relationship between executive cash compensation, business size and business productivity in Britain. The areas that the research will explore are executives’ cash compensation and business size, executives’ cash compensation and business productivity, executives’ cash compensation and executives’ power. The research will explore the agency theory as an academic literature to explain the operating environment concerning executive cash compensation. The study will examine a sample size of 200 companies that have been listed in the London Stock Exchange from 2009 to 2013. While observing the method of positivism, the study will adopt the survey, empirical and inferential research methodologies. The hypothesis to be formulated will establish the relationship between executive cash compensation, business productivity, business size, agency theory, executive power and business innovation among LSE companies. Most of previous research studies, especially those conducted in Britain and the US, revealed that executive cash compensation and business size are positively correlated, while executive cash compensation and business productivity are weakly correlated. The outcomes of current research will help in the identification of collective features among the sample which will help in the formation of informed conclusions on the research hypotheses that the study will formulate.

Research Objectives

The aim of the proposed study is to find out whether business productivity and business size influence the executives cash compensation among the LSE companies. The research will use bonuses and salary to measure cash compensation, total assets, number of employees and total sales to measure business size, return on both assets and equity to measure business productivity and CEO and directors share ownership, and director/CEO duality role to measure the executives’ power. The first objective of the proposed research study is to find out whether the business size influences executive cash compensation in the LSE companies and whether the influence differs across industries. The second objective is to determine whether the business productivity influences the executives’ cash compensation in the LSE companies and whether the influence is sustained across industries. The third objective is to determine whether executives’ power influences the executives’ cash compensation in LSE companies and whether the influence is sustained across industries.

The Relevance of the Proposed Research to Business Research

The most popular measure of executives’ pay is cash compensation which comprises of cash bonuses and basic salary (Tauber and Levy 2002). Executive cash compensation excludes elements of long-term executive compensation, hence, a straight-forward measure. Further, long-term incentives are associated with the challenges of data collection and valuation of executive share options. The previous studies that involved both short- and long-term executive compensation measures received the contrasting outcomes for the two different compensation measures. To avoid the same issues, the proposed study will use short-term executive compensation measures with business productivity and business size. There are few previous research studies regarding executive cash compensation in Britain as it adopted the US research results. They both share most corporate cultures and even most executives from US are employed in British companies. Current research will fill the gap because executive compensation in Britain is based on predetermined performance targets, while in the US most equity-based compensation does not involve performance targets. The study will cover the period between 2009 and 2013.The period is unique from the previous years, since it includes the years of global economic downturns which reduced business productivity. In this case, the results of the study will identify whether the pay for performance is a relevant factor in executive compensation. The research will concentrate on the explanation of the agency theory and executive compensation and the link between executive cash compensation, business size and business productivity. They are prominent theories adopted from academic literature regarding executive compensation.

Literature Review

The academic literature in current research will review the agency theory in relation to the executive cash compensation. The section will also explore the relationship between executive cash compensation and business productivity and business size.

The Agency Theory and Executive cash Compensation

The agency theory argues that the executives’ interests are not always aligned to the shareholders’ interests (Bebchuk and Fried 2003). The executives may take steps that maximize their benefits to the disadvantage of shareholders. Further, the theory postulates that a weak governance structure allows executives to inflate their pay. The executives, being the agents, work in the best of their interests by usurping powers (Bebchuk and Fried 2003). They influence the board to set higher salaries and bonus for the directors and the CEO. Brick et al. (2006) found that the balance of power between the directors, chairman, board and the CEO is critical in executive compensation. According to Core et al. (1999), businesses whose governance structures are weak are more likely to face the agency problems. The executives of businesses with agency problems have higher compensation. He further argued that the executives who control boards maximize their pay. According to Hayes and Schaefer (2000), the contracts that the board and CEO negotiate are likely to maximize the benefit of executives rather than those of the shareholders. According to Benito and Conyon (1999), top executives in management-controlled firms have a higher influence in decision-making control and decision management. In such organizations, shareholders have little influence at all stages of decision-making.

Executive Cash Compensation and Business Size

The proposed research in current section will review the sub-variables of business size and their relationship with the executive cash compensation. According to Bebchuk and Grinstein (2005), the executives’ cash payments are strongly correlated with the business size as executives in larger businesses generate higher income than the executives in the smaller one. A study conducted by Schaefer (1998) measured a pound change in the CEO’s wealth with respect to pound change in the business value and called the resultant value pay sensitivity. The value decreased with the square root of business size. Such results imply that the CEO pay is 10 times higher for a business worth 10 billion pounds than a business worth 100 million pounds. Such studies indicate that the larger the business is, the higher the payment to the executives.

