Directors' Remuneration and Performance in Australian Banking

• Author: Saeed Askary,Hristos Doucouliagos,Janto Haman
• DOI: http://doi.org/10.1111/j.1467-8683.2007.00651.x
• Date: 01 November 2007
• Published date: 01 November 2007

Directors’ Remuneration and

Performance in Australian Banking

Hristos Doucouliagos*, Janto Haman and

Saeed Askary

This paper explores the relationship between directors’ pay and performance within Austra-

lian banking, using panel data for the 1992–2005 period. The relationship between CEO pay

and performance is investigated also. Several earnings models are estimated, using different

dependent variables, alternate measures of performance and different estimation techniques.

The results indicate an absence of a contemporaneous relationship between directors’ pay and

bank performance, and no association with prior year performance. However, there is a more

distant pay-performance relationship, with total directors’ pay having a robust positive asso-

ciation with earnings per share lagged two years, as well as with ROE lagged two years. The

other key determinants of directors’ pay in Australian banking are bank specif‌ic managerial

policies, lags in the administration of pay, bank size, directors’ age and directors’ stock

ownership. In contrast to total directors’ pay, the evidence conf‌irms a strong positive and direct

association between CEO remuneration and prior year bank performance. The pay-

performance association is stronger and more direct for CEO remuneration than it is for total

directors’ remuneration. The responsiveness of CEO pay with respect to bank performance

appears to have increased over time.

Keywords: Corporate governance, directors’ remuneration, bank performance

Introduction

Asubstantial and inf‌luential literature has

emerged on CEO compensation and the

performance of corporate entities.1Relatively

little is known however about the determi-

nants of the pay of other senior personnel. For

example, there exist only a handful of empi-

rical studies that explore the relationship

between directors’ pay and performance (e.g.

Main, Bruce and Buck 1996; Wan, Ong and

Tung 2000; and Stathopoulos, Espenlaub and

Walker 2004). While several studies have

explored CEOs’ remuneration in Australia

(e.g. Izan, Sidhu and Taylor 1998; and Fleming

and Stellios 2002), there are no existing studies

on the determinants of board remuneration

using Australian data. Pay is an important

mechanism for soliciting effort, rewarding

productivity and ensuring compliance with

owners’ interests. Hence, the dearth of infor-

mation on the directors’ pay-performance

association is surprising, especially given the

amount of publicity in Australia regarding the

remuneration of senior personnel.

The issue of executive and director’s pay has

attracted the interest of both the Australian

public and policy makers (Woldring 1995; Hill

and Myablon 2002; and Brown and Samson

2003). Understandably, it has attracted also

the interest of the Australian Stock Exchange

(ASX). According to “the nine principles and

recommended best practices” issued by the

corporate council of the ASX, corporate enti-

ties are required to ensure that the level and

composition of remuneration is suff‌icient and

reasonably linked with the performance level

of directors (Fraser, 2003).

The aim of this paper is to contribute to our

understanding of pay and performance in

Australian corporations, by investigating em-

pirically the determinants of board directors’

*Address for correspondence:

School of Accounting, Econom-

ics and Finance, Deakin Uni-

versity, Melbourne Campus,

221 Burwood Highway, Bur-

wood, Victoria 3125, Australia.

Tel. (61 3) 9244 65311; Email:

douc@deakin.edu.au

DIRECTORS’ REMUNERATION AND PERFORMANCE IN AUSTRALIAN BANKING 1363

Volume 15 Number 6 November 2007

© 2007 TheAuthors

Journal compilation © 2007 BlackwellPublishing Ltd, 9600 Garsington Road,

Oxford, OX4 2DQ, UK and 350 Main St,Malden, MA, 02148, USA

pay inAustralian banking. We investigate also

the determinants of CEOs’ pay, and compare

the pay-performance relationship between

these two parts of the managerial hierarchy.

We deliberately focus on Australian banking

for two reasons. First, Australian banks re-

ceive signif‌icant scrutiny from investors, the

f‌inancial press and the public in general.

