Academic journal article The Journal of Developing Areas

Effect of Corporate Governance on CEO Pay - Risk Taking Association: Empirical Evidence from Australian Financial Institutions

Academic journal article The Journal of Developing Areas

Effect of Corporate Governance on CEO Pay - Risk Taking Association: Empirical Evidence from Australian Financial Institutions

Article excerpt

(ProQuest: ... denotes formulae omitted.)

INTRODUCTION

CEO (chief executive officer) compensation continues to be a topic of great research interest to many finance academics (see Jensen & Meckling, 1976; Jensen & Murphy, 1990; Joskow & Rose, 1994; Merhebi et al., 2006; Murphy, 2012; Ndayisaba & Ahmed, 2015) and in financial press in Australia since the failure of the second largest insurance company (HIH Insurance) in 2001 (ACSI, 2015; Creighton, 2015). During Global Financial Crisis (GFC), many financial institutions went into liquidation while others were rescued by their governments. Erkens at al. (2012) argue that in 2008, the USA government bailout plan reached USD 700 billion, while in England bailing out financial institutions costed British taxpayers USD 750 billion. However, Australia did not see large and many corporate collapse following the GFC as compared to other western countries. This has generally been due to its proactive regulatory framework that was in place before and during the GFC. RBA (2008) notes that Australian banking system was soundly capitalized and performing; had relatively little exposure to the US sub-prime related assets; and remained highly profitable during the global crisis of 2008-2009.1 As a result, Australian government did not have to bailout any commercial bank or other financial institution, except taking steps to guarantee deposits up to one million Australian dollars to avoid a run on banks during the crisis (ACSI, 2015). Corporate failure prior to GFC (One.Tel and HIH Insurance in Australia) and more recently during GFC (Lehman Brothers in US and Icelandic banks) has encouraged Australian regulatory agencies such as Australian Prudential Regulation Authority (APRA), Australian Securities and Investments Commission (ASIC), Reserve Bank of Australia (RBA) to implement stronger regulatory measures. Guiding principles and new legislations have incorporated corporate governance changes to bolster sustainability and management accountability. As a result of this, the Australian Securities Exchange (ASX) requires board of directors to remunerate CEOs and directors accordingly to their performance and pay guidelines. In banking sector, Basel III reforms requires FIs to be more capitalised, and maintain minimum rate of 8% of capital to be held in reserve as insurance against losses, to improve stability and reduce future economic shocks (ACSI, 2015). All these measures are enforced by regulatory agencies to reduce agency costs.

The collapse of many financial institutions during the GFC has not gone unnoticed. These failures have not only increased government intervention policies worldwide but also created research interest in the area of corporate governance, executive remuneration and bank performance around the globe (see Grove et al., 2011; Mehran et al., 2011; Pathan & Faff, 2013). There has been a new wave of empirical research in the area of executive remuneration examining either the possible association between executive remuneration and risk taking (Fahlenbrach & Stulz, 2011) or the link between governance and expected default probability (risk taking) in banking and financial sectors (Erkens et al., 2012). In searching for some plausible explanations behind the crash of US stock market that affected world financial markets in 2008, executive remuneration structure of financial institutions is suspected to be the major cause. It is argued that executive pay structures were poorly designed and provided incentives that encouraged senior management to take on high risk opportunistic investments prior to the GFC (Han, 2016). However, other studies such as Fahlenbrach and Stulz (2011) find no substantial empirical evidence whatsoever to suggest banks that had a well-designed CEO remuneration system to have positive stocks returns during the GFC. Thus the empirical evidence regarding compensation structures and firm value still remains inconclusive at best. …

Search by... Author
Show... All Results Primary Sources Peer-reviewed

Oops!

An unknown error has occurred. Please click the button below to reload the page. If the problem persists, please try again in a little while.