How director remuneration impacts firm performance: An empirical analysis of executive director remuneration in Pakistan

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Borsa _Istanbul Review _ Borsa Istanbul Review 19-2 (2019) 186e196

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How director remuneration impacts firm performance: An empirical analysis of executive director remuneration in Pakistan Ejaz Aslam a,*, Razali Haron a, Muhammad Naveed Tahir b a

IIUM Institute of Islamic Banking and Finance (IIiBF), IIUM, Jalan Gombak, 53100, Malaysia b Department of Economics Forman Christian College University, Lahore, 54000, Pakistan Received 25 April 2018; revised 16 January 2019; accepted 16 January 2019 Available online 29 January 2019

Abstract This study empirically investigates the interrelationship between pay and performance of CEOs/board of directors in an emerging market, Pakistan. The study uses GMM approach to account for the problem of potential endogeneity and unobserved heterogeneity that arises due to the potential reverse causality (pay and performance) for a sample of non-financial firms listed in the KSE over the period of 2009e2016. This study provides evidence that the pay-performance framework supports the agency theory whereby CEOs/board of directors are compensated for their prior level of market-based performance. In addition, it weakly supports the notion of the steward/tournament theory. Thus, CEOs/board director's remuneration is highly persistent and takes time to adjust to long-run equilibrium. _ Copyright © 2019, Borsa Istanbul Anonim S¸irketi. Production and hosting by Elsevier B.V. This is an open access article under the CC BY-NCND license (http://creativecommons.org/licenses/by-nc-nd/4.0/). JEL classification: G30; M12; P17; C39 Keywords: Executive remuneration; Firm performance; Corporate governance; Emerging market; GMM

1. Introduction Since the last couple of decades director's remuneration is a hot debate which often increased at the time of crises. Most recently, the subprime crisis 2007-08 intensely attracted the general public attention towards the remuneration of board in firm. Surprisingly, this crisis greatly hit the United States (US) and other developed countries, but it had less effect on the developing countries. This presumably was because of good policies the developing countries adopted after the 1997e1998 financial crises (Chen, Ezzamel, & Cai, 2011; Javid & Iqbal, 2010). The issue about executive director's remuneration has been broadly aired in the electronic and printed media, the academic literature and sporadically in the regulatory arena.

* Corresponding author. E-mail addresses: [email protected] (E. Aslam), hrazali@iium. edu.my (R. Haron), [email protected] (M.N. Tahir). _ Peer review under responsibility of Borsa Istanbul Anonim S¸irketi.

Historically, in 1990s, some prominent cases attracted the eyes of the world, such as ‘fat cat’ controversy encompassing Cedric Brown's remuneration at British Gas. Later on 2003 shareholder revolt at GlaxoSmithKline directed by Jean-Pierre Garner's remuneration package, recently in 2008 the outcry connected to the disclosure that Sir Fred Goodwin, Chief Executive of the failed fizzle well-known Royal Bank of Scotland (RBS) walk away with a benefit of £30m (Bebchuk & Neeman, 2010; Erkens, Hung, & Matos, 2012). Besides these cases, there has been expanding distress with regards to the overall executive director compensation and the broadening hole between compensation at the highest point of both for the public and private corporations and the average employee in the corporations. The abrupt rupture of curiosity about the executive compensation is parallel to the emerging trends of the division of partnership and control in modern enterprise and general acknowledgement of the agency theory (Murphy, 1999). Agency issues emerge from the separation of possession and control in modern corporations (Fama &

https://doi.org/10.1016/j.bir.2019.01.003 _ 2214-8450/Copyright © 2019, Borsa Istanbul Anonim S¸irketi. Production and hosting by Elsevier B.V. This is an open access article under the CC BY-NC-ND license (http://creativecommons.org/licenses/by-nc-nd/4.0/).

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Jensen, 1983). The relationship between remuneration and performance is a mixed bag. For instance, some studies found a strong relationship between remuneration and performance (Ntim et al., 2015; Raithatha & Komera, 2016; Sheikh et al., 2018), while others found either a weak relationship (Chen et al., 2011; Haron, 2018) or no significant relationship at all (Conyon & He, 2011; Fernandes, 2008). The existing literature on executive director remuneration is dominated by the CEO remuneration because of the perception that CEO is the dominated personality for firm performance. So the greater part of the early studies on executive director's remuneration concentrated on the examination of the relationship between CEOs and firm performance (Raithatha & Komera, 2016; Sheikh et al., 2018). Doucouliagos, Haman, and Askary (2007) found that CEOs are experienced and knowledgeable persons who utilize their skills to accomplish the company targets and secure the shareholder investment. Moreover, Jensen, Murphy, and Wruck (2004) clarified that viable incentives given to executive tend to mitigate the agency problem and enhance firm performance. Whereas the literature on the performance-pay relationship has been largely focused on the Anglo-Saxon economies, very limited research has been carried out in the context of emerging markets (Raithatha & Komera, 2016). Regarding Pakistan, studies examining and concentrating on the payperformance framework particularly on the CEOs have been an ongoing phenomenon (Javid & Iqbal, 2010; Sheikh et al., 2018). The impact of financial advancement alongside changes in the market for managerial ability has brought about critical changes in the remuneration approaches adopted by the Pakistani firms. In this paper, we analyze the interrelationship between the pay and performance of the CEOs and board of directors under the corporate governance practices in an emerging market, Pakistan. We select Pakistan as it mirrors the qualities of a developing business sector economy, for example, immature administrative and institutional components, and weak investor activism (Rehman & Mangla, 2012). The current study contributed to the literature in several ways. First, we examine the interrelationship between pay and performance both for CEOs and board of directors over the period of 2009e2016. This period is chosen because after the subprime crisis of 2007-8, Securities Commission of Pakistan (SECP) introduced new reforms for listed firms to disclose the executive compensation in detail. Moreover, the current study has remuneration data at the firm level for the last 8 years. Such a dataset enables us to complete a thorough factual investigation in analyzing the interrelationship of pay and performance among the non-financial firms of Pakistan. Second, our study focuses on emerging market and Pakistan market is still in its growing stage. Large number of companies in Pakistan are controlled by families and their behavioral peculiarities and institutional settings are different from the Anglo-Saxon economies (Essen, Heugens, Otten, & van Oosterhout, 2012). In this situation, our investigation can provide better insight on the interrelationship between pay and performance in non-financial firms in Pakistan.

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Third, the current study can be considered as a response to calls for more research on how CEOs and board of directors of developing economies are redressed and on factors that may impact remuneration decision in emerging economies. Therefore, our study analyzes the cash and non-cash compensation of the CEOs as well as board of directors of the emerging economy of Pakistan thus significantly contributes to the international literature on board compensation. Finally, our study contributes to the discussion of the payperformance framework by examining the lag performance with the current year compensation and performance framework with the current year compensation on the forward year performance. The current study employs the Generalized Method of Moment (GMM) estimator that simultaneously accounts for the problem of potential endogeneity, unobserved heterogeneity, and serial correlation (between the pay and performance) among the sample firms. To the best of our knowledge, the current study is novel as this is the only comprehensive investigation carried out so far on the payperformance and performance pay framework for CEOs and board of directors among the Pakistani firms, by using the recent firm-level dataset. The rest of the paper is organized into six sections. Section 2 outlines the literature review and hypotheses development regarding the pay-performance and performance-pay frameworks. Section 3 describes the data and variables. Section 4 explain the methodology. Section 5 presents the results and discussion. Section 6 concludes the study with some policy implications of findings. 2. Review of literature Remuneration is a contract which is tied to a performance (Perry & Zenner, 2001). Shao, Chen, and Mao (2012) found that remuneration agreements can effectively tackle the organization issue amongst the investors and directors. According to the optimal contracting theory, the effective director's remuneration agreements should result in the most astounding degree of performance. Monem and Ng (2013) found that the sensitivity of changes in the level of executive director remuneration changes the shareholder wealth. Moreover, the board of directors' remuneration usually comprises of several separate payments depending on different tasks in different departments in the organization. Normally these will incorporate a fundamental pay and various performancerelated profits e profits in terms of money and/or shares. These profits are typically identified with measures of corporate performance, both short and long-term (Holm & Zaman, 2012). Corporate governance deals with the controlling and monitoring of the company and its members as well, which also encompasses issues related to the remuneration of board of directors. Controlling and monitoring include observations on the fairness, transparency, accountability, and responsibility of organizational operations and all these aspects are expected to improve further under a certain code of corporate governance. In fact, literature agrees that poor corporate governance

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is demonstrated by poor execution of firms (Chen et al., 2011; Javid & Iqbal, 2010). Even though the executive remuneration framework is critical, the foundation of an efficient system is challenging. Not just are the commitments and endeavors of managers hard to quantify, their choices influencing the execution of the firm cannot generally be precisely surveyed. Among the various incentive and monitoring mechanisms, executive remuneration is especially important for the senior managers. On the other hand, a few economists believe that these executives deserve every nickel they receive (Ewers, Bradshaw, McGovern, & Ewers, 2002). So, the current study empirically supported the performance pay framework in Pakistan, where board of directors and CEOs perform better in the future based on prior amounts and structure of remuneration packages. 2.1. Pay-performance framework Since few decades ago, the main focus of the literature was mainly generated from the agency theory (Bebchuk & Fried, 2003). The agency theory is particularly known as a contradiction between the firm management (agent) who tries to get high compensation and the proprietor of the firm (principal) whose aspiration is to amplify his profit from the company ownership (Villalonga & Amit, 2006). Jensen and Murphy (1990) stated that these conflicting inspirations developed because of the information asymmetry among the owner and management. However, this conflict can be ironed off by observing and offering them attractive remuneration contracts based on the organization performance. In this way, the attention should be on the activity of management to the greatest interest of the principals in order to acquire the high compensation to maximize the wealth of shareholders. A number of studies find a positive link between the CEOs and board of directors' compensation with the firm performance (Conyon & He, 2011; Kent, Kercher, & Routledge, 2018; Raithatha & Komera, 2016; Sheikh et al., 2018), which is consistent with the agency theory. Moreover, Perry and Zenner (2001) found that alteration in the remuneration structure of CEOs significantly affected the firm performance. Merhebi, Pattenden, Swan, and Zhou (2006) found that the board of directors' pay has a positive and significant relationship with firm performance in Australia. Moreover, Conyon and He (2011) reported for China that increment in CEO compensation is positively associated with the development of shareholder wealth both for public and private firms. Based on the above discussion, the first hypothesis can be stated as follows: H1a: A higher level of firm performance is positively related to future CEO/board director's remuneration. However, managerial hegemony theories also contend that the pay-performance relationship is modest (Essen et al., 2012). The managerial hegemony theory refers to the power and influence applied by the executive management directly and indirectly to control the nature of the remuneration contracts (Sapp, 2008). Bebchuk and Fried (2005) noted that management influence is more when the performance of the organization is beneath the targets and particularly when the

corporate governance is weak. Moreover, Bebchuk and Fried (2003) noted that top management significantly utilized their power in outlining the level and the structure of their compensation bundles despite the organization accomplishment. According to the managerial hegemony theory, the higher management might use their power to set high salaries when the corporate governance structure is frail, and companies have a low level of performance. In this appreciation, the way in which interrelationships between executive director's remuneration and organizational performance can be made inside a fitting structure of corporate management has been widely considered in past literature (Lakshan & Wijekoon, 2012). Therefore, we can state the second part of our first hypothesis as follows: H1b: A lower level of firm performance is negatively related to future CEO/board director's remuneration. In managerial power perspective, Bebchuk and Fried (2010) suggested that board of directors have a colossal effect on the setting of their agreement and performance. Doucouliagos et al. (2007) in Australia and Oviantari (2011) in Indonesia found that board of directors' pay has a robustly positive association with earnings per share, as well as with return on assets and return on equity. Shao et al. (2012) found that a change in fair value (CFV) is positively related with board of directors' remuneration in China. Hallock, Madalozzo, and Reck (2010) studied sample in the U.S and found that low-conditional-wage CEOs may not be as profitable for the firm. Brick, Palmon, and Wald (2006) found a weak positive relationship between the remuneration of (Directors and CEOs) and performance in Cronyism. They also found that excess in CEOs and executive director remuneration leads to underperformed firm due to poor governance control. Moreover, Girma et al. (2007) and Haron (2018) found a weak relationship between pay and performance in the UK and Malaysia, respectively. Fernandes (2008) found that the executive director's remuneration has an insignificant relationship with the company performance in Portuguese firms. Moreover, this study also found that zero level nonboard of directors on the board really has fewer agency issues and has effective arrangement of investors' and the management interests. Scholtz and Smit (2012) found that the performance elasticity in the corporation is relatively small, ranging from 0.025 for cash remuneration of all executives' firms in South Africa. The study also found that executive director pay with the performance sensitivity is stronger for equity-based pay rather than for cash-based remuneration. 2.2. Performance-pay framework The performance-pay framework receives less consideration in the earlier academic literature. Although the modern management strategies have moved toward an accentuation on the way in which the overall firm performance will be upgraded through giving an eye-catching or potentially adequate reward scheme to the top management of the firm (Chen et al., 2011), it is consistent with the stewardship and tournament perspective. The stewardship theory does not

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seem to agree with the agency theory when it comes to the managerial compensation system drawn by the agency framework (Alam, 2006). Meanwhile under the agency framework the senior management is described as selfserving and distinctive, but the stewardship sees them as dependent and would act together in a team. This is because in the stewardship theory, senior management will not allow individual inspiration to supersede their role to deal with the assets of the entity for the betterment of the organization. Hence, senior management will focus and maintain a reasonable management team for the organization that can maximize the wealth of shareholders. Thus, stewardship theory emphasizes on the requirement for compensation agreements to alleviate the agency conflict between the shareholders and managers. It also highlights the aspects of human capital in term of knowledge, skill, capabilities, and experience and so forth. Moreover, it significantly decreases the need to adjust their remuneration packages with the organization performance (Hendry & Kiel, 2004). Hence, we can state our second hypothesis as follows: H2: A high level of CEO/board director's remuneration is positively related to the firm performance. In addition, in the performance-pay relationship the stewardship theory also plays significant role in the selection of board compensation to enhance the firm performance (Gregory-Smith, 2012). The stewardship framework empowers the lower-level individuals at the boardroom level to work harder to secure the title of CEO including the related remuneration bundles as a reward (Chen et al., 2011). Subsequently, the high compensation to the higher performer is viewed as empowering the performance at all levels inside the organization (Conyon & Sadler, 2001). In addition, Zhang, Bartol, Smith, Pfarrer, and Khanin (2008) confirmed that CEOs incentives with risk-taking behavior boost the operational performance of the firms. In addition, Conyon and Sadler (2001) found a weak relationship between the executive director pay and performance in the UK because firms at that time faced severe problems. In line with the tournament theory, incentive pattern of internal structure significantly motivates to secure the optimal goal of the firm. Figure S1 in Supplemental file available online explains the relationship between pay and performance vice versa under the corporate governance framework. 3. Data and variables 3.1. Data sources and sample characteristics For the purpose of this study, data is retrieved from the KSE 100 index listed in the Karachi Stock Exchange (KSE), Pakistan, over the period of 2009e2016. The KSE 100 index is chosen for this study because of its outstanding[i] performance during the sample period in Asia, known as the Asian tiger. The KSE 100 index comprises of top 100 outperforming firms in Karachi Stock Exchange (KSE), Pakistan. Out of 100, 26 financial firms (i.e. Banks, Investment companies, leasing, Insurance, and Mudarabah) are

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excluded from the sample because these firms follow the regulation of central bank of Pakistan and they have different governance structure. Moreover, to make a fair comparison, this study constructs a balanced panel sample and excluded the firms with inaccessible and incomplete annual statement during the study sample period. So, the final sample consists of 50 firms with complete information about the disclosure of board remuneration, board committees, board structure, and still exist during the study period. All the data are extracted from the company's annual reports collected by hand from the company websites. 3.2. Selection of variables Table 1 discusses the key research variables under examination, total remuneration of board of directors which comprises of two forms, cash base remuneration (comprised in base salary, pension, bonuses, medical, utilities and other fringe benefits) and non-cash based remuneration (comprised in form of granted equity, options award, pension, medical, insurance, club subscription, conveyance, utilities, house rent, allowance, and provident funds and incentives plans etc.) that directly influences company performance (Lam, McGuinness, & Vieito, 2013; Raithatha & Komera, 2016; Shao et al., 2012; Sheikh et al., 2018). The accounting-based performance indicator (ROA, TQ, and EPS) is used to measure the performance for two key reasons. Firstly, it is very likely that remuneration packages of the executives are directly influenced by the performance achievement of the previous year (Oviantari, 2011). Secondly, it assists in avoiding the reverse causality problem between the remuneration and performance, which helps to reduce the endogeneity problem (Fakhrunnas & Ramly, 2017). The other independent variables are used as control variables which may influence the remuneration structure and company performance. Corporate governance structure is mainly used as a cornerstone that supports the interrelationship between the remuneration of board of directors and corporate performance (Lee & Isa, 2015). A corporate governance variable helps to reduce the issue relating to accountability, transparency, and disclosure (Solomon, 2007). More specifically the variables of corporate governance are size of a boardroom, board committees existence, independent directors, and dual role of CEO (Raithatha & Komera, 2016; Sheikh et al., 2018). Firm characteristics refer to the corporate size and leverage which influence both performances of the company and executive director remuneration (Doucouliagos, Haman, & Stanley, 2012; Ntim et al., 2015). Moreover, the economic output is measured in term of gross domestic product and inflation is measured in term of consumer price index (CPI). The high rate of GDP indicates the most solvent position of the economy and a low GDP shows a less solvent position of the economy (Al-Najjar, 2014; Sheikh et al., 2018). 3.3. Summary statistics Table S1 Supplemental file available on line reports the descriptive statistics of selected variables of KSE 100 indexed

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Table 1 Research variables. Variables Remunerations' Packages (Dependent and Independent) Salary Bonus Total Cash Remuneration Pension Insurance Retirement fund Medical Utility funds Other funds Total (non-cash) remuneration Firm Performance Indicators (Dependent and Independent) Tobin's Q Earnings Per Share Return on Assets Macro Economical (Controls) Gross Domestic Product Inflation Corporate Governance Mechanisms (Controls) Duality Role Board Size Non-Executive Directors Existence of Board Committee Firm Characteristics (Controls) Family Ownership Institutional Investment Corporate Size Total debt to Equity Total debt to Assets

firms during the period of 2009e2016. The average cash base remuneration of CEOs increased with continued upward trend with the change of 145% from 4404 thousand PKR in 2009e10812 thousand PKR in 2016. In contrast, the non-cash base remuneration has a mixed trend of growth, with the change of 150% from average 1992 thousand PKR in 2009e4988 thousand PKR in 2016. In addition, the same upward trend is detected in the cash base remuneration of directors with the change of 131% and non-cash base remuneration of directors with the change of 113% over the period of 2009e2016. Moreover, the lower median value than the mean value signifies that the remuneration is positively skewed which indicates that a greater number of CEOs and director's remuneration in the form of cash and non-cash is less than the overall average remuneration. In the performance variables, the mean of ROA of pooled sample is 4.08% with SD of 8.87% and the median value is 3.23%. The average value of ROA varies across the years. The mean of ROA decreases 2.08% in year 2009 to
0.002% in year 2010 and after that significantly decreases from 7.59% in year 2014 to 1.45% in year 2015 followed by 1.34% in the year 2016. This is possibly because of political issues and energy crises. The mean of TQ of pooled sample is 0.6% with SD of 0.9% and the median value is 0.3%. Similarly, the ROA and the TQ values are also varied across the years. In addition, the EPS appears to be more fluctuating than ROA and TQ

Definition and Measures Natural log of gross salary Natural log received bonus Natural Natural Natural Natural Natural Natural

log log log log log log

of pension insurance retirement fund of medical fund of gratuity fund of gratuity fund

Ratio of market value of shares over the total value of asset Corporate earnings of the firms annually Ratio of Operating income over assets GDP relative real growth GDP Consumer price index Role of CEO as Chairman Total number of members on the board Total number of members of non-executive directors Existence of Audit, and Remuneration committee separately Distinguishes between family owned and non-family owned firms; family ¼ 0 and non-family ¼ 1 Total number of shares owned by big firms Natural log of corporate total assets Proportion of total debt over equity Percentage of assets financed by debt

across the years. In year 2009, average EPS is
0.23% that is dramatically decreased to
5.35% in year 2010 then it has significantly increased to 18.53% in year 2011 followed by an extensive increased to 53% in 2012. The negative returns in the year 2009 and 2010 is because of political unrest and energy crisis and after that the recovery seems to be due to political stability. In corporate governance variables, the average of board size of pooled sample is near to 8 along with SD of 1.14. For example, Jameson et al. (2014) used an average board size of eight regarding Indian firms. Moreover, on average, the boards are comprised of 65%e67% of non-board of directors on the board over the year. On average, 34% of the CEOs in KSE 100 firms are holding the position of chairman for the board of directors. In addition, about 94% of the firms in pooled sample have internal audit committee and surprisingly only 62% of the firms have remuneration committee. On average, about 50% of the firms in KSE 100 index are from family firms and this percentage is almost stable over the period. In addition, the average of total asset 9265247 thousand PKR decreases in year 2010e7467388 thousand PKR in 2011 and then seems to decrease to 8696742 thousand PKR in 2014. The reason of this decrease is perhaps due to political unrest and energy crisis too. Moreover, firms are taking more debt about 3 times on assets and 2.3 times on equity in 2010 because of instability of the firms due to the political unrest and energy crisis.

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3.4. Correlation analysis Table S2 Supplemental file available on line describes the correlation matrix. Multicollinearity does not appear to be an issue in the finding as none of the supreme estimations of relationship coefficients between regressors are more than 0.70. This is additionally affirmed by variance inflation factor (VIF) as none of the VIF is more than the usually utilized edge level of 10 (unreported). The high levels of an interrelation exist between and within the remuneration packages for CEOs and board of directors with the indicators of corporate performance. The results show that performance indicators and remuneration packages are positively correlated with each other. Moreover, the performance indicators ROA and TQ positively correlated with the cash and non-cash-based remuneration of CEOs and board of directors, but in contrast, EPS is negatively correlated with cash and non-cash remuneration of CEOs. CEO duality and family ownership are negatively associated with both remuneration packages of CEOs and directors that are inconsistent with agency and managerial power theory. The rest of the corporate governance variables (board size, non-board of directors and board committees) are positively associated with ROA and TQ performance and remuneration packages of CEOs, but in contrast they are negatively associated with EPS and cash remuneration of board of directors. In addition, firm internal feature TA is positively and D/A and D/E are negatively associated with firm performance and both remuneration packages of CEOs and directors. 4. Methodology In order to test the hypotheses, the Generalized Method of Moment (GMM) is used to investigate the interrelationship between the pay and performance. GMM approach is used because it controls the problem of potential endogeneity that may arise due to the potential reverse causality between the pay and performance (Sheikh et al., 2018). In addition, GMM is also suitable to solve the unobserved heteroscedasticity problem that arises due to the time invariant variables like board size, non-board of directors (Mollah, Hassan, Al Farooque, & Mobarek, 2017). Studies on the impact of pay on performance and vice versa along with corporate governance (CG) should control endogeneity and heteroscedasticity problem, and thus the GMM is suitable to address this issue (Haron, 2018; Raithatha & Komera, 2016; Sheikh et al., 2018). The current study has two main models for the payperformance and performance-pay. In the first model pay performance contemporaneous remuneration package is estimated with the lagged performance and control variables. 2 X k

Remit ¼ a0 þ

3 X L

b1 Perfit
1 þ

9 X

b2 Xit
1 þ εit

ð1Þ

M

In the second model, performance-pay with the current remuneration package is estimated with the forward year company performance.

L

Perfitþ1 ¼ a0 þ

2 X k

191

b1 Remit þ

9 X

b2 Xit þ εit

ð2Þ

M

In the above two equations, i denotes a company, t denotes a year, Perfit represents performance variables (ROA, TQ, EPS), Remit represents the (cash and non-cash) remuneration packages both for CEOs and executive directors, Xit represents the set of control variables, εit represents the error term. 5. Empirical results and discussion 5.1. Discussion on pay-performance results of CEOs and board of directors Table 2 reports the findings of cash and non-cash remuneration of the CEOs and board of directors as dependent variables. The diagnostic test ArellanoeBond validates the use of second and earlier difference of the dependent variable and all the values of m2 are statistically insignificant for the second order correlation in error terms. Similarly, Hansen J-statistics of over-identification test is statistically significant for the Wald test. The dynamic GMM results suggest that past cash and non-cash remunerations have a positive and significant influence on current cash and non-cash remuneration of the CEOs and board of directors, consistent with the finding of Raithatha and Komera (2016). This might be due to the fact that the remuneration committee considers past compensation as the reference while setting for current compensation. The firm performance, particularly in term of Tobin's Q (TQ) and earnings per share (EPS) is positively and significantly associated with the cash base remuneration of CEOs, consistent with the finding of Sapp (2008). This confirms that CEOs cash base remuneration is linked to the firms TQ and EPS performance. Moreover, ROA and TQ have positive but insignificant relationship with non-cash base remuneration of CEOs that seems to be inconsistent with the managerial power. In addition, all performance measures are not significantly associated with cash base remuneration of board of directors that seem inconsistent with the views of agency theory (Fernandes, 2008). In contrast, firm performance measures, particularly EPS and TQ, have positive and significant relationship but ROA has negative and significant relationship with the non-cash base remuneration of board of directors of the firms, similar to the findings of Conyon and He (2011) and Ntim et al. (2017). These results imply that CEOs/board of directors' pay relates to the restricted stock and other stock base bonuses in Pakistan that is linked with market base performance of firms. The corporate governance variables (board size, CEO duality, non-board of directors) are not significantly contributed in the remuneration settings of CEOs and board of directors, inconsistent with the findings of Croci, Gonenc, and Ozkan (2012) and Ntim et al. (2017). These outcomes are steady with the general view that board in Pakistan are overwhelmed by non-official directors who are contracted from

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Table 2 GMM e cash and non-cash remuneration of CEOs/board directors as functions of firm performance at previous Interval (t-1). Explanatory variables

Cash Rem CEOs

Cash Remuneration of CEOs Non-Cash Remuneration of CEOs Cash Remuneration of Directors Non-Cash Remuneration of Directors Return on Assets Tobin's Q Earnings Per Share Board Size CEO's Duality Non- Executive Directors Remuneration Committee Family ownership Institutional Investment Total Assets Debt to Equity Gross Domestic Product AR (1) in diff. (m1) p-value AR (2) in diff. (m2) p-value Over identification Sargan test p-value Hansen J statistic p-value

0.9458***

Non-Cash Rem CEOs

Cash Rem Directors

Non-Cash Rem Directors

0.8129*** 0.9730***
29.71 457.7939* 25.91**
110.00
310.00 147.86
0.2881**
440.00 0.00 427.3136* 99.06
180.00 0.00 0.271 0.776 0.991

49.51 3.67
14.75 146.93
320.00
260.00 0.1952*
630.00 0.0000** 37.90 65.77 7.52 0.00 0.23 0.679 0.951

1.0468***
130.00 294.04** 49.3333* 476.58
870.00
5.7eþ02* 0.3643* 393.93 0.00
310.00
53.78 134.52 0.00 0.27 0.715 0.982


51.28 484.46 41.79 479.22
140.00
54.48 0.1934* 353.16 0.00
280.00 188.69 39.36 0.00 0.38 0.42 0.999

Notes: *, **, *** indicate statistical significance at 1%, 5% and 10%, respectively.

inside the family or they have close connection with controlling investors (Javid & Iqbal, 2008). Hence, these grey directors on board did not play any role for the selection of compensation of the CEOs and board of directors. Thus, the insignificant relationship found in CEO duality implies that the notion of more concentrated power in one person by combining the position of CEO and Chairman, board of directors may lead to expropriation through higher CEO compensation is not supported in Pakistan. Hence, the remuneration committee has a positive and significant relationship with the remuneration of CEOs and insignificant relationship with the remuneration board of directors (Bebchuk & Fried, 2003; Raithatha & Komera, 2016). This positive relation is in line with general view about CEOs in Pakistan who used their power to influence the remuneration committee in the settlement of excessive compensation not linked to the performance of firm. In addition, family ownership does not play a significant role on the pay selection process but in contrast institutional ownership has positive but minor influence on the pay selection of CEOs and executive director's, similar to the monitoring role of institutional ownership suggested by the agency theory (Hartzell & Starks, 2003). Firm size as measured by total assets has a positive and significant association with cash compensation of the CEOs and insignificant relationship with director remuneration. This supports the argument that larger firms are complex and difficult to run and hence require quality CEOs with higher compensations. Other control variables, firm risk and GDP do not appear to influence the CEOs/board directors' compensation decisions. 5.1.1. Discussion on performance-pay results of CEOs Table 3 presents the estimation results of return on assets (ROA), Tobin's q (TQ), and earnings per share (EPS) as dependent variables in the performance pay framework of CEOs. The diagnostic test ArellanoeBond validates the use of

second and earlier difference of the dependent variable and all the values of m2 are statistically insignificant for the second order correlation in error terms. Similarly, Hansen J-statistics of over-identification test is statistically significant for the Wald test. The dynamic GMM results suggest that past performance indicators (ROA, TQ, and EPS) have a positive and significant influence on the current performance indicators of the firm. CEOs cash base compensation is negatively associated with firm performance measured by TQ and EPS, inconsistent with the finding of Azim et al. (2011). Consistent with the stewardship theory, non-cash compensation of CEOs is positively Table 3 GMM - Tobin's Q, ROA, and EPS at next interval (tþ1) as functions of CEOs cash and non-cash remuneration. Explanatory variables

