CEO's Share of Top-Management Compensation, Characteristics of the Board of Directors and Firm-Value Creation

INTRODUCTION The media attention concerning the compensation received by Chief Executive Officers (CEOs) has increased in the past two decades due to the growing gap vis-a-vis the middle class income (Abma, 2012; Anderson el al., 2004), the financial scandals in the wake of the recent global crisis, and the "Occupy Wall Street" movement (Sharma & Huang, 2010). In terms of corporate governance, CEO compensation is ultimately the board's responsibility. The board of directors, by determining CEO compensation, contributes to establish the company's compensation structure, especially by setting the gap between CEO compensation and that of the other company executives. Therefore, we pose ourselves the first research question, which is formulated as follows: Can board characteristics partially explain the CEO pay slice (CPS), i.e. the CEO's share of the combined remuneration of the five top-paid executives. The board characteristics which are studied in our article are independence, size, total director compensation, stock-based director compensation, director stock ownership, directors' average number of tenure years on the board and the CEO's dual position as Chairman of the Board. Another research question is connected with the impact that a greater CPS may have on firm market-valuation. Two theoretical views have been proposed to address this question. The tournament theory, which was initially formulated by Lazear and Rosen (1981), sustains that the compensation gap between the CEO and other executives, could be a source of motivation for the latter. This enhanced motivation could create company value. The fair-wage view, on the contrary, claims that the increased competition among the members of the executive team could be detrimental to cooperation, which in turn would be harmful for the company (Pfeffer, 1995; Deusch, 1985; Levine, 1991). If a greater CPS is a source of value creation, our study will support the tournament theory, whereas a negative link between CPS and firm value will upheld the fairwage theory. This study makes a unique contribution to the academic literature. To the best of the authors' knowledge, it is the first to examine if board characteristics are determinants of CPS and if the latter can be a driver of the company's market value. The study addresses this question in the context of Canadian capital markets. Specifically, it examines the research questions using as a sample the constituent firms of the S&P/TSX 60 index, which are the largest public Canadian companies. The results indicate that CPS is positively related to the independence of the board of directors and negatively linked to director stock ownership. The largest CPS, where the greatest proportion of the board is independent, could be explained by the larger dependence to the CEO as a link to the company. The negative relationship observed for director stock ownership could be explained by tighter controls on CEO compensation by the directors having more common interests with shareholders. Results also that PRPDG has a positive effect on company market value, which agrees with tournament theory. The following sections will successively present the literature review and the formulation of hypotheses, the methodology and sample, and the results and the conclusion. II. LITERATURE REVIEW AND STATEMENT OF HYPOTHESES 2.1. The Tournament Theory The compensation-performance relationship has been the object of several studies that attempted to analyze the legitimacy of awarded salaries and its links with performance. The effects on firm performance of actions advanced by executives were frequently correlated with their compensation. In particular, wage dispersion seems to have an impact on the effort made by the worker, and therefore the performance of the company. The "Tournament Theory", put forward by Lazear and Rosen (1981), refers to the idea that wage dispersion enhances worker motivation. …