Executive Cash Compensation and Business Productivity

Present topic will explore the influence of business productivity on CEO compensation. Most of the research studies conducted in the US and Britain indicate that executive compensation is weakly related to business productivity. It is believed that the weak relationship is as a result of weak governance and executive powers. According to Thomsen and Conyon (2012), the total pay of the executives may not be related to the business productivity but to the complexity of the organizations that they manage. However, Hallock and Torok (2009) reported that the pay structure of the executives had a positive relationship with the same-year productivity. According to the meta-analysis conducted by Gregg et al. (2005) concerning pay studies of CEOs and directors, the change in pay of the executives with respect to change in the annual profits was 0.3, with a 2% variance. The study estimated the correlation between the executive earnings and Return on Assets as 0.12 and that of the executive pay with respect to Return on Equity as 0.20. Such results indicate a correlation of less than 0.5, indicating a weak correlation between business productivity and executive pay. Jensen and Murphy (1990) indicate that the data concerning productivity explains few areas of the executives’ job productivity requirements, hence, insufficient to form an informed conclusion. Mehran (1995) explored various data sets, model specifications, variable measurements and applications of statistical techniques and found a statistically insignificant relationship between executive pay and business productivity. The factor analysis done by Weisbach and Michael (2007) indicated that productivity factors account for less than 5% of executive pay. Murphy (1999) indicated that the executive compensation authorities held in high esteem confessed that their five decades of research on the relationship between executive remuneration and business productivity had failed to identify any connection. The measurement aspects also make business productivity an unfavourable element in influencing the executive pay. A contradiction exists on whether to use stock value or accounting performance. According to Gabaix and Landier (2008), stock value is a better reflection of shareholder wealth. Smith (2008) also supported the idea by their argument that stockholder value is a better measure of productivity as it reflects the wealth of executives. The above literature review indicated the relevance of the relationship between executive cash compensation, business size and agency theory and business productivity. However, the academic literature is still indecisive about the degree of the relationship. It sets the ground for further research using robust primary data to reveal the degree of relationship and dynamism among the above variables.

Executives’ Power

According to Cheng and Firth (2006), the executive who hold a larger proportion of the company shares obtain higher remuneration than other employees. Kerr and Kren (1992) said that in the companies where the executives determine the agenda discussed in the board, they push for the agenda that increase their salaries. Brickley and Jarrell (1997) argues that when the CEO is also the board’s chairman, internal governance is greatly weakened giving the CEO an opportunity to increase his pay without much resistance. According to Benito and Conyon (1999), when the CEO takes the role of the president of the council as well as his usual management roles, his salary and allowance increase. However, the study conducted by Adams and Ferreira (2005) did not show evidence of an increase in remuneration when the CEO is also the chairman of the board.

Research Methodology

The proposed study will adopt a quantitative research methodology. As such, the study will adopt methodologies that are survey-based, historical-based and inferential statistics-based.  Historical-based methodologies will be of significance to the research because they will form the preliminary step in the development of the research. It will be necessary to obtain data from the past records of companies to identify the nature of relationship between executive cash earnings, business productivity and business size. Historical-based research forms a necessary component of a positivistic study on data related to executive compensation. The previous researchers on CEO compensation used annual reports as their main source of historical data (McKnight and Tomkins 1999). Survey-based methodologies are necessary in any research to facilitate the formation, derivation and completion of the study. The survey-based methods will help unearth the assumptions and believes about executive compensation that the participants of the surveys hold closely. For the purpose of the surveys, the study will design quantitative and qualitative questionnaires. The methodologies based on inferential statistics will also be of great significance to the study. They will facilitate the computation of survey and historical data to obtain statistical results, which will form the basis of derivation of conclusions on the research theory. The statistical techniques will also help in testing hypotheses that will be formulated from variables, such as executive pay, business productivity and business size. It will underscore the use of a positivist approach of the research. The longitudinal and cross-sectional surveys will be used in data collection from companies listed in the London Stock Exchange. The historical data that the survey will use will be collected from the financial year 2009 to 2013. The study will design fifty qualitative and quantitative questionnaires to be used in the survey. The findings of the longitudinal survey will inform the coverage of cross-sectional study questionnaires. The methodologies based on inferential statistics will mainly be applied in computing the degree of relationship within the variables and testing of the hypotheses. The methods will include the spearman correlation coefficient, Chi-square tests, Analysis of Variance (ANOVA), Z-score and T-tests. The processing of qualitative and quantitative data will be done by the statistical software package EVIEWS. The data will be analysed by confirming the data validity and range, drawing summary tables, charts and summary statistics. The study will use executive power, business size and business productivity as the independent variables. The executive compensation will be the dependent variable. The Ordinary Least Square (OLS) model will be applied in testing the significance of the independent variables on the dependent variable. The study will take a sample size from 2009 to 2013.The cumulative sample size that will facilitate statistical testing will be 1000 observations (6 years*200 companies). To obtain consistent data, the sampling population will consider companies that have been listed for five years in the London Stock Exchange. The sample will contain companies from sectors, such as retail drugs, energy, commodities, insurance, construction, communication, technology, media, clothing, consultancy, food, property, banking and manufacturing. The primary historical information will be collected from the websites of participating companies, databases, such as ORBIS and previous surveys from journals. The positivist research paradigm will be applied throughout the research study. A survey will be conducted on 200 companies that are listed in the London Stock Exchange, which will be selected randomly on the basis of sales and diversity of the sector. The companies will be divided into three groups, based on their sales. The companies with annual sales below 600 million pounds will fall in the category of small. Those with annual sales between 600 million pounds to 1.5 billion pounds will fall into the medium category. The companies with annual sales above 2 billion pounds will be categorized as large companies. Structured questionnaires will be mailed to the Chief Payroll Officers (CPO) of the respective companies. The selection of the CPO for current survey is based on their knowledge about the monthly executive pay and their membership in the compensation committee (Denscombe 2007). They also have vast knowledge on matters of compensation. The questionnaires that will be used in the survey will provide a list of choices from which the respondent will choose the best statement. The questionnaires will also use Likert scales where the respondent will tick the box with the information applicable to his company. Other scales will provide the recording of details of qualitative and quantitative nature. The data collected will be processed by the EVIEWS software. Summary tables, charts and summary statistics will be drawn. The assumptions drafted in the research objectives will be linked with the results of the analysed data to form conclusions.

 

 

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