Executive Compensation and Corporate Financial Performance in Brazilian. Industrial Companies

Transcription

1 Abstract: Executive Compensation and Corporate Financial Performance in Brazilian Industrial Companies Elizabeth Krauter University of Sao Paulo FEA-RP/USP Av. dos Bandeirantes, 3900 Bloco B2 sala Ribeirao Preto / SP Brazil Telephone: Fax: ekrauter@usp.br Almir Ferreira de Sousa University of Sao Paulo FEA/USP Av. Luciano Gualberto, 908 sala G Sao Paulo / SP Brazil Telephone: Fax: abrolhos@usp.br POMS 22 nd Annual Conference Reno, Nevada, U.S.A. April 29 to May 2, 2011

2 Executive Compensation and Corporate Financial Performance in Brazilian Industrial Companies Abstract The objective of this paper is to investigate the relationship between executive compensation and corporate financial performance. The research data are secondary and the non-probabilistic sample is comprised of 44 Brazilian industrial companies. In order to operationalize the independent compensation variable, we use average monthly salary, average variable salary and three indexes that we created for this research benefits, career and development. These compensation data refer to the fiscal year of In order to operationalize the corporate financial performance, we use two accounting indicators growth of sales and ROE for the fiscal years of 2006 and We use the size of the companies as a control variable. The results of multiple regression analysis do not allow corroborating the hypothesis that there is a positive and significant relationship between executive compensation and corporate financial performance. Key-words: executive compensation; financial performance 1. Introduction Executive compensation is a complex and controversial subject that has attracted attention from the media (CONYON, 2006) and from researchers in several areas (CARLON; DOWNS; WEST-GRAY, 2006). Recently, the case of million-dollar bonuses became news in main communication vehicles all over the world. Executives received considerable sums as variable compensation, despite having contributed to the crash of the companies they managed.

3 The most used approach in research about executive compensation is the principal-agent theory (CONYON, 2006), or agency theory. According to this theory, the principal (shareholder) hires an agent (executive) to execute a task in her/his favor, involving the delegation of authority for making decisions. If the parties shareholder and executive act in order to maximize their personal usefulness, there are reasons to believe that the agent will not always act according to the shareholder s best interests (JENSEN; MECKLING, 1976). Since shareholders have imperfect control over their executives, the compensation system is considered by many an efficient mechanism to align interests and limit divergences (AGGARWAL; SAMWICK, 1999; DEVERS et al., 2007; SHIM; LEE, 2003). Researches that have studied the relationship between executive compensation and corporate financial performance have used data from American corporation and have focused on the American context (BÁLKIN; GÓMEZ-MEJIA, 1987; BARKEMA; GÓMEZ-MEJIA, 1998). The results are divergent and non-conclusive (BÁLKIN; GÓMEZ-MEJIA, 1987; BARKEMA; GÓMEZ-MEJIA, 1998). Some of the researches have found weak relationships; others have observed non-significant relationships between the variables (BARKEMA; GÓMEZ-MEJIA, 1998). Despite of the considerable number of the researches conducted over the past few years, there is little empiric evidence on the existence of a relationship between executive compensation and corporate financial performance. For Barkema and Gómez-Mejia (1998), the conduction of research in contexts different from the American may contribute to better understand this topic. The relevance and importance of the theme, the divergences found in results from previous research of the same nature and the lack of studies in the context of the Brazilian marketplace have motivated the conduction of this research. The objective is

4 to investigate the relationship between executive compensation and corporate financial performance in the context of the Brazilian marketplace. 2. Literature review and hypothesis 2.1 Human Resources (HR) management and corporate performance Over the past few years, several researchers have tried to understand the nature of the relationship between HR management and corporate performance. They have looked for evidence that HR management has positive impact in this context. Some of them focused on several HR practices and verified their effect in several performance measures (for example, GERHART; MILKOVICH, 1990; HAREL; TZAFRIR; 1999). Others have examined the effect of HR practices systems named High Performance Work Systems like Huselid (1995); Varma et al. (1999). Delery and Doty (1996) have identified three perspectives to describe this relationship: universal perspective, contingency perspective and configurational perspective. Alcázar, Fernández and Gardey (2005) have proposed the inclusion of a fourth perspective. Using the terminology presented by Brewster (1995), they have called it contextual perspective. The universal perspective represents the simplest approach for analysis of the relationship between HR management and corporate performance (ALCÁZAR; FERNÁNDEZ; GARDEY, 2005; BOSELIE; DIETZ; BOON, 2001; DELERY; DOTY, 1996). The relationship between the independent variable (HR practices) and the dependent variable (corporate performance) is universal, and the same for the entire population (DELERY; DOTY, 1996; YOUNDT et al., 1996). The main premises of this perspective are:

