CEO compensation

RESEARCH PAPER REVIEW

CEO Compensation An Audacious Research Work Arhan Sthapit Bank CEO Compensation Research; By Prof. Dr. Manohar K. Shrestha, Suresh Gautam and Santosh Mainali; Published By: Bisleshan P. Ltd.; Strategic Alliance of Nepal Rastra Bank and Nepal Economic Review (NER); First Edition 2011 July; Pages: 44+4+4; Price: NRs. 200/- (individual), 500/-(institution).

CONTEXT OF CEO COMPENSATION Compensation to the chief executive officer (CEO) of commercial banks has drawn attention from different walks of life in recent years, as it has taken an upward spiral and gained volum es. ‘ ’ At times, it becomes an issue of envy and equity. While equity— based on the job-evaluation (relative job-worth) in compensation— is a universally accepted guideline for building pay-plans (Sthapit, 2008; Singh & Sthapit, 2008; Fisher, Schoenfeldt & Shaw, 2006), there is also a spell of envy cast by those apparently jealous about the handsome pay and perks of commercial bank CEOs. Yet, compensation disparity between CEOs and other employees of a bank in Nepal has formed a big chasm. It is, of course, a burning issue. If we were to go by the equity theory, there would be the need for striking a balance between the inputs the CEO brings to his job and the outcomes he receives from it. While ‘Inputs’ include experience, education, special skills, effort, and time worked, ‘Outcomes’ include pay, benefits, achievement, recognition, and any other rewards and inputs are to be continually compared with outcomes (Fisher et al, 2006). Worldwide, executive compensation has been a highly charged HR topic since the 1990s. Conspicuously, for more than 40 years, the spring issue of Business Week reported on executive pay at more than 350 publicly held companies in the US. Company performance Mr. Sthapit, Lecturer of Management at Tribhuvan University, also possesses nearly seven years’ experience in joint-venture commercial banking in the early-1990s. He is currently pursuing his PhD research at Jodhpur National University (Rajasthan, India) in the area of Strategic Human Resources.

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Peoples' Journal of Management, March 2012, Vol. I, No. 1

was also rated for the most recent three years, and only tenuous links between performance and CEO compensation were noted. Its findings also brought the CEO compensation row to new heights: CEO cash compensation increased 9.1 percent in 2003, whereas salaried worker pay increased 3 percent. In 1993, the average CEO in the US earned $3,841,273. By 2000 this figure had reached $13.1 million, but by 2003 had amounted to $8.1 million. In 1980, CEO pay was 42 times the pay of the ordinary factory worker; in 2001 it was 531 times as much, but again, because of the falling stock market, it had dropped to 282 times by 2002. CEO pay rose some 313 percent between 1990 and 2002, much faster than the profits, sales, worker pay, or inflation. On this score, Carpenter & Sanders (2002) emphasized on the need to link the CEO pay with firm’s performance. Most previous studies have found a significant (yet weak) link between the compensation of the top executive of the firm and the company’s performance (Agarwal & Mandelker [1987], Abowd [1990], Lewellen, Loderer, Martin & Blum [1992], Akhigbee, Madura & Tucker [1995], Core, Holthausen & Larcker [1999], Guay [1999]). Therefore, it is relevant to investigate if the CEO pay of Nepali commercial banks is being linked with their performance in terms of returns on investment, and reducing non-performing loans, among others. Meanwhile, in view of increasing unionisation of public and private sector organisations in the country after the Second Popular Movement of 2006, the influence of unions and their federation at the national level has become a force to be reckoned with. It could also apply to fixing CEO pay and perks. In an empirical study in South Korean firms, Cho, Cho & Woo (2012) found that unions reduce corporate expenditures on CEO perks and pay, and also decrease the probability that the perk expenditure will exceed the tax exemption limit. This issue can be an emerging in CEO compensation research in the future.

