The role and effect of corporate governance and remuneration consultants on CEO compensation : empirical evidence from UK companies

This thesis investigates the role and effect of different aspects of corporate governance, ownership structure and remuneration consultants on determining the level and the structure of CEO compensation. The main objective of this research is to better understand the impact of these aspects on compensation of Chief Executive Officers (CEOs) in UK firms. Two models are constructed and a set of hypotheses is developed. These models are tested using a sample consisting of the top 350 companies listed on the London Stock Exchange. Firms in the financial, investment and insurance industries are excluded due to the different nature of their accounting, governance, and compensation practices. The study covers the period of five financial years (2004-2008). Twenty-two hypotheses are derived from both models. These hypotheses are tested using multivariate techniques in order to determine to what extent corporate governance, ownership and remuneration consultants’ attributes play a role in monitoring managers and setting appropriate CEO compensation. Using a sample of 237 non-financial FTSE 350 firms during 2004-2008 (i.e. 851 firm-year observations), and after controlling for the standard economic and human capital determinants of compensation, this study finds that corporate governance, ownership and remuneration consultants’ characteristics play an important role in determining CEO compensation. However, the findings do not suggest that these attributes always play a positive role in constraining opportunistic managerial behaviour. Surprisingly, some of the governance attributes have been found to facilitate the executives’ needs rather than to attempt to monitor them. The findings of the thesis suggest that a number of theoretical perspectives can be used to explain the relationship between corporate governance, remuneration consultants and CEO compensation in the UK firms. For example, while the findings of board independence and CEO duality provide strong support to the stewardship theory, as firms enjoy better compensation governance when their boards contain more executive directors and are chaired by CEOs, the results of chairman independence and ownership, and remuneration committee independence, are found to be in line with both agency theory and the alignment of interests’ hypothesis of agency theory since we find these variables play a strong role in mitigating the agency problems and agency costs through setting appropriate CEO compensation. Conversely, the managerial power perspective receives great support from the findings of a number of governance, ownership, and consultants’ variables. That is, the analysis concludes that larger boards, well-compensated board and remuneration committee non-executive directors, CEOs with greater share ownership, CEOs sitting on the remuneration committee, less independent remuneration consultants, and the switch of remuneration consultants all play significant roles in increasing the level of CEO compensation and setting inappropriate designs for remuneration that are more favourable to the CEO (i.e. more fixed and less equity-based compensation). Overall, the findings of this thesis imply that shareholders, regulators, and practitioners should be concerned about the composition and the characteristics of a firm’s board of directors, remuneration committee, and external directors who comprise the firm’s internal control structure as this research finds that the quality of corporate and compensation governance varies depending on board and remuneration committee size and characteristics. Furthermore, it is advised that the relevant parties should pay attention to the remuneration consultants’ independence status and characteristics since this study finds that independent, specialized, and larger remuneration consultants play a significant role in enhancing the quality of compensation arrangements’. Therefore, this study offers new insights over the effect that corporate governance and remuneration consultants can exert over the design of CEO compensation contracts.