5 a) There is linear relation between HR practices or systems and the company performance (BOSELIE; DIETZ; BOON, 2001; DELERY; DOTY, 1996; YOUNDT et al., 1996); b) Some HR practices are better than others, and the use of such practices results in better organizational performance. They are named High Performance Work Practices or best practices (DELERY; DOTY, 1996); c) The company performance is measured in terms of financial indicators, such as profit, or by market share and sales level (BOSELIE; DIETZ; BOON, 2001). The universal perspective does not consider synergy or integration of different HR practices. Even when different practices are analyzed together, like in the High Performance Work Systems model (BECKER; HUSELID, 1998; HUSELID, 1995), the analysis is limited to an additive point of view (ALCÁZAR; FERNÁNDEZ; GARDEY, 2005). Additionally, there is no consensus among researchers concerning what the best practice would be (YOUNDT et al., 1996). The contingency perspective rejects the universal perspective s linearity and includes interactivity among variables. The relationship between independent variable and dependent variable is not stable, and changes due to the presence of other variables, named contingency variables. Thus, the influence of HR practices over corporate performance is conditioned by other variables (ALCÁZAR; FERNÁNDEZ; GARDEY, 2005; DELERY; DOTY, 1996). According to Alcázar, Fernández and Gardey (2005), contingential variables can be grouped into three categories: a) Strategic variables: HR practices need to be consistent with the company s strategy to result in higher performance (DELERY; DOTY, 1996; YOUNDT et al., 1996). According to Delery and Doty (1996), strategy is the contingency variable most used in research.

6 b) Organizational variables: HR practices are conditioned by factors such as: company size, technology, structure. c) Environmental variables: HR practices cannot be formulated and implemented without considering the context: competitive, technological, macroeconomic and labor. The configurational perspective is more complex than the two previous ones. It adopts a systemic point of view, considers synergy and incorporates the principle of equifinality (ALCÁZAR; FERNÁNDEZ; GARDEY, 2005; DELERY; DOTY, 1996). According to this principle, a single goal can be achieved by using different paths and starting from different initial conditions (CHIAVENATO, 2000). This vision defines the HR system as a multidimensional set of different elements that may be combined to form an infinite set of configurations (ALCÁZAR; FERNÁNDEZ; GARDEY. 2005). Such configurations represent ideal types and, therefore, are not phenomena observable empirically (DELERY; DOTY, 1996). According to this perspective, in order for a company to achieve superior performance, its HR practices need to have horizontal and vertical alignment. Horizontal alignment is the internal consistency of HR practices from a company. Vertical alignment is the congruency of HR practices with other organizational features for example, with the company s strategy (ALCÁZAR; FERNÁNDEZ; GARDEY, 2005; DELERY; DOTY, 1996). The contextual perspective was created to explain the European organizational context. This perspective proposes the expansion of the concept of HR management to encompass the company relations with government and unions. It also aims at expanding the players involved in the formulation and implementation of HR management, with the inclusion of stakeholders. Different from other perspectives, this

