1. Introduction
Chief Executive Officer (CEO) compensation is a topical yet controversial issue [
1,
2,
3,
4]. Despite the widespread civic attention and rigorous academic inquiry, the nexus between executive compensation, governance mechanisms, and corporate outcomes remains unraveled. Contemporaneously, the remarkable increase in executive compensation has brought the CEO compensation thesis under intense scrutiny by various stakeholders. Mounting pressure from academic work/research, which is supplemented by the mainstream media, has resulted in civic pressure on the corporate elite as well as on the regulators to curb the unprecedented trends in executive compensation. Consequently, regulatory agencies around the world have either introduced new regulations or have amended the existing ones to tackle the issue of executive compensation. The “Binding Say-on-Pay” in Switzerland [
5] and the “say-on-pay” rule in the UK and the USA [
6] are some of the notable examples.
Despite the regulatory initiatives, the ratio of CEO compensation to the average salary of employees in the UK, Germany, Canada, and Japan, is 84, 147, 204, and 67 times, respectively (see also ref. [
7]). In this vein, ref. [
8] notes that CEOs’ salaries are 350 times more than workers’ salaries in the US, where CEOs’ total pay exceeds USD 7000 per hour, compared to an average of USD 20 per hour for ordinary workers. Ref. [
9] further notes that CEO compensation has risen 940 per cent since 1978, whereas the typical worker/employee has received a 12 per cent salary increase during the same period.
Due to the separation of ownership and control, agents’ interests must be aligned with those of the shareholders to mitigate the principal–agent problem. This is particularly the case for publicly traded companies as the alleviation of the agency problem in public listed companies has been the focal point of discussion [
10,
11]. Executive compensation is an integral part of the agency contract. The contract must be structured, agreed, and executed in a fashion that incentivizes and encourages agents to work in the best interests of the principal, i.e., shareholders’ wealth maximization. To safeguard their economic and other interests, shareholders erect controlling mechanisms in the form of a corporate board who accepts the responsibility to be a vigilant monitor of agents’ actions. Corporate governance scandals such as Enron and WorldCom in the USA and the deceitful bankruptcy of Italian Parmalat, along with the recent financial crises, have all resulted in increased calls for a vigilant corporate board.
An emerging literature stream scrutinizes the relationship between corporate governance features and CEO compensation (see ref. [
8], among others). Particularly, board attributes such as board size and board gender diversity, i.e., proportion of female directors on the board, are considered important determinants of CEO compensation. The main thesis in these studies rests upon the notion that boards of directors are responsible to set the economic rewards in the form of compensation packages for managers such as the CEO. Therefore, board composition including its construct, i.e., independence and composition in terms of diversity, have direct implications for agency costs and CEO compensation is a main element of such costs.
Sustainability literature points to the significance of boardroom gender diversity for sustainable organic growth. Ref. [
12], for instance, observes that European firms with a higher fraction of female directors on their corporate boards submit superior ESG (environmental, social, and governance) performance relative to their counterparts. The study further concludes that board gender diversity positively relates with sustainability disclosure, improves best management practices, and enhances stakeholders’ trust, which translates into higher firm valuation.
Others, such as ref. [
13], warn that CEOs endeavor to circumvent board control in an effort to maximize their financial rewards, i.e., pay. These arguments allude the notion that corporate board composition and construct have direct bearing for agency costs. Against this backdrop, this study analyzes how corporate boards’ delegation mechanisms affect CEO compensation.
Given the contractual significance, boards tend to link CEO compensation with firm performance whereas CEOs strive to strike this condition down. Earlier research, e.g., refs. [
8,
11], note that CEOs have the tendency to lure higher economic benefits for themselves when firms perform better relative to the market. This is a natural phenomenon, which is at the core of agency theory and largely referred to as the principal–agent problem [
11].
Prior research, informed by the resource dependence theorem, recognizes the significance of human capital in gaining and sustaining a competitive advantage in today’s knowledge-intensive era [
7] and further argues that companies must strive to attract talented individuals, especially those who are at the core of corporate upper echelons, including executives and top managers such as CEOs, by offering attractive economic benefits. Other research warns that top managers with powerful organizational positions, e.g., longer-tenured dual-CEOs, directly affect agency costs [
14]. Correspondingly, the study considers the impact of CEO traits on CEO compensation.
Factors such as shareholder activism, recognition of female directors as effective leaders, i.e., phenomenon of glass-ceiling, calls to increase women’s representation on corporate boards, and changes in regulations to maintain one-third board-gender-diversity, highlight the significance of this topic and its timeliness for an empirical investigation.
Furthermore, due to the separation of ownership and control, shareholders, especially minority shareholders (relative to institutional- and block-shareholders), demand diversified boards both in terms of gender and skillset diversity. Corporate boards dominated by outside directors while maintaining higher gender diversity have strong bearing from the market. Board diversity sends positive signals to the market: higher board gender diversity and independence enhances market confidence. Since minority shareholders are not involved in the day-to-day functioning of the companies, they perceive outside directors as custodians of their interests. Such directors would equally ensure that an independent and diversified board of directors would ensure that the agents work in the best interest of the shareholders and do not exploit firm resources for personal benefit, thereby reducing agency costs such as CEO compensation.
Against this backdrop, the main purpose of this paper is to empirically investigate the effects of board gender diversity on CEO compensation. This test is particularly important for publicly listed firms in which there is a clearer separation of ownership and control, thus the tendency of principal–agent problem is higher in such firms, as narrated by agency theory [
15].
In essence, this study provides additional insights with respect to the determinants of CEO compensation by addressing the following questions. First, to what extent does the corporate board attributes influence CEO compensation? Second, is corporate performance a determinant of CEO compensation? Third, to what extent do CEO traits affect their compensation related to corporate performance? Fourth, to what extent is CEO compensation explained by the firm-related attributes?
To address the above-extended questions, the study exploits a unique hand-built dataset, which is drawn from various sources such as corporate reports, annual reports, bulletins, company websites, executive/personal websites, corporate archives, and other publicly available sources such as newspapers, etc., belonging to 297 FTSE350 constituent firms, for the period 2011–2019. Additionally, the study supplements, compares, and contrasts the collected data with other datasets such as Bloomberg and DataStream to confirm the data accuracy.
The analysis suggests that large and diversified corporate boards have direct implications for agency costs proxied by CEO pay package. The analysis further suggests that longer-tenured CEOs who also serve as a board chairperson receive higher total compensation and bonuses. Into the bargain, corporate performance is proxied by return of assets (ROA) and firm attributes, i.e., firm size and institutional ownership, which have divergent but direct implications for CEO compensation. These insights have direct bearing for a variety of stakeholders operating in financial markets, regulatory agencies, and/or the academic sphere, both in the UK and beyond.
4. Analysis and Results
4.1. Descriptive Statistics
The average values of CEO compensation proxies have the following values 15.01, 13. 67, and 13.74 as illustrated in
Table 1. The min. and max. values of −8.83 and 31.97 with an average value of 6.45 show the firm profitability trends measured by ROA, whereas the average Q-ratio of 2.56 illustrates the average market value of the sampled firms during the study period.
Turning to the board attributes, it can be seen that the female board of directors represent one-fourth of the corporate boards included in our sample, whereas the average corporate board size is approximately 10, represented by 67% outside directors. On average, the sampled board have had 9 meetings during the fiscal year. As for the CEO attributes, only a fraction of the sample have powerful CEOs and the average CEO-tenure is approximately 5 years. Diversity at the executive level is relatively low, at 12.34, compared to female representation at the board level. Firm attributes have the following means values, 9.74, 1.58, 91.23, 1.09, and 1.56, illustrating the general trends during the study period. The correlation matrix presented in
Table 2 along with the VIF scores show no concerns of multicollinearity.
4.2. Econometric Modelling
The study uses various versions of Equation (1) to analyze the determinants of CEO compensation. Moreover, robustness tests based on generalized method of moments (GMM) produced similar results, confirming the econometric choice (results are available upon request). Econometrically, Equation (1) is as below:
where CEO compensation has three proxy measures for total CEO compensation, salary, and bonuses. Firm performance is measured using ROA and Q-ratio. Board attributes include board diversity, size, independence, and frequency of board meeting. CEO traits include role duality, tenure, and executive diversity. Firm-specific attributes include firm size, leverage, institutional ownership, firm beta, and current ratio. Lastly,
ε is the error term,
α is the constant, and
β and
γ are the vectors of coefficient estimates.
