Managerial compensation and firm performance: The moderating role of managerial ownership and other governance factors

• Published date: 01 July 2023
• Author: Ismail Adelopo,Emmanuel Adu‐Ameyaw,Kwok Yip Cheung,Hajara Santali Bako
• Date: 01 July 2023
• DOI: http://doi.org/10.1002/jcaf.22609

Received:  September Accepted:  December 

DOI: ./jcaf.

RESEARCH ARTICLE

Managerial compensation and firm performance: The

moderating role of managerial ownership and other

governance factors

Ismail Adelopo1Emmanuel Adu-Ameyaw2Kwok Yip Cheung3

Hajara Santali Bako4

Department of Accounting, Economic

and Finance, Faculty of Business and

Law, The University of the Westof

England, Bristol, UK

Department of Accounting, Economic

and Finance, Faculty of Business and

Law, The University of the West

of England, Bristol, UK

The Hong Kong University of Science

and Technology, Clear WaterBay, Hong

Kong

Department of Accounting, Economic

and Finance, Faculty of Business

and Law, The University of the Westof

England, Bristol, UK

Correspondence

Kwok Yip Cheung, The Hong Kong

University of Science and Technology,

Clear Water Bay,Hong Kong.

Email: cheung@hotmail.com

This study looks at how executive compensation affects firm value and the extent

to which this relationship is sensitive to managerial ownership and corporate

governance factors. We use data from UK FTSE  firms for the period –

, generating a total of  firm-year observations. Consistent with optimal

compensation theory, we find that the managerial compensation –firm value is

more sensitive to executives’ ownership levels and other corporate governance

indicators. Our results remain robust to alternative econometric models. Wecon-

tribute to the literature on corporate governance and firm value . While the

paper builds on the executive bonus compensation literature, it also furthers

our understanding on the extent to which managerial ownership, institutional

ownership, board size and non-executive ownership matter in the executive

bonus compensation—corporate value relationship with specific emphasis on

UK FTSE  firms. Our second contribution is related to the moderating role

of managerial (executive) ownership. We show that as executives residual inter-

ests go up, managers become more conscious of the firm’s idiosyncratic risk, and

hence lessen their aggressive investment and financing strategies culminating in

lower firm value.

KEYWORDS

firm performance, managerial compensation, ownership

1 INTRODUCTION

The substantial pay packages of company executives

have aroused the attention of both academics and non-

academics. Concerns on corporate executives’ compensa-

tion policy, widening pay inequality and poor corporate

performances which were revealed by the /

global financial crisis alerted shareholders and regulators

on how to design pay compensation to influence man-

agerial quality decision. It is therefore not surprising that

shareholders’ votes on executive compensation have been

introduced in several European countries (see e.g., Ferri &

Maber, ). Academic studies suggest that shareholders

can use compensation as a tool to align their interests with

corporate executives (Kaplan & Rauh, ;Ntimetal.,

; Ortiz-Molina, ; Ozkan, ). Thus, efficient

bonus compensation policies could induce corporate exec-

utives to employ costly effort to enhance the future growth

opportunities of the firm and achieve shareholder value

maximization. Accordingly,the differing interests between

managers and shareholders are minimized through effi-

cient compensation design (Ntim et al., ; Ortiz-Molina,

J Corp Account Finance. ;:–. ©  Wiley Periodicals LLC.31wileyonlinelibrary.com/journal/jcaf

32 ADELOPO  .

). Despite the growing surge in research interests

(both theoretical and empirical) on these subjects, our

understanding of the implications of executive bonus

compensation on firm value is still far from complete.

Evidence from prior studies have been mixed (Balafas

&Florackis,;Ntimetal.,). Most prior stud-

ies have employed panel data regression framework and

found evidence of a decreasing relationship between exec-

utive compensation and firm value. However, Ntim et al.