ROA

Return on Assets Tobin's Q Earnings Per Share Cash Remuneration of CEOs Non-Cash Remuneration of CEOs Board Size CEO Duality Non- Executive Directors Family ownership Institutional Investment Total Assets Debt to Equity Gross Domestic Product Consumer Price Index AR (1) in diff. (m1) p-value AR (2) in diff. (m2) p-value Over identification Sargan test p-value Hansen J statistic p-values

0.4588***

TQ

EPS

0.9259*** 0.0001 0.0001* 0.2337
2.3232*
0.9011* 2.1011* 0.00
0.3153
0.6187*** 1.5814***
7.7583*** 0.00 0.54 0.472 0.977


0.0000* 0.00001*
0.0603* 0.0052 0.0153 0.045 0.00 0.1014***
0.0055
0.0463 0.0689 0.00 0.739 0.21 0.63

0.5863***
0.0001 0.0003* 1.0084
3.5104
0.7016 1.641 0.00 0.6985
0.7434* 1.372
10.3968* 0.00 0.078 0.99 0.596

Notes: *, **, *** indicate statistical significance at 1%, 5% and 10%, respectively.

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related to future ROA, TQ and EPS performance of firm, similar to the findings of Doucouliagos et al. (2007). This indicates that CEO crafted more efforts to get the firm's goals and operational objectives, if they have been awarded sufficient incentives earlier in terms of non-cash (equity, options award, pension, medical, insurance, club subscription, conveyance, utilities, house rent, allowance, and provident funds and incentives plans and so forth). The corporate governance variable board size has a positive significant association with the firm TQ performance and this suggested that board size is a matter for the TQ performance of the firm. Moreover, CEO duality has a negative and significant relationship with performance, particularly ROA and insignificant relation with the other performance indicators. Thus, more power of the CEOs by combining the position of CEO and Chairman in the board of directors yields negative impact on the performance of the firm due to their inefficient decision and control of the firm. Surprisingly, non-board of directors has a negative effect on the firm performance. Hence, these outcomes agree with the general view that board in Pakistan is overwhelmed by non-board of directors selected from inside the family or they have close connection with controlling investors (Javid & Iqbal, 2010). These non-board of directors in board do not fairly assess the firm interest and fail to make a difference subsequently because of inefficient knowledge regarding the duties to be performed. The family ownership appears to have a positive impact on the ROA performance of the firm because family firms are more concentrated to enhance the value on utilizing assets. In addition, the firm's size in term of total assets has positive relations with the TQ performance of the firm. Surprisingly, in Pakistan firm's higher debt on equity significantly decreases the performance of the firms. The gross domestic product (GDP) has a positive and significant relationship with firm performance which indicates that when overall GDP of the country increases, the performance of KSE 100 firms also increases. The inflation which is measured by the consumer price index (CPI) has a negative relationship with the performance. When inflation increases, the overall performance of the firms decreases because sales decreases due to less purchase. The institutional investment does not have any influence on the firm performance. 5.1.2. Discussion on performance-pay results of board of directors Table 4 presents the estimation results of return on assets (ROA), Tobin's q (TQ), and earnings per share (EPS) as dependent variables in the performance pay framework of CEOs. The diagnostic test ArellanoeBond validates the use of second and earlier difference of the dependent variable and all the values of m2 are statistically insignificant for the second order correlation in error terms. Similarly, Hansen J-statistics of over-identification test is statistically significant for the Wald test. The past performance indicators (ROA, TQ, and EPS) have a positive and significant influence on the current performance indicators similar with the pay performance framework of CEOs.

193

Table 4 GMM - Tobin's Q, ROA, EPS at next interval (tþ1) as functions of CEOs cash and non-cash remuneration. Explanatory variables

ROA

Return on Assets Tobin's Q Earnings Per Share Cash Remuneration of Directors Non-Cash Remuneration of Directors Board Size CEO Duality Non- Executive Directors Family ownership Institutional Investment Total Assets Debt to Equity Gross Domestic Product Consumer Price Index AR (1) in diff. (m1) p-value AR (2) in diff. (m2) p-value Sargan test p-value Hansen J statistic p-values

0.4138***

TQ

EPS

0.8933***
0.0001 0.0011*** 0.5056
2.5315*
0.9645** 2.0623* 0.000 0.0383
0.6313*** 1.1728**
6.4598** 0.000 0.256 0.964 0.441

0.00011 0.0001*
0.0534*
0.0676 0.0219 0.0809 0.000 0.1229***
0.0023
0.0584* 0.0662 0.000 0.863 0.35 0.185

0.5989***
0.0001 0.0001* 1.4855*
1.8209
0.7073 1.2565 0.000 0.3074
0.7161* 1.3925
10.2028* 0.000 0.151 0.185 0.409

Notes: *, **, *** indicate statistical significance at 1%, 5% and 10%, respectively.

