Academic journal article International Review of Management and Business Research

Endogeneity of the Relationship between Managerial Compensation and Firm Value: Evidence from French Listed Firms

Academic journal article International Review of Management and Business Research

Endogeneity of the Relationship between Managerial Compensation and Firm Value: Evidence from French Listed Firms

Article excerpt

(ProQuest: ... denotes formulae omitted.)

Introduction

The relationship between the managerial compensation and the value of the firm has been heavily debated in the literature (Firth and al., 1996 ; Elston and Goldberg, 2003 and Cao and al., 2010). Indeed, the executive compensation plays a key role in aligning the interests of the managers with those of the shareholders (Hall and Liebman, 1998). This accounts for the great impact of wages on performance during the 1980-1994 periods which is primarily due to the increasing use of stock options. Thus, the relationship between the ownership structure including managerial ownership and compensation through stock options was emphasized (Merhan, 1995). This relationship has been confirmed in several contexts mainly in Australia (Evans and Evans, 2002), China (Cao and al., 2010 ; Conyon and He, 2011), the United States (Core and al., 1999 ; Boyd, 1994 et Baek and Pagan, 2006), Finland, (Vittaniemi, 1997), Portugal (Fernandes, 2008) and researchers concluded that the link between option allocation and corporate performance is statistically negative and positive.

It is worth stating that the relationship between managerial compensation and the value of the firm cannot be explicitly accounted for unless we include the governance or control mechanisms encompassing the managerial ownership and the Board of Directors (Lei and Song 2008 and Lee and Cheng, 2011). Therefore, the binding of opportunistic managerial compensation is possible only in the presence of a board of directors who depends on the manager. More accurately, independent directors, aware of the power of the CEO, seek to curb his opportunism by preventing him from earning a large salary that does not reflect his effort and which negatively affects the value of the firm. This expropriation of the shareholders' wealth can have a negative impact on the firm. First, a high salary reduces the results heralded by the firm. Such a reduction is adversely remunerated by the market and brings about a downward trend of the firm's value. Then, a high salary may be perceived by the investors in the market as an evidence of the existence of an interests' conflict. This fact can negatively influence the value of the firm (Vittaniemi, 1997; Core and al., 1999 and Baek and Pagan, 2006). Furthermore, the market investors do not only control the executive compensation regardless of his ownership and the governance implemented. Indeed, good governance allows to monitor the agency conflicts, insures a transparency climate and leads to the congruence of interests. This good governance takes into account the 'weight' of the manager in the firm and attempts to provide him with an equitable remuneration granted according to his effort. The rise or the fall of this remuneration occurs according to the managerial performance. Because this pay level is controlled by independent directors, investors will adjust the value on the market.

Henceforth, we can deduce that the property of the manager affects the level of his remuneration through the power with which it entrusts him. Nevertheless, this level is monitored by the established governing characteristics. Executive compensation properly reflects his competence and fairly reflects his performance within the corporation. This is likely only in the presence of an effective governance. Indeed, a lax governance system is unable to curb the manager's opportunism and limit its discre tionary power (Cohen and Lauterbach, 2008). Such a system becomes thoroughly dependent on the manager and is prone to hide acts that might increase his wealth and shrink that of the shareholders. However, such relationships cannot escape the market that controls the competence of the manager through the performance achieved by the firm. In other words, if the announced performance is good and if it is fulfilled under an independent control that precisely sets the executive compensation regardless of the power entrusted to him by his property, it will be well assessed by the market. …

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