Board of directors and owners as monitors of CEO compensation - Empirical investigation of Finnish panel data from 2007 to 2012

Abstract

The recent debate on executive compensation among media and politicians in Finland has been centered upon the possible inefficiency of boards as monitors and controllers of executive compensation schemes. It has also been suggested that firm owners should be allowed to vote for the CEO compensation arrangements. The purpose of this thesis is to examine whether and how the monitoring and controlling efficiency of the boards and outside owners are related to CEO compensation level in Finland. The monitoring efficiency is proxied with the following variables: Board size, Fraction of outside directors, Fraction of busy outside directors, Outside ownership concentration, Institutional investor ownership and Foreign ownership. The monitoring efficiency will be investigated separately in terms of 5 different CEO compensation variables: (1) Fixed compensation, (2) Short-term bonus compensation, (3) Cash compensation (1+2), (4) Long-term compensation and (5) Total compensation (3+4).

Our research data draws on the unbalanced panel of 66 (318 firm-year observations) Finnish companies from 2007 to 2012. The data was collected from companies' annual reports, companies' web pages, Orbis database and the web pages of: Nasdaq OMX, Central Statistical Office of Finland and Bank of Finland. We examine the monitoring efficiency by using correlation analysis and multiple least squares regression. Using dummy variable technique in the regression models we account for the industry-specific and year-specific factors affecting CEO compensation level. We also control for the wide range of firm-specific factors that can be assumed to be important in the CEO pay equation. These factors are: Firm size, Firm performance, Firm growth opportunities and Firm risk.

We document minor evidence that larger boards are associated with weaker monitoring efficiency consequently leading to higher level of CEO fixed compensation. Furthermore, our results lend some weak evidence that concentrated outside ownership and board consisted more of non-executive members may allow a more efficient monitoring consequently leading to lower level of CEO equity-based compensation. We also report evidence that larger firms pay their CEOs higher level of compensation suggesting that larger and more complex firms require higher quality and more expensive CEO talent. Additionally, we show evidence that higher prior firm performance is positively associated with CEO short-term bonus and total compensation.