PUTAJ Humanities and Social Sciences

Vol. 21, No.1, 2014 (June)

CEO Compensation Determinants: Is the Size or Performance of

the Firm a determinant of CEO Compensation in Pakistan1
Amir Hussain, Zia Obaid & Sana Khan

Abstract
CEO compensation has been a focus of attention for many decades among
researchers, financial analyst, and the general public due to a striking rise in the
pay of executives. Researchers have tried to find out the reasons and factors
underlying CEO compensation. The large numbers of studies carried out on the
topic are still controversial with varying results. In Pakistan only a limited
number of studies have been carried out on the topic. Researchers are keen on
finding the determinants of CEO compensation and many studies on the topic
have been carried out. According to Tosi (1989) there have been around 250
researches carried out on the topic during the last century; however the
outcomes of these researches have not proved to be very convincing. As different
researchers use different method of research, there is a controversy among
researchers in isolating the imperative CEO compensation determinants, the
characteristics of these determinants and the way these determinants have an
effect on CEO pay. Another factor that adds to the controversial results in
determining the determinants of CEO compensations are the sources used to
collect data on executive pay. This research aspires to isolate the main
determinant of CEO compensation in the light of the previous literature. There
was no single data base from which data related to CEO compensation, size of
the firm, and performance of firm could be gathered. As a result of this the
sample size had to be restricted to a time frame of three years and panel data of
15 companies of KSE. The small sample size was due to the fact that companies
who suffered a loss from the years 2008-2010 were eliminated. Also, companies
for which annual reports for the years 2008-2010 could not be found were also
eliminated. In order to obtain results and come to a conclusion, different tests
were used including descriptive statistics, correlation matrix, pooled OLS and
common effects models. The research shows that CEO compensation does not
have any significant relationship with performance of the firm. However, it has a
significant / positive relationship with size of the firm.
Keywords: CEO Compensation, Size & Performance of the Firm
CEO compensation or executive compensation is the financial reward that is paid to the
CEO of a firm. It comprises of basic pay, bonuses, shares/stock options, and retirement
plans along with other benefits. CEO pay is usually determined by the board of directors
of a company. Over the past decades CEO compensation has received a great deal of
attention and there have been many debates related to the topic. One of the major reasons
1

This research article is developed from a thesis submitted to HEC through R&DD, Institute of
Management Sciences, Peshawar.

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for this is that there has been a dramatic raise in the pay of CEOs of firms in the past
decades as compared to that of an average workers wage. Some of the observers argue
that the increasing CEO compensation is a result of increasing competition for scarce
CEO skills while others argues that it is an unjust phenomenon caused by various social
and political shifts that allow CEOs to have greater control over their own pay.
Executive compensation has been greatly studied in many developed countries of the
world especially in the USA. However, not much research has been carried out on the
topic in Asia. In case of Pakistan, many researches have been carried out on various
topics of corporate governance, but very diminutive work has been done on CEO
Compensation. This research is important in adding to the current limited body of
knowledge regarding CEO compensation in Pakistan. The research can be useful for
financial analysts to determine whether the prevailing amount of compensation given to
CEOs in Pakistan is, in fact, fair or not; and whether size or performance determine the
amount of compensation a CEO receives. The study also aims to allow various
companies to have information regarding the determinants of CEO compensation which
may help in setting up future CEO compensation. The primary goal is to divorce the main
determinant of CEO reward in Pakistan, and to determine the effect of size and the
performance of the firm on CEO compensation. Secondly, to contrive a theoretical
framework in the light of the given literature review and isolate the key variables that
affect CEO compensation. Variables study like performance of the firm is measured by
return on equity (ROE) and size of the firm which is a function of Net Sales.
Literature Review
A great deal of work has been carried out in the area of CEO Remuneration and the
previous empirical literature shows that it is in-fact a multidisciplinary area. Different
fields of studies such as finance, accounting, economics, management etc. have
conducted studies in this area and have contributed to the current pool of literature.
Masson (1971) conducted a study in which he determined the relationship between CEO
reward, the net sales and the stock-performance of the firm. According to Massons
findings, there is no relationship, neither positive nor negative, between executive
compensation and the sales of the firm. However, it was found the CEOs, whose
financial returns were more closely aligned with the stock-holders interests, performed
better in the stock market.
Murphy and Jensen (1990) carried out a statistical study, in which they incorporated data
on thousands of CEOs for a period of five years. Their sample data consisted of 2505
CEOs financial benefits (annual increments / pays ) of 1400 public sector firms for the
period of 14 years i.e. 1974-1988. They also gathered data for CEOs of 430 public
sector companies on stock options and stockownership. In addition to this, Murphy and
Jensen also gathered CEOs reward data for 700 plus public owned companies. They
determined a weak association between CEO compensation and firm performance in
terms of stock holders wealth.
Kato and Kubo (2003) came up with the first panel data research on the sensitivity of
performance of CEO compensation in Japan. They used ten years panel data (1986
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1995) of 51 different Japanese companies for the CEOs compensation. Their findings
indicated that executives monetary reward is delicately associated with firms
profitability (performance). They also reveal
weak impact of stock market for
executives / CEOs compensation in Japan. Finally, they disclosed negative impact of
bonus system for CEOs to the performance of firms in Japan, which is in contradiction
to the previous literature that indicates that bonuses are actually a part of wage that has
been disguised.
Bebchuk and Grinstein (2005) conducted a research in order to determine the extent to
which the decisions to expand the size of the firm are related to the resulting increases in
the CEO pay. Their results showed that there is an asymmetry between the increase and
decrease in the size of the firm. While an increase in the size of the firm results in an
increase in the CEO pay i.e. they are positively correlated; size decreases are not
negatively correlated with CEO pay.
Parthasarathy, Menon and Bhattacherjee (2006) used managerial compensation data to
examined the determinants of CEO compensation in India, They used a linear regression
model for the development of inferences on total executive compensation, and the
proportion of incentive pay that is a part of total CEO compensation. Their results
indicated that the size of the firm is a significant determinant of both, total compensation
and incentive pay of the CEO.
Shah, Javed, and Abbas (2009) carried out a research for transitional economy in order to
find out the determinants of executive rewards and remuneration. They used a data (panel
set) which included a time series data spanning over 2000-2006 and cross sectional data
integrating unbalanced panel. For analyzing their data they used common effect model
after correlation and descriptive statistics. The results indicated that there is nonsignificant association among executive remuneration and firm performance; however,
size of the firm has a positive significant relationship with CEO compensation.
Cooper, Rau & Gulen (2009) their research concluded a negative relationship between
remuneration and firm performance. The high pay results in negative consequences
which last up to five years. This is due to the fact that a high pay results on
overconfidence of CEOs.
Zeshan Anjum (2010) examined the relationