CEO compensation and government ownership

• Author: Jesus M. Salas,Ginka Borisova,Andrey Zagorchev
• DOI: http://doi.org/10.1111/corg.12265
• Published date: 01 March 2019
• Date: 01 March 2019

ORIGINAL ARTICLE

CEO compensation and government ownership

Ginka Borisova

1

|Jesus M. Salas

2

|Andrey Zagorchev

3

1

Ivy College of Business, Iowa State

University, Ames, Iowa, USA

2

College of Business and Economics, Lehigh

University, Bethlehem, Pennsylvania, USA

3

Department of Business, Rhodes College,

Memphis, Tennessee, USA

Correspondence

Jesus M. Salas, College of Business and

Economics, Lehigh University, Bethlehem, PA

18015, USA.

Email: jsalas@lehigh.edu

JEL Classification: G15; G32; M12

Abstract

Research Question/Issue: Despite the benefits of privatization (i.e., divestiture of

government‐owned enterprises), governments still own substantial stakes in econom-

ically important firms. Given public concern about excessive compensation and

frequent government responses, this paper compares the level and structure of

CEO compensation in privatized firms, including those still partially owned by govern-

ments, to firms never owned by the government.

Research Findings/Insights: Using a multinational sample of firms, we find that

privatized firms have lower total CEO compensation than private firms never owned

by governments. CEO equity‐linked wealth in privatized firms is less sensitive to stock

performance, and equity compensation is negatively related to government owner-

ship stakes. Privatized companies engage in less risk‐taking than nonprivatized

companies, suggesting that government risk aversion could explain differences in

CEO compensation.

Theoretical/Academic Implications: This study finds that the role government

ownership plays in the level and structure of executive compensation is broadly con-

sistent with pay regulations governments periodically impose. It provides empirical

support for the argument that government owners are risk‐averse and associated

with lower equity‐linked executive pay, which discourages CEO risk‐taking.

Practitioner/Policy Implications: This study encourages corporate boards to

consider the degree of government involvement in their firms when setting CEO

compensation packages and policies. Government concerns about excessive

compensation may require boards to find other ways to incentivize CEOs, particu-

larly given the weaker governance linked to state‐influenced firms. Additionally,

governments should analyze their influences on CEO compensation, and how these

can affect performance, when considering their ownership stakes in public

companies.

KEYWORDS

corporate governance, contracting theory, government ownership, national privatization

1|INTRODUCTION

A significant literature has been devoted to the dramatic increase in

executive compensation in the last 30 years and to the role of corpo-

rate governance in this trend (e.g., Bebchuk & Fried, 2003; Gabaix &

Landier, 2008). For instance, Chhaochharia and Grinstein (2009) show

that executive compensation fell after major stock exchanges imposed

tougher governance restrictions following a series of corporate

scandals in 2001–2002. Alongside academic investigations, the rise

in compensation inequality following the financial crisis of 2008 has

energized media attacks and public outrage against corporate execu-

tives. In response, the U.S. government proposed limiting executive

Received: 5 January 2017 Revised: 3 September 2018 Accepted: 3 November 2018

DOI: 10.1111/corg.12265

120 © 2018 John Wiley & Sons Ltd Corp Govern Int Rev. 2019;27:120–143.wileyonlinelibrary.com/journal/corg

compensation in firms that were bailed out by the government during

the crisis (Weisman & Lublin, 2009). Some European governments

followed suit and proposed regulating executive pay in firms that

receive government aid or that are under some form of state control

(Flynn & Vinocur, 2012; Saltmarsh, 2009).

This anecdotal evidence supports Murphy's (2013) assertion

that, despite being largely ignored in the literature, government inter-

vention has been a major influence on executive compensation over

time. Although governments can pass legislation to broadly restrict

executive pay, implementing regulations that cannot be effectively

circumvented by firms' compensation committees remains a signifi-

cant challenge. However, governments could directly affect executive

compensation in a subset of firms in which governments themselves

have voting power or influence.

In this study, we test the direct impact of governments on com-

pensation by examining a sample that includes privatized companies.

These companies have been state owned and either partially or fully

divested by the government to become publicly traded. Governments

retain explicit ownership stakes in partially privatized firms, and even

fully privatized firms can still be subject to forms of state control

(Bortolotti & Faccio, 2009). Using these different degrees of govern-

ment influence and a direct measure of government ownership stakes,

we specifically test whether the level and structure of CEO compensa-

tion differs between privatized companies and de novo private firms.

1

We explore several hypotheses regarding the relation between

privatization and compensation. On the one hand, evidence suggests

that privatized companies have worse corporate governance than

nonprivatized companies (Borisova, Brockman, Salas, & Zagorchev,

2012). As a consequence, privatized companies may overpay their

CEOs and use less incentive‐based compensation plans. On the other

hand, we recognize it is possible that CEOs of government‐owned

companies accept lower compensation for a number of reasons. For

example, it is possible that working in government‐owned companies

gives CEOs access to nonpecuniary benefits, such as numerous

external directorships. Another possibility is that governments suc-

cumb to political and media pressure, undercompensating CEOs of

privatized firms due to complaints about excessive CEO pay. As a

consequence, privatized firms may not hire the best manager and

thus underperform. It is also possible that CEOs accept less total pay

in exchange for less equity‐based pay, and governments may prefer

to compensate executives in this manner to discourage CEOs from

taking on excessive risks (Boubakri, Cosset, & Saffar, 2013; Hall &

Murphy, 2002).

We find that CEO compensation is lower in privatized companies

than in nonprivatized companies. Thus, our analysis does not support

the idea that agency problems and poor governance in privatized firms

are associated with higher levels of CEO pay. CEOs of privatized firms

also have significantly less wealth linked to stock performance and

smaller equity components of compensation than de novo private

firms. In additional tests, however, we find CEOs in privatized firms

have total pay more strongly related to their firm's market perfor-

mance ex post, suggesting a compensation structure that includes

incentives but that is counterbalanced by political concerns about

large equity‐based pay gains. Additionally, although political pressure

likely influences the lower compensation in privatized firms, we do

not find evidence suggesting that governments can only hire poor‐

quality CEOs because of low levels of compensation, given that

privatized firms do not underperform relative to de novo private firms.

These results are confirmed in similar tests when we measure govern-

ment influence by the size of state ownership stakes.

In addition, our results do not show that CEOs of privatized firms

benefit from nonpecuniary benefits such as external directorships. In

fact, we find that CEO jobs are more perilous due to political

factors. Specifically, CEO turnover is higher in privatized firms than

in nonprivatized firms, particularly in periods immediately following

major elections. CEOs therefore do not appear to accept jobs at

privatized firms because of nonpecuniary benefits.

Because privatization is not random and to control for inherent

firm‐level differences in these subsamples, we also test for differences

in CEO pay using a propensity‐score matched sample that pairs each

privatized firm with a similar de novo private firm. This matching ren-

ders insignificant the firm‐level differences that exist between these

groups, importantly including firm size, as privatized firms are often

some of the largest in their respective nations. Additionally, our mea-

sure of residual government ownership in privatized companies is

unlikely to be endogenously determined with executive compensation.

Governments did not choose to invest (or subsequently divest) in

these corporations because of the level of executive compensation

or related governance factors, as other shareholders might have.

Rather, it is more likely that governments continue to influence exec-

utive compensation with the control afforded by their residual owner-

ship stakes following privatization. Nevertheless, to ensure our results

are robust to other forms of potential endogeneity and unobserved

effects, we also include instrumental variable regression models and

employ firm‐clustered robust standard errors. Our sample firms are

drawn from the European Union (EU) because it provides an informa-

tive mix of institutional differences and relative cultural homogeneity

and because this region has a high incidence of government owner-

ship (Megginson, 2010).

Our main results about compensation structure are consistent

with the argument that governments are risk‐averse and discourage

CEO risk‐taking by offering less equity‐linked pay. We find greater

CEO equity‐linked wealth tied to better performance in de novo pri-

vate firms and to worse performance in privatized firms, suggesting

the risk‐averse nature of the latter. CEO compensation in privatized

firms therefore is biased against equity‐linked pay, and CEOs are will-

ing to accept lower wages overall given the low focus on equity‐based

performance targets.

In theory, compensation should be linked to firm performance,

and equity‐based incentives align goals of shareholders and managers

(Jensen & Meckling, 1976). However, firm ownership has been linked

to differences in compensation structure, and our work adds to this

stream of literature. For example, Hartzell and Starks (2003) find that

institutional ownership is related to higher performance‐based com-

pensation and lower overall levels of compensation. More recent work

explores the effects of family ownership on executive compensation

and how resultant agency issues lower pay‐for‐performance sensitivi-

ties (Cheng, Lin, & Wei, 2015). We show that state ownership, which

continues to be prevalent in some of the largest international firms, is

linked to different compensation structures based on characteristics

BORISOVA ET AL.121