The cash compensation of directors has an insignificant relationship with performance of firms, which is inconsistent with the stewardship theory. In contrast, non-cash compensation is positively and significantly related to future performance as measured by TQ, and EPS and is consistent with the tournament perspective (Chen et al., 2011; Conyon & Sadler, 2001). These results confirm that the board of firm directors in Pakistan crafted more effort to enhance the market based performance when they are formerly remunerated in term of non-cash incentives. As for the corporate governance variables, board size has a mixed influence on the firm performance, similar to the finding of Mahmudi and Nurhayati (2015). This mixed relation indicates that a larger board soundly assesses the firm's interest and enhances the firm's performance if they appointed well experienced directors on the board. CEO duality and nonboard of directors have negative and significant influence on the ROA performance of the firm. In addition, family ownership has a positive and significant relationship with the ROA performance of the firm. Firm size positively contributes to the firm performance, supporting the finding of Scholtz and Smit (2012). This supports the argument that larger firms are complex and have more assets to generate good profits. In contrast, debt enhancement on equity has a negative and significant influence on firm performance. The country growth in term of gross domestic product (GDP) has a positive and significant relation with firm performance. Surprisingly, the results indicate that higher inflation hurts firm performance significantly. 6. Conclusion and implications This study examines the interrelationships between CEOs/ executive director's remuneration and firm performance (remuneration taking as cash and non-cash both for CEOs

194

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and board of directors). The firm performance proxies were used by several accounting and market based financial indicators (ROA, TQ, and EPS), within the KSE 100 listed non-financial firms during the period of 2009e2016. A series of related control variables (corporate characteristics, corporate governance, and macroeconomic variables) are incorporated. The GMM results indicate a weak two-way relationship between the firm performance and CEO/executive director remuneration. The GMM model was used to avoid the unobserved heteroscedasticity and endogeneity along with being robustly model for both frameworks (pay performance and performance pay) along with multiple control variables. In the pay-performance framework, the CEOs cash and non-cash base compensation of the board of directors are affiliated with the past market base performance in term of TQ and EPS, which is consistent with the finding of Azim et al. (2011). Moreover, the sensitivity of cash base remuneration of CEOs is high as compared to the non-cash base remuneration of a board of directors in Pakistani firms, consistent with the findings of Sheikh et al. (2018). This provides an additional empirical support that the remuneration sensitivity of CEOs to the performance is higher compared to the board of directors. It also offers a new contribution in the prior research by signifying a firm setting of poor corporate governance mechanism and support to the first-tier (CEO power and opportunism) for the agency problem. The performance-pay framework indicates the less degree of coherence with the framework of payperformance. The sensitivity of all performance measures in relation to the remuneration component variables provides a weak but significant relationship with the non-cash base remuneration both for the CEOs and board of directors, consistent with the findings of Doucouliagos et al. (2007) and Monem and Ng (2013) but in contrast to those of Conyon and Sadler (2001). The current study has numbers of new contributions to the existing theoretical and empirical literature. Prior studies just evaluated the direct links between the board pay and performance and generally reported a mixed relation (Chen et al., 2011; Conyon, 2013; Doucouliagos et al., 2012) but the current study incorporates both framework (pay-performance and performance pay) for CEOs/board of directors and how their remuneration and qualities affect the performance and vice versa. However, the current findings indicate that pay performance framework strongly supports the agency theory approach whereby the board of directors and CEOs are compensated for their prior level firm performance and findings are consistent with the previous studies such as Doucouliagos et al., 2007; Sheikh et al., 2018. In contrast, the findings of the performance- pay framework weakly support the notion of the stewardship and tournament theory, whereby board of directors and CEOs perform better in the future, on the basis of prior amounts and structure of remuneration packages. These results are inconsistent with those of Scholtz and Smit (2012).

The findings of the current study are important for the practitioner, policymakers and for the regulatory authorities, especially for those countries and firms that are scrutinizing the puzzle of CEOs/executive director remuneration and corporate governance structure in emerging markets. The key implication of this study is that greater firm performance can be achieved by pursuing policy reforms regarding incentive alignment of executive pay under a good structure of corporate governance. For example, in order to get maximum output, non-cash based incentives (including equity-based pay) should be substantial for the board of directors in order to align with the firm performance. Moreover, firms should strengthen the board independence and properly constitute the board committees (remuneration, risk, nomination etc.). Additionally, our study provides evidence that for better output, the firm should need to improve their corporate governance mechanism in general. Although this study reported significant and reliable findings, it is limited in some aspects. For example, it includes a limited number of observations due to the short sample period. Moreover, the study misses some important variables like external corporate governance, board member features, and equity-based remuneration due to non-availability of data. Therefore, future studies may provide new insights by applying our framework in cross countries especially in the developing countries. Methodologically, more knowledge might be gathered by future researchers by carrying out some structured and unstructured interviews with the board of directors, owners, and regulatory authorities relating to the corporate governance and pay-performance relationships. Conflict of interest There is no conflict of interest associated with this research. Acknowledgement The authors are grateful to the anonymous referees and editor of the journal for their extremely useful suggestions to improve the quality of the article.

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