Ebook CEO Compensation, Firm Size and Firm Performance: Evidence from Finnish Panel Data
After Enron Corp’s financial frauds and bankruptcy in December 2001, chief executive officer (CEO) remuneration in traded firms has been a popular public topic in a number of countries (e.g. The Economist (1999, 2000), Krugman (2002), and Samuelson (2003)). Perhaps more importantly, Enron Corp’s scandal was not a unique incidence. Afterwards we have witnessed, for example, the accounting and compensation scandals of Arthur Andersen, AOL Time Warner, Dynegy, Merck, Qwest, Tyco, WorldCom and Xerox in U.S., Parmalat in Italy, Dutch-based Royal Ahold, and Swedish Scandia.
Shareholders of these firms have lost billions of dollars and all these scandals are said to be related to CEOs equity based incentives, such as stock options. For example, the CEO average pay at the largest companies in the US was 40 times that of the average worker a generation ago, but in 1999 it was 475 as much. A great majority of this compensation increase can be associated with stock option schemes. In Europe, on the contrary, in 1999 executive total compensation was ranked from 11 in the Switzerland to 24 in the UK times that of average employees. (The Economist, September 28th , 2000). In 2002, the pay of top American CEOs was still over 400 times average earnings, but in 2004, however, the figure is reckoned to have fallen close to 160 (The Economist, March 3rd, 2005).
The differing interests and contractual nature between shareholders and top executives is not a new thought in economics. Already Adam Smith (1776) pointed this out: “What are the common wages of labour depends everywhere upon the contract usually made between those two parties, whose interests are not the same. The workmen desire to get as much, the masters to give as little as possible”. He also stated: “The directors of [joint stock] companies, however, being the managers of other people’s money than of their own, it cannot be expected that they should watch over it with the same anxious vigilance [as owners]... Negligence and profusion, therefore, must prevail, more or less, in the management of the affairs of such a company.”
In line with Adam Smith’s observation Berle and Means (1932) later suggested that the separation of ownership and control in a modern corporation may introduce the principal-agent problem due to asymmetric information between shareholders and executives. Although it can be unjustified to categorise executives’ behaviour as a group, asymmetric information may enable executives’ to behave opportunistically and ineffectively. This in turn can increase the probability of serious corporate accounting and compensation scandals leading a substantial decrease in shareholder value.
This study examines CEO compensation in Finland over the period 1996-2002 covering the recent years of stock market up- and downturns. By providing new evidence from a very different institutional context than the U.S. and the UK, we hope to increase our understanding on CEO compensation practices across different countries. Especially, we follow the previous empirical studies by exploring CEO pay-for-firm size elasticity and CEO pay-for-firm performance sensitivity. The key research question is whether CEO compensation is related to firm size and performance in Finland. We estimate several model specifications, where we control for industry of the firm, CEO age, the size of the board, the voting share of a largest shareholder and the share of firm foreign ownership, since all these variables may affect the level and the changes of CEO compensation.
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