4.3. Determinants of Total CEO Compensation
The analysis starts with examining the determinants of total CEO compensation. Results are reported in
Table 3. Results for Model 1 are extracted using Equation (1). As can be seen in column two of
Table 3, there is a significant positive relationship between ROA and total compensation. The statistically significant positive relationship at the 1% level across models suggests that firm profitability, i.e., ROA, is a key determinant of total CEO compensation. Thus, hypothesis H1 is accepted.
Model 2 measures the impact of board attributes on total CEO compensation. The analysis suggests a statistically significant positive relationship at the 1% level between board diversity, board size, and total CEO compensation. Thus, hypotheses H2 and H3 are accepted. However, the statistically weak insignificant results for the board independence, i.e., NED-ratio and board meeting frequency, do not provide enough evidence to support or oppose hypotheses H4 and H5. Model 3 analyzes the impact of CEO traits on total CEO compensation. All CEO traits relate positively with total CEO compensation. CEO role duality and CEO tenure relate positively with total CEO compensation at the 1% level of statistical significance. Thus, hypotheses H6 and H7 are accepted. Similarly, hypothesis H8 is accepted as executive diversity relates positively with total CEO compensation at the 10% level. As for the relationship between firm-specific attributes and total CEO compensation, the analysis suggest that firm size (positively) and institutional ownership (negatively) relate with total CEO compensation. Thus, hypotheses H9 and H11 are accepted. There is not enough statistical support for the remaining hypotheses H10, H12, and H13.
To strengthen the validity of the observed results, further interaction analysis is performed using the Equation (1). Results are reported across Models 4–8. The analysis suggests that large and diversified boards favor total CEO compensation and even so when the board is chaired by the CEO, i.e., CEO role duality. Similarly, large boards chaired by a dual CEO with longer tenure tend to relate positively with total CEO compensation. However, large independent boards have the opposite effect.
4.4. Determinants of CEO Salary-Based Compensation
To determine the determinants of CEO salary-based compensation, the study repeats the analysis reported in
Section 4.2. Equation (1) is used with similar set of independent variables and CEO salary as the dependent variable. As can be seen in column two of
Table 4, there is a statistically significant positive relationship between ROA and total compensation at the 10% level. However, the results are not consistent across models. Thus, hypothesis H1.1 is accepted with a lesser degree of statistical significance.
As before, Models 2 measures the impact of board attributes on CEO salary-based compensation. The analysis suggests a statistically significant positive relationship at the 1% level between board diversity, board size, and total CEO compensation. Thus, hypotheses H2.1 and H3.1 are accepted. However, the statistically weak insignificant results for board independence, i.e., NED-ratio and board meeting frequency, do not provide enough evidence to support or oppose hypotheses H4.1 and H5.1.
Similarly, Model 3 analyzes the impact of CEO traits on CEO salary-based compensation. CEO role duality is positive but not statistically significant, thus, there is not enough statistical support to accept or reject hypothesis H6.1. Interestingly, CEO tenure relates negatively with CEO salary-based compensation at the 1% level of statistical significance. Thus, hypothesis H7.1 is rejected. However, hypothesis H8.1 is accepted as executive diversity relates positively with CEO salary-based compensation.
As for the relationship between firm-specific attributes and total CEO compensation, the results are similar to those observed above, except for firm beta which is significant at 5% in the positive direction, thus, hypotheses H9.1, H11.1, and H12.1 are accepted while there is not enough statistical support for the remaining hypotheses H10.1 and H13.1. Results of the interaction analysis confirm the earlier argument that large and diversified boards are the main determinant of CEO salary-based compensation, even so when a dual-role CEO leads the board. However, large and independent boards relate negatively with CEO salary-based compensation.
4.5. Determinants of CEO Bonus-Based Compensation
Finally, to determine the determinants of CEO bonus-based compensation, the study repeats the analysis reported in
Section 4.2. Equation (1) is used with similar set independent variables and CEO bonuses as the dependent variable. As can be seen in column two of
Table 5, there is no statistically significant relationship between ROA and CEO bonus-based compensation, therefore, there is not enough support to accept or reject hypothesis H1.2.
Models 2 measures the impact of board attributes on CEO bonus-based compensation. The analysis suggests a statistically significant positive relationship at the 1% level between board diversity, board size, and CEO bonus-based compensation. Thus, hypotheses H2.2 and H3.2 are accepted. As before, the statistically weak insignificant results for board independence, i.e., NED-ratio and board meeting frequency, do not provide enough evidence to support or oppose hypotheses H4.2 and H5.2.
Likewise, Model 3 analyzes the impact of CEO traits on total CEO compensation. CEO role duality and CEO tenure relate positively with CEO bonus-based compensation at the 1% level of statistical significance. Thus, hypotheses H6.2 and H7.2 are accepted. However, there is not enough statistical support to accept or reject hypothesis H8.2.
As for the relationship between firm-specific attributes and CEO bonus-based compensation, the results are largely the same as observed in the Table above for total CEO compensation. Thus, hypotheses H9.2 and H11.2 are accepted, whereas there is not enough statistical support for the remaining hypotheses H10.2, H12.2, and H13.2. Results for the interaction variables are consistent and support the argument that large and diversified boards when led by a dual CEO relate positively with CEO bonus-based compensation, whereas independent and large corporate boards have the opposite impact.
4.6. Further Analysis
Thus far, the study has used one performance proxy, return on assets (ROA). In this session the study performs further analysis by replacing ROA with market performance measure, Tobin’s Q (the Q-ratio). Results are reported in
Table 6.
The study uses the same equation, i.e., Equation (1), to perform further analysis with Q-ratio as an alternative measure of firm performance to extract Model 1, Model 2, and Model 3. The analysis suggests a negative relationship between the Q-ratio and CEO compensation proxy measures. However, the relationships are not statistically significant. The consistency in results across all models for board diversity and board size strengthen the argument that board gender diversity and board size are the main determinants of CEO compensation in the FTSE350 constituent firms. Results for the remaining variables are largely consistent.
6. Conclusions
The study draws a sample from FTSE350 constituent firms listed on the London Stock Exchange (LSE) for the 2011–2019 period to analyze the effects of board attributes and CEO traits on CEO compensation while controlling for firm related attributes. The study built a unique handpicked dataset, which is drawn from various sources such as corporate reports, annual reports, bulletins, company websites, executive/personal websites, corporate archives, and other publicly available sources such as newspapers, etc., to test the extended hypotheses. The study further supplements, compares, and contrasts the initially collected data with other datasets such as Bloomberg and DataStream. The analysis provides new and interesting insights and adds to the ongoing debate on CEO compensation [
4,
13].
Specifically, the analysis suggests that large and diversified boards determine CEO compensation. Large and diversified boards, i.e., those with a higher fraction of female directors, favor higher CEO compensation, supplementing [
7,
18] for board size and [
17,
18] for board diversity. These results enrich the existing literature by adding divergent insights to the ongoing intellectual debate on the phenomenon [
7]. Similarly, results for CEOs’ structural power within organizations advance the scholarly debate on the matter [
14]. Overall, results observed in this study suggest that large and diversified corporate boards explain agency costs, i.e., rents paid to agents such as the CEO, against their services. Furthermore, CEOs with strong organizational positions are able to withdraw higher compensation in more highly profitable corporations [
8,
11], however, institutional ownership discourages higher CEO compensation.
These findings supplement the research analyzing the determinants and effects of sustainable CEO compensation [
21]. In conclusion, this study notes that large and diversified boards are the main determinants of CEO compensation. Since boards of directors are responsible for negotiating agency contracts with the agents and are responsible for approving the economic benefits paid to the agents, large and diversified boards are more able to negotiate sustainable economic contracts with the agents.
Linking these arguments to the sustainability phenomenon, e.g., [
12], which links board composition with sustainability and firm valuation, it is thus argued that large and diversified boards are vigilant observers: on one hand, they negotiate and offer sustainable CEO compensation packages to attract talented agents and, in doing so, they send strong signals to the CEO assuring them their economic safety, which further motivates them to work in the best interests of the shareholders.
Arguably, financially well-rewarded agents would strive to implement boards’ strategies and agendas in an efficient manner to reap the sustainable organic growth. The study thus identifies this as a new avenue for future research to analyze the effects of sustainable CEO compensation contracts of corporate sustainability and valuation.
While the analysis remained focused on CEO compensation in publicly listed companies operating in the UK, future research may replicate this study on a different sample. Likewise, future research may consider using related attributes of board diversity in terms of skillsets, ethnicity, educational background, etc., for a more comprehensive analysis to lift the lid on boardroom diversity.