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Board Structure

CEO Compensation in Pakistan

Written by Z. Anjam

Paper category

Master Thesis


Business Administration>General




Master Thesis: Agency theory Agency theory is aimed at business relationships involving principals and agents (M. C. Jensen & Meckling, 1976). When the goals of the principal and the agent are different and there is asymmetric information, the agency problem will arise. The concept of information asymmetric is the basis of all principal-agent models. This is because the agent owns private information while the principal does not, and is usually considered a risk averse (Wienclaw, 2009). The principal hires an agent because he has the potential to increase the value of the asset. In order to increase the value of the principal, all or part of the rights of the asset must be transferred to the agent within a limited time. The theory uses the metaphor of contract to describe this relationship (Milgrom, 1992). Agency theorists put forward the idea that various internal and external control mechanisms can reduce agency problems. The internal control mechanism includes the supervision of external large shareholders, the supervision of the board of directors, and the mutual supervision of management personnel (Lin, 2005). Agency theories can be divided into two categories; the first is called the empirical agency theory, and the second is called the principal-agent problem. The first branch focuses on a wide range of issues, namely the separation of ownership and control, and emphasizes how managers can control through incentive plans, external labor markets, and capital markets to reduce this empirical effect (Fama, 1980; Fama & Jensen, 1983) . The second branch deals with the principal-agent problem, which treats the ownership and distribution of the company as a given and focuses on the design of Ex. Employment contracts and information systems (Mengistae and Lixin Colin, 2004). Like management power theory, agency theory focuses on the divergence of interests between CEOs and shareholders. Unlike agency theory, more attention is paid to the mechanisms that can be used to reduce or control conflicts of interest. Agency theory is based on the principle that the principal (shareholder/board of directors) delegates tasks to the agent (CEO), in which it is expected that the agent will perform work in the interests of the principal. There are several assumptions in agency theory. People assume that the agent is risk-averse, self-centered, and his interests may be different from those of the principal. This creates the possibility of opportunistic behavior, in which agents act for their own interests at the expense of principal interests (Fama, 1980). This is called agency cost. For example, the CEO can make acquisitions and mergers, and shareholder returns are small or even negative, but this will increase the size of the company and reduce financial risks. 2.2 Literature review The board of directors guides and controls the company, so an effective board of directors is the foundation of a company's success. The board of directors serves the company as a bridge between managers and investors, and is essential for good corporate governance and investor relations (Hermalin & Weisbach, 1988). The board of directors is responsible for setting company goals and strategies, plans and policies to achieve these goals, monitoring progress towards these goals, appointing CEOs with appropriate leadership characteristics, and determining CEO compensation (Bebchuk & Fried, 2003; Cahan, Chua and Nyamori, 2005; Raheja, 2005). The corporate governance structure, methods and laws vary from country to country. The main difference in corporate governance between countries is the single or dual board structure, depending on the country. This structural difference has an environmental impact on the level of CEO compensation (Ozkan, 2007). With the help of previous literature, we can discover the diversity of the relationship between CEO compensation and board structure. This chapter describes some of the previous literature on the relationship between CEO compensation and the structure of the board of directors. According to Conyon and Simon (1998), they used panel data of UK listed companies from 1991 to 1994 to study the role of board control and compensation committees in determining CEO compensation, and used variables such as the percentage of non-executive directors. The existence of the board of directors, the compensation committee, and the duality of the CEO serve as supervisory measures for the board of directors. They found that all these variables have only a limited and insignificant effect on the CEO's salary level (Conyon & Simon, 1998). According to Jinmingwan’s research, there is no significant relationship between the board of directors with a higher proportion of independent directors and the level of CEO compensation. (Ten thousand). Contrary to most of our findings from developed countries on the impact of internal directors on CEO compensation, we found it in India. Ramasawamy found that the percentage of internal directors has no significant effect on the CEO's salary of family businesses, but in the case of non-family organizations, internal directors can significantly affect the CEO's salary level (Ramaswamy, 2000). Another study conducted by Neslihan Ozkan (2007) is about the impact of corporate governance mechanisms on CEO compensation. He used data samples from 414 UK companies in 2003 and 2004. The results show that companies with larger board sizes and a higher proportion of independent directors have a positive and significant impact on CEO compensation (Ozkan, 2007). Read Less