Banks such as the National Australia Bank,

the Commonwealth Bank, Westpac and the

Australian New Zealand Banking Group

attract also the attention of non-Australian

investors. Australian bank stocks are seen

widely and correctly by the investment advi-

sory community as an important part of a

diversif‌ied portfolio, are held extensively by

institutions, and form part of virtually all

superannuation (pension fund) holdings.

The deregulation of Australian banking has

focused attention on the banks, principally in

the light of controversies regarding bank oper-

ating hours, branch closures and bank fees.

Moreover, like banks elsewhere, Australian

banks are subject to signif‌icant regulatory

control and supervision. While interventions

such as deposit insurance and protection by

central banks and monetary authorities lead to

moral hazard problems (Macey and O’Hara

2003), it is also possible that the greater regu-

latory scrutiny may put extra pressure on

banks to design optimal contracts.2

Second, empirical investigations that

involve organizations from different sectors

are troubled with the need to account ad-

equately for the inherent heterogeneity in

the sample. This makes drawing statistical

inferences more diff‌icult. While individual

organizational f‌ixed effects are a vital factor in

explaining heterogeneity, combining organi-

zations from different industries imposes

additional burden. By focusing on a single

industry we can abstract from industry ef-

fects and focus purely on the impact of f‌irm

level differences. A similar industry spe-

cif‌ic approach has been adopted by Collins,

Blackwell and Sinkey (1995) and Mishra and

Nielsen (2000) for US banking.3

Weinvestigate the pay-performance associa-

tion for Australian banking, by using a panel

datasetfor all publicly traded Australian banks

over the period 1992 to 2005. The dataset

covers the remuneration packages of 265 direc-

tors, 30 of whom are CEOs, resulting in a com-

bined total of 1,419 years of remuneration

observations. We make f‌ive contributions to

the literature. First, we add to the relatively

small pool of studies that informs on the pay-

performance association in Australia. Second,

we present estimates for both CEO and

directors’ remuneration and compare the

pay-performance responses. Third, while most

Australian studies use data relating to the

1980s and early 1990s, this study uses more

recent data. Fourth, the extant Australian

studies combine observations for many indus-

tries. Our study is more focussed by exploring

only the banking sector. Finally, while the situ-

ation is changing, most studies have ignored

the role of corporate governance as a factor in

directors’ remuneration. Given the justif‌ied

global interest in corporate governance and its

heightened importance to banking (Macey and

O’Hara 2003), it is desirable to explore empiri-

cally the impact of corporate governance on

directors’ and CEOs’ pay.

The paper is structured as follows. Section 2

of the paper presents a brief overview of the

theory relating to pay and performance, as

well as a brief review of several recent studies.

The data and econometric methodology are

discussed in section 3. The results are pre-

sented and discussed in section 4, followed by

the summary and conclusions in section 5.

Theoretical framework and

prior studies

One of the most extensively debated issues in

the corporate governance literature continues

to be managerial compensation. Several theo-

ries have been developed to explain the

process through which directors’ remunera-

tion is determined. These theories include

agency theory, competition in executive labour

markets, as well as a range of socio-economic

and socio-psychological factors. Bender (2003)

and Perkins and Hendry (2005) review some

of these theories.

Empirical researchers tend to rely upon the

theory of managerial compensation derived

from agency theory and draw upon the

principal-agent relationship (Dogan and

Smyth 2002; Crespi-Cladera and Gispert 2003).

According to agency theory, the aim of com-

pensation contracts is to reward managers

in such a way that they strive to maximise

f‌irm performance and shareholders’ wealth.

However, factors such as institutional rules

and markets, sectoral performance, f‌irm or

company size, and ownership structure mod-

erate the board-shareholder relationship and

consequently the pay-performance association.

A generic earnings function can be

expressed as:

ln ,earnings f

()

=

()

eZ(1)

where ln is the natural logarithm, eis manage-

rial effort and Zis a vector of variables other

than performance that inf‌luence earnings.

1364 CORPORATE GOVERNANCE

Volume 15 Number 6 November 2007 © 2007 TheAuthors

Journal compilation © BlackwellPublishing Ltd. 2007