RE S E ARCH UNDE R RE V I EW : A W EL COM E E F F O RT

In this context, in the advent of the NRB taking the initiative to systematise the bank CEO pay, a research work has been conducted by a team led by Prof. Dr. Manohar K Shrestha. The current article aims at making a brief review of the same research paper. Conducting a research work on such a widely and heatedly discussed issue as bank CEO’s compensation is really a welcome effort; probably it is the first research commissioned from the formal sector in this particular subject. It has indeed come as a ‘curtain-raiser’ that should open new avenues for initiating new research endeavours with more of the depths and lengths in the future. It could earn Prof. Shrestha’s team big accolades. Bringing the research work into the printed form is yet another commendable initiative of the NRB and NER. It has made the study finding and insights accessible for the concerned authorities and interested researchers and readers. The research paper, however, has left a few stones unturned. The following paragraphs will elucidate some of such areas. L it e r at u re r ev iew

It would be better if the existing literature review on how the study variables were identified for setting the regression equation was given. In this paper, readers will find no specific literature review on CEO compensation (including the pay and perquisites), let alone the

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international practices; even though the research claims “to make international comparisons.” Literature review is expected to build the groundwork on the basis of which every research work is formulated and initiated. There is no dearth of related past studies across the globe. For instance, Singler (2003) found that all three independent variables— viz. return on equity (ROE), CEO tenure and company revenue— were statistically significant in explaining CEO cash compensation in the public-sector firms of the US healthcare industry. Nourayi & Mintz (2008) also examined the association of CEO's compensation with tenure and firm's performance and size and reported that firm size is the significant determinant of CEO compensation while both market-based and accounting-based performance measures are negatively correlated with the CEO pay. The study identified nine factors as independent variables: a) return on equity, b) return on assets, c) interest-rate spread, d) cash reserve ratio, e) capital adequacy ratio, f) non-performing loan, g) credit deposit ratio, h) log total assets, and i) log operating income before bonus and tax. But, as pointed out above, there is no literature back-up to establish these nine variables as those on which the CEO compensation is supposedly dependent. Then, a striking question instantly crops up if net earnings (net profit) before and/or after tax, inter alia, should be taken as another independent variable, as it can offer the most convincing basis to fix the concerned CEO’s pay and perk.

Population and Sample Determination As per the NRB report on Banking and Financial Institutions Statistics, 2011, there were 28 commercial banks in Nepal at the end of fiscal year 2009/010. The study covers 5-year data from 2005/06 to 2009/10. However, in the study, neither the population (and size) was clearly identified, nor were any criteria of sampling the 21 banks elucidated. As a result, there is no justification as to why influential banks like Standard Chartered Bank (Nepal) and Nepal SBI Bank, as well as giant government-undertakings like Nepal Bank Ltd., Rastriya Banijya Bank and Agricultural Development Bank (upgraded into a commercial bank) were excluded from the study. The study has included the data of Development Credit Bank Ltd even for the period it was not a commercial bank. It was only in May 2008 that it was upgraded from a development bank (DCBL website, 2012). The data of any development bank can no way be treated as those of a commercial bank. Such inconsistencies could dampen the very quality of the research. The comments also apply to the data of Prime Commercial Bank, Bank of Asia (Nepal), Citizen Bank and Sunrise Bank. The annual data of these four banks for the 1st and 2nd years (2005/06 and 2006-07) of this five-year study are not available. How would then the data of these four banks be comparable with those having all 5-year data?

Data Analysis and Discussion The paper would have been better if it made improvements in the data analysis part. There are examples galore. Table 4 showed a significant, positive correlation between the CEO salary and operating income before bonus and tax at 0.01-level, but the regression (i) between the same variables was negative and insignificant at (-0.144). The contradiction is not natural; it is adequately indicative of having problems in the data-series itself. But, the study has not bothered to explain this contradiction (page 17). In the regression analyses (p. 17), the study has not performed any autocorrelation tests even though the data clearly demand the same. It would also be better applying multicolinearity test to the data. In most of the cases, there is enough room for improvement in explanations of the

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statistical outputs. In all regression analyses, the relationships between CEO salary and any other independent variables were tested against the ‘theory’ without stating what the ‘theory’ actually is. Let alone the explanation as to what any regression (significant or insignificant) between CEO salary and any other variable implies. Another lapse could be noticed in the explanation of regressions. In regression (i) on page 17, for example, the study rejected null hypothesis citing that “calculated value of F is greater than critical or tabulated value.” In fact, F-value in this instance is the basis for determining whether the regression model fits well. Such technical veracity should better be taken care of . In the same regression, the result showed that decrease in interest-rate spread would bring about an increment in the CEO salary. The study has no explanation whether such a finding is normal (expected) or not. In Table 5, the regression model 3 has revealed a statistically significant relationship between salary and non-performing loan (t-value 2.23 at 0.01 level); if the result were to be believed, increased non-performing loans should mean increased CEO-pay. How could this happen? The study has not spelt out any possible reason behind such bizarre findings. In Table 5, 6 and 7, many regression models have shown statistically significant intercepts, but the authors have not explained what they mean in practical life. In fact, a statistically significant intercept indicates that there are more independent variables than the studied ones that influence the dependent variable (the CEO salary in the given instance). A researcher’s job ’ ” does not get complete until the results are properly explained and their “whys and how s adequately researched. F o r mat a n d pr es e nt ati o n

Using Gregorian calendar (English date) is always sine-qua-non for any professional write-up in English. The paper has used Bikram calendar in several instances (e.g., 2058, etc.), lest it could not only confuse the readers but also make it impossible for any non-Nepali reader to understand. The bibliographic format of the paper is not the properly organised one. Many in-text citations have not gone missing in the reference. The examples include Bebhuk & Parmann (2010), Williamson (1985) [p. 6], and Basu (2010) [p. 22]. Above all, it has made references to the NRB Act from time to time in the text but without any mention in the reference. Likewise, the ‘Reference’ has no mention of the Basel-II albeit being mentioned in the context of capital adequacy, purportedly “one of the independent variables of the CEO pay.” Basel -II is the capital adequacy framework and standards (NRB, 2012) that constitute the basis of the NRB’s capital adequacy guidelines. Au contraire, the reference section contained Barro and Barro (1990) and few other journal-works without any in-text citation. In the reference section, the paper has quoted the newspaper materials by their publication house instead of the author or newspaper; it contradicts with established international practices of citations like APA, Chicago, MLA or Author -Date.

There is also adequate room for improving the presentation language; more specifically, in case of consistency and lucidity. Some paragraphs were well written in a more rhetorical and ‘ ’ figurative style that would give a sensitised message to the readers while sentences in other paragraphs are either very sloppy or stereotyped. In the ‘data analysis/explanation’ section, the ‘ ’ sentences appear as copy-paste; except a few changes made in data figures. Inadequate explanation of data and results would make a research report less communicative and convincing.

CEO Compensation: An Audacious Research Work: Arhan Sthapit 51

Inter-study/ Inter-country Comparisons The issue CEO compensation does not exist in isolation. It is inextricably interrelated with so many policy and financial factors, and has become a globalised topic. It is but natural that this matter has very widely been researched throughout the world. While DeYoung, Peng & Yan (2009) studied the issue in US large commercial banks, there are a myriad of related studies including those of Petra & Dorata (2008), Sigler [2003], Carpenter & Sanders (2002), Guay [1999], Core, Holthausen & Larcker [1999]), Akhigbee, Madura & Tucker [1995], Lewellen, Loderer, Martin & Blum [1992], Abowd [1990], and Agarwal & Mandelker [1987]. But, the current study has made no comparison with international practices and left a big lacuna unfilled.

More issues for future studies The study has made use of an opinion survey of the Bankers’ Association officials through an open-ended question. It would be better if it had also conducted a survey of key stakeholders including incumbent and retired CEOs of the select commercial banks and performed the primary data analysis. It would not only help cross-check but also crystallise the findings and their policy implications elicited from the secondary data analysis. If different indicators of CEO performance were to affect the CEO compensation, the other way round might also be possible. A CEO’s past compensation (i.e., take-home) and status would also influence his salary at the new bank. Future studies could also go for applying Granger Causality Tests on such issues. Now that NRB has sought to set the tabs on the commercial bank CEOs to end the pay-disparity would naturally expose a question as to whether there should be any ceiling on salary and perks of the top executives of NRB itself. Shouldn’t the paper raise such an issue in order to maintain the fundamental ABC (accuracy, balance and credibility) of the study? Raising such an issue may not, however, please the NRB top-brass. CONCLUSION

In the nutshell, the study has come to the readers as an audacious, relevant work conducted, nonetheless, with a directed goal, and as the one with few technical shortcomings. It is comparable with a game where players have good attitude and wonderful game but make unforced mistakes without comprehending what they are playing; let alone the result of the game. Despite the few flaws and limitations, the research work is highly commendable for exploring adventurously into a relatively uncharted territory of research. Kudos should go to Prof. Dr. Shrestha and his team. It has opened up newer avenues for more meaningful and specific research works in the days to come. It could also make one wonder if Prof. Shrestha can do great with his scholarly observation and without using too much ‘numerical based empirical study.’ Page-formatting is largely satisfactory. Mediocre organisation of text in a few instances has, however, given a little cramped and poky look. Using a different font for the box items could give a better look. Cover designing is communicative. REFERENCES Abowd, J. (1990). Does Performance-Based Compensation Affect Subsequent Corporate Performance? I n d u s t r i a l a n d L a b o r R e l a t i o n s R e v i e w (February). 52-72. Agarwal, A. & G. Mandelker (1987). Managerial Incentives and Corporate Financing and Investment

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Decisions. Journal of Finance (September). 823-838. Akhigbe, S., J. Madura, & A. Tucker (1995). Re-examining the Link Between Executive Compensation and Corporate Performance: A Note. American Business Review (June), 83-89. Banking and Financial Institutions Statistics (2011 January). Banking and Financial Institutions Regulation Department Research Division, Nepal Rastra Bank. No. 56. p 46. Retrieved from http://www.nrb. org.np/Banking_and_Financial_Statistics Carpenter, M. A. & Sanders W. M. G. (2002). Top management team compensation: The missing link between CEO pay and firm performance? Strategic Management Journal, 23 (4), 367-375. Cho, J., Cho, D. & Woo, K. (2012). The impact of labor unions on corporate perks in Korea: human resource management perspective. Asia Pacific Journal of Human Resources. 50, 61–74. Retrieved www.ahri .com Core, J., R. Holthausen, & D. Larcker (1999). Corporate Governance, Chief Executive Officer Compensation, and Firm Performance. Journal of Financial Economics. 51. 371-406. Development Credit Bank Ltd. (DCBL) official website http://www.dcbl.com.np/about/ Fisher, C. D., Schoenfeldt, L. F., Shaw J. B. (2006). Human resource management (Sixth ed). Boston, USA: Houghton Mifflin Company. Guay, W. (1999). The Sensitivity of CEO Wealth to Equity Risk: An Analysis of Magnitude and Determinants. Journal of Financial Economics, 53. 43-71. Nepal Rastra Bank, NRB (2012). Basel-II In Nepali Perspective. NRB official website http://www.nrb.org. np/bsd/pdffiles/FAQBaselllinNepaleseperspective.pdf Nourayi, M. M. & Mintz S. M., (2008). Tenure, firm’s performance, and CEO’s compensation. Managerial Finance. 34 (8). 524 – 536. Retrieved from http://dx.doi.org/10.1108/03074350810874055 Petra,S.T.&Dorata,N.T.(2008).Corporategovernanceandchiefexecutiveofficercompensation.Corporate Governance. 8 (2). 141 – 152. Retrieved from http://dx.doi.org/10.1108/14720700810863779 Sigler, K.J. (2003). CEO compensation and healthcare organisation performance. Management Research News (Emerald). 26 6. 31-38. Retrieved from http://dx.doi.org/10.1108/01409170310783510 Singh, T.M. and Sthapit, A. (2008). Human resource management: Text and cases (First ed.). Kathmandu, Nepal: Taleju Prakashan. Sthapit, A. (2008 Oct 28). Emergent Human Resource Management: Evolving Dimensions. The Rising Nepal: Gorkhapatra Corporation. 4