() employed a robust technique (i.e., systems of equa-

tions modelling) on South African datasets and reported

positive relationship between them. We adopt a similar

technique on our panel data of  firm-year observation

of UK FTSE  firms for the period – to analyze

the influence of executive bonus compensation on firm

value. This examination is important because it provides

an insight into how top management incentives induce

corporate value post  financial crisis. Most prior stud-

ies on this issue (e.g., Conyon & Murphy,; Core et al.,

) were conducted before the crisis, leaving an obvious

gap in the literature on the impacts of the financial cri-

sis on the ‘compensation-firm value’ debate. Furthermore,

previous British studies (e.g., Conyon & Murphy, )

on this topic used lagged values to deal with endogene-

ity concerns, we bolstered our empirical findings with a

more sophisticated techniques in dealing with endogene-

ity by using a three-stage least squares technique in a

simultaneous equation modelling framework.

Although the UK has made a series of corporate gov-

ernance reforms pre-financial crisis to curb the lofty

executive bonus pay (Cho et al., ; Greenbury Report,

), recent researchshows that excessive executive bonus

pay is regarded as one of the key factors that led to the

collapse of many UK institutions during the –

financial crisis (see von Ehrlich & Radulescu, ). To

the end, we seek to understand the extent to which the

‘compensation- firm value’ debate has been influenced

by corporate governance mechanisms such as managerial

stock ownership, institutional ownership, board size and

non-executive ownership in the UK. Recent findings from

the High Pay Commission () also indicates that the

remuneration of some top British executives has increased

by more than % in the last  years. This makes the

UK a preferred market to conduct our litmus test on how

executive bonus compensation drives firm value.

By way of preview, the evidence obtained in this

study shows that executive bonus compensation posi-

tively affects firm value. This suggests that executives

adopt appropriate policies to increase firm value as their

incentives in the form of bonuses go up. Thus, through

optimal compensation, risk-averse executives are moti-

vated to embark on appropriate investment and financing

policies to enhance corporate value. Wealso find that firms

with higher executive or managerial ownership stakes

experience lower firm value as executives’ bonus compen-

sation increases. This signaled managerial entrenchment

effect (Bebchuk & Fried, ; Weisbach, ) where

executives become more risk averse to undertake risky

investment and financing policies which ultimately deter-

mine corporate value. That is, as executives’ ownership

increases, they become less motivated to borrow to finance

investment projects because such projectfailure may affect

their personal and economic benefits (Brailsford et al.,

). Further, we observe that board size matters in the

‘compensation-firm value’ debate. Executivesin firms with

small board size tend to experience lower corporate value

as their bonus pay increases but those in large board size

firms tend to increase firm value. This finding supports

the monitoring role of large boards (e.g., Ntim et al., ).

Finally,we find that low non- executivesownership is asso-

ciated with low corporate value given executive bonus

compensation.

We conduct further tests to ascertain the robustness

of our results. First, we measure our dependent variable

by using alternative proxy (Tobin’s Q). Second, in addi-

tion to OLS estimations, we use the fixed effects model

to deal with firm fixed effect and time-invariant covari-

ates. Finally, we address the issue of endogeneity and

reverse causality by estimating simultaneous equation

model using a three-stage least squares (SLS) estima-

tor. Consistently, our results remain robust to all these

analyses.

We make contributions to the literature in the fol-

lowing ways. First, we contribute to the literature on

corporate governance and firm value (e.g., Chu et al.,

; Conyon & Murphy, ;Haque&Ntim,;

Ntim et al., ; Ozkan, ). While the paper builds

on the executive bonus compensation literature, it also

furthers our understanding on the extent to which man-

agerial ownership, institutional ownership, board size and

non-executive ownership matter in the executive bonus

compensation—corporate value relationship with specific

emphasis on UK FTSE  firms. Our second contri-

bution is related to the moderating role of managerial

(executive) ownership. Here, we demonstrate the signifi-

cant role of managerial ownership in the executive bonus

compensation-firm value relationship. Thus, we show that

as executives residual interests go up, managers become

more conscious of the firm’s idiosyncratic risk, and hence

lessen their aggressive investment and financing strategies

culminating in lower firm value. Our third contribution

is linked to the monitoring role of board size. We demon-

strate that board size is crucial in achieving shareholder

value maximization policy.