7 one adopts the social environment as analysis level (ALCÁZAR; FERNÁNDEZ; GARDEY, 2005). For the contextual perspective, HR management contributes to the success and longterm survival of the company not only because it improves performance, but also for helping to integrate and legitimate the company in its environment (ALCÁZAR; FERNÁNDEZ; GARDEY, 2005). 2.2 Compensation and corporate performance From all HR practices, compensation is considered crucial both for the company, for being a relevant item in cost composition, and for people, because it symbolizes the relative value of their work (DUTRA, 2002; SCHUSTER; ZINGHEIM, 1992). The underlying assumption is that the compensation system may help to direct the efforts of employees towards the business strategic purposes. When the compensation system is structured appropriately, such process may contribute to enhance the corporate performance (GÓMEZ-MEJIA; WELBOURNE, 1988). The results of the researches that have studied the relationship between executive compensation and corporate financial performance are divergent (BÁLKIN; GÓMEZ- MEJIA, 1987; BARKEMA; GÓMEZ-MEJIA, 1998). Some have found weak relationships; others have observed non-significant relationship between the variables (BARKEMA; GÓMEZ-MEJIA, 1998). They have used data from American companies and have focused on the American context (BÁLKIN; GÓMEZ-MEJIA, 1998). Several of these researches have used fixed salary and variable salary to measure compensation. Companies have, frequently, included non-financial compensation into their compensation packages for executives (CARLON; DOWNS; WEST-GRAY, 2006) and such information has been ignored in many researches Non-financial

8 compensation encompasses: mechanisms for career planning and professional development. Figure 1 presents the concept of compensation used in this research. Financial compensation Direct compensation Monthly salary Variable salary Compensation Indirect compensation Benefits Non-financial compensation Figure 1 The concept of compensation Source: Prepared by the authors Most of the researches have used only one accounting indicator to measure financial performance. The performance was measured subjectively, from the respondent s perception (BECKER; GERHART, 1996). These facts, along with the lack of research in the context of the Brazilian marketplace, have led us to test the following hypothesis: There is a positive and significant relationship between executive compensation and corporate financial performance, in the context of the Brazilian marketplace. 3. Methodology This research is descriptive and we use the quantitative method. According to the classification proposed by Delery and Doty (1996) to describe the relationship between RH management and corporate performance presented on section 2.1 this research fits the universal perspective, because it starts from the premise that there is linear relationship between compensation and corporate performance, and this relationship is universal.

9 We use multiple regression analysis. It was used in previous researches as the developed by Attaway (2000), Ozkan (2007). The sampling method used was nonprobabilistic. The sample is comprised of 44 industrial companies. We use SPSS 16.0 for Windows. The data used on research is secondary. Information from independent variables and from control variable was extracted from PROGEP (Programa de Estudos em Gestão de Pessoas) database. Data from the dependent variables was extracted from FIPECAFI (Fundação Instituto de Pesquisas Contábeis, Atuariais e Financeiras) database. The information on compensation is from the fiscal year of 2006 and refers to compensation received by directors, vice-presidents and presidents, herein named executives. To operationalize compensation variable, we collected the following information on PROGEP database: a) Value of the average monthly salary of the executive in December 2006, in Brazilian real; b) Average sum received by the executive in 2006, in Brazilian real, as variable compensation or bonus; c) Access of executives to 12 benefits: healthcare plan, medical ambulatory in the company facilities, dental plan, subside for purchasing medications, psychological support, group life insurance, subside for education, subside for professional specialization, subside for studying languages, support to children s education, subside for purchasing a home, and financing and loans. d) Access of executives to 25 mechanisms for stimulating and supporting career, which include: planning and tracking of professional development, encouragement and support to career planning, repositioning of dismissed executives, internal recruiting, information about career possibilities, and preparation for retirement.

10 e) Access of executives to 8 mechanisms to encourage education and professional development: educational programs that incorporate the identification of critical corporate and human competencies; multiple learning methods; programs that reflect the company s commitment to corporate citizenship; managers and leaders involved with the learning process; programs to disseminate the organizational culture; efficient systems for assessing investments in education and the results achieved; sharing knowledge and exchanging experiences; partnerships with higher education institutes. As from this information about benefits, career, education and professional development, we have been created 3 indexes: benefits, career and development. In the database, such information is classified as: No (= the company does not offer the item to its executives) Partial (= the company offers the item to some of its executives) All (= the company offers the item to all its executives) To create such indexes, points from 0 to 2 have been attributed, as follows: No = 0 point Partial = 1 point All = 2 points To create the benefits index, which measures the access of the executives to 12 benefits, 2 points for each benefit offered by the company to all executives have been attributed; 1 point for each benefit conceded to some of its executives; 0 point for each benefit not offered at all. The points have been summed up, and the result corresponds to the organization s benefits index. The punctuation varies from 0 to 24, that is, the index of the company

11 that does not offer any of the 12 benefits to its executives is equals 0; the index of the company that offers the 12 benefits to all of its executives is equals 24. To create the career index, which measures the access of the executives to 25 career support mechanisms, the same criterion of the previous index has been used. Two points have been attributed for each career support mechanism offered by the company to all of its executives; 1 point for each mechanism granted to part of its executives; 0 point for each career support mechanism not offered. The points have been summed up, and the result corresponds to the career index. The index punctuation varies from 0 to 50. The index of the company that does not offer any of the 25 career support mechanisms to its executives is equals 0. As for that company that offers the 25 mechanisms to all of its executives, its index is equals 50. To create the development index, which measures the access of the executives to 8 educational and professional development mechanisms, the same procedure of the previous indexes has been used. Two points have been attributed for each educational and professional development mechanism offered by the company to all of its executives; 1 point for each mechanism granted to part of its executives; 0 point for each mechanism not offered. The points have been summed up, and the result corresponds to the development index. The index punctuation varies from 0 to 16. The index of the company that does not offer any of the 8 educational and professional development mechanisms to its executives is equals 0. As for that company that offers the 8 mechanisms to all of its executives, its index is equals 16. (The tables with PROGEP research questionnaire items and the companies punctuation in the three indexes are not attached. They may be requested to the authors).

12 To measure the financial performance of the companies, 2 accounting indicators are used: sales growth and return on equity, of two fiscal years 2006 and These indicators are among the most used ones for empiric researches (CARTON; HOFER, 2006; LEE; HALL; RUTHERFORD, 2003). The control variable has been selected based on the possible influence that it exercises upon the dependent and independent variables. Literature highlights that the company size is an important factor. In this work, the size is represented by the number of employees in 2006 Terpstra and Rozell research (1993) used the number of employees as control variable. Due to the great variation in the number of employees among the sampled companies, we have opted by the variable transformation. This way, the natural logarithm of the number of employees is used to measure the sampled organizations size. The sector of actuation is another variable of control very used in the researches. In the case of this study, the sampled companies belong to 14 different sectors, and the number of companies in each area is small. Thus, we have opted by not using the sector as control variable. 4. Results According to the criterion adopted by PROGEP to classify the organizations regarding the size, 9 (20.5%) are small-sized (they have between 100 and 500 employees); 14 (31.8%) are medium-sized (they have between 501 and 1500 employees); and 21 (47.7%) are large-sized (they have more than 1500 employees). Table 1 shows the descriptive measures of the three indexes. The mean value of benefits index was points; with 50% of the companies presenting values equals or lower

13 than 16 points. The index value varied from a minimum of 9 and a maximum of 24 points. The career index presented mean value of points, oscillating between 2 and 48. Fifty percent of the companies presented value equals or lower than points. Bearing in mind that the maximum punctuation for this index is 50, we conclude that there is little stimulus and support for professional growth of the executives. We stress out that the career offered by the company is an item that is quite valorized by these professionals (FIA, 2007). Thus, it is a background that suggests important opportunities to be developed by the organizations. The development index presented mean value of points, varying from 0 to 16. Fifty percent of the companies indicated spectrum equals or lower than 12 points. The researched organizations differ a lot with regard to this data. While some of them do not offer any educational and professional development support mechanism, others provide the 8 mechanisms to all of its executives. Table 1 Descriptive statistics of the indexes n Mean Median Standarddeviation Minimum Maximum Benefits index Career index Development index From PROGEP database, information on average monthly salary and average variable salary earned by the executives in 2006 was also extracted. The mean of the average monthly salary was R$ 27,000.40, varying between R$ 10, and R$ 52, As for the mean of the average variable salary was R$ 141, in the year of 2006, which is equivalent to approximately R$ 11, a month. Some companies do not

14 pay variable salary to its executives, because of this, the minimum value corresponds to zero. Table 2 shows the descriptive measures of such information. Table 2 Average salary of executives in 2006 Table 3 shows the descriptive measures of accounting indicators. The sales growth of 2006 presented mean of 5.12%, varying from 19.1% to 34.8%. The return on equity (ROE) of 2006 presented mean of 18.51%, oscillating between 44.8% and 57.7%. The sales growth mean value of 2007 was 4.96%, varying from 35.4% to 66%. The mean of the ROE in 2007 was 16.67%, varying from 23.8% to 54.6%. Table 3 Descriptive statistics of accounting indicators n Mean Median Standarddeviation Minimum Maximum Average monthly salary (in Brazilian real) 44 27, , , , , Average variable salary (in Brazilian real) , , , , n Mean Median Standarddeviation Mimimum Maximum Sales growth 2006 (%) ROE 2006 (%) Sales growth 2007 (%) ROE 2007 (%) We use the size as a control variable. The size is represented by the number of employees in As the variable had great variation, from a minimum of 131 to a maximum of 20,228 employees, we have opted by the variable transformation. We used the natural logarithm (ln) of the number of employees. Table 4 exposes the descriptive measures before and after the transformation. Table 5 shows the variables acronyms used in the statistical tests.

15 Table 4 Descriptive statistics of control variable n Mean Median Standarddeviation Mimimum Maximum Number of employees 44 3, ,359 4, ,228 Size (ln number of employees) Table 5 Variables acronyms Variable name Average monthly salary Average varible salary Benefits index Career index Development index Sales growth 2006 Return on equity 2006 Sales growth 2007 Return on equity 2007 Size Acronyms salmen salvar ibenef icarr idesen cven06 roe06 cven07 roe07 size To test the hypothesis that there is a positive and significant relationship between executive compensation and corporate financial performance, we use linear regression analysis. We use, simultaneously, all compensation variables as independent variable; the financial performance variables, alternately, as dependent variable; size as control variable. We use this general model of multiple regression: DF i = β 0 + β 1 salmen i + β 2 salvar i + β 3 ibenef i + β 4 icarr i + β 5 idesen i + β 6 size i + µ i Where: i represents the i th company; DF represents financial performance variables (cven06, roe06, cven07, roe07); µ = error term. Table 6 shows the results of the multiple regression, estimated with the least square method (LSM), with cven06 as dependent variable. The value of R 2 indicates that 19.3% of the variation in cven06 is explained by the set of variables in the regression. The model presents R 2 adjusted of 6.2%. The Sig. (p-value) of F test, equals 0.213

16 (higher than 10%) does not allow rejecting the null hypothesis, which is R 2 equals zero. Sig. t analysis indicates that only ibenef and icarr variable coefficients are significant; icarr coefficient presents negative sign. Table 6 Results of multiple regression model cven06 Independent Standardized t Sig. t variables coefficients constant size salmen salvar ibenef icarr idesen R 2 = R 2 adjusted = Sig. F = n = 44 Table 7 Results of multiple regression model roe06 Independent Standardized t Sig. t variables coefficients constant size salmen salvar ibenef icarr idesen R 2 = R 2 adjusted = Sig. F = n = 44 Table 7 shows the results of the multiple regression, estimated with the least square method, with roe06 as dependent variable. The value of R 2 indicates that 22.3% of the variation in roe06 is explained by the set of variables in the regression. The model presents R 2 adjusted of 9.7%. The Sig. of F test, equals (higher than 10%) does

17 not allow rejecting the null hypothesis, which is R 2 equals zero. Sig. t analysis indicates that only icarr variable coefficient and constant are significant; icarr coefficient presents negative sign. Table 8 Results of multiple regression model cven07 Independent Standardized t Sig. t variables coefficients constant size salmen salvar ibenef icarr idesen R 2 = R 2 adjusted = Sig. F = n = 44 Table 8 shows the results of the multiple regression, estimated with the least square method, with cven07 as dependent variable. The value of R 2 indicates that 9.4% of the variation in cven07 is explained by the set of variables in the regression. The model presents R 2 adjusted negative and equals 5.3%. The Sig. of F test, equals (higher than 10%) does not allow rejecting the null hypothesis, which is R 2 equals zero. Sig. t analysis indicates that only size variable coefficient is significant. Table 9 shows the results of the multiple regression, estimated with the least square method, with roe07 as dependent variable. The value of R 2 indicates that 9.7% of the variation in roe07 is explained by the set of variables in the regression. The model presents R 2 adjusted negative and equals 4.9%. The Sig. of F test, equals (higher than 10%) does not allow rejecting the null hypothesis, which is R 2 equals zero. Sig. t analysis indicates that no coefficient is significant.

18 Table 9 Results of multiple regression model roe07 Independent Standardized t Sig. t variables coefficients constant size salmen salvar ibenef icarr idesen R 2 = R 2 ajustado = Sig. F = n = 44 Therefore, the 6 models tested do not present any statistical significance. The Sig. of the F test was higher than 10%, in all models, not allowing to reject H 0, R 2 is equals zero. The 6 models comply with all requirements of the multiple regression analysis. The residual normality assumption was reached by using the Kolmogorov-Smirnov test. The homoscedasticity of residues was verified by means of the Pesarán-Pesarán test. The absence of serial autocorrelation in the residues was verified by means of Durbin- Watson test. The multicollinearity exam among independent variables was made by the VIF measurement (Variance Inflation Factor). The results of multiple linear regression analysis did not allow corroborating the hypothesis that there is a positive and significant relationship between executive compensation and corporate financial performance, in the context of the Brazilian marketplace. These results are compatible with the results of others researches developed in other context which did not corroborate the relationship between the variables.

19 5. Conclusion The objective of this research is to investigate the relationship between executive compensation and corporate financial performance. The non-probabilistic sample is comprised of 44 industrial companies. This research is different from previous one for producing broader concepts to operationalize the variables. Previous one has used fixed salary and variable salary to operationalize compensation variable. We use direct compensation (monthly salary + variable salary) and three indexes that we created benefits, career and development. The benefits index measures the access of executives to 12 benefits; the career index measures the access to 25 career support mechanisms; the development index measures the access to 8 professional development mechanisms. Moreover, we use two accounting indicators for two fiscal years, and they were extracted from FIPECAFI database. Several of previous researches adopted only one accounting indicator to measure financial performance and the performance was measured subjectively, from the respondent s perception. The results of multiple regression analysis did not allow corroborating the hypothesis that there is a positive and significant relationship between executive compensation and corporate financial performance in the context of the Brazilian marketplace. We expected that the utilization of an approach other than that used in previous researches creation of three indexes, use of two accounting indicators of two fiscal years would enable corroborating the hypothesis. However, such expectation has not been confirmed. The main contributions of this research are in: expanding the existing knowledge on the relationship between executive compensation and corporate financial performance; studying this relationship in the context of the Brazilian marketplace; and providing subsidies for companies to enhance their compensation systems.

20 This research has some limitations. The sampling method used to select the companies is non-probabilistic. Thus, it is not possible to generalize the results found for the population. Another limitation is the size of the sample. Due to the difficulty to obtain, in Brazil, the corporate accounting data, the sample is comprised of 44 companies. Additionally, the utilization of accounting information can be a limiter, because it is subject to manipulation. This research has adopted the universal perspective to investigate the relationship between executive compensation and corporate financial performance. According to this perspective, this relationship is linear and universal. New researches can be developed using others perspectives. In spite of these limitations, the results are important for the discussion on the relationship between executive compensation and corporate financial performance. References Aggarwal, R. K. and Samwick, A. A. (1999), Executive compensation, strategic competition and relative performance evaluation: theory and evidence, The Journal of Finance, v. LIX, n. 6, pp Alcázar, F. M., Fernández, P. M. R. and Gardey, G. S. (2005), Researching on SHRM: an analysis of the debate over the role played by human resources in firm success, Management Revue, v. 16, n. 2, pp Attaway, M. C. (2000), A study of the relationship between company performance and CEO compensation, American Business Review, v. 18, n. 1, pp Bálkin, D. B. and Gómez-Mejia, L. R. (1987), Toward a contingency theory of compensation strategy, Strategic Management Journal, v. 8, n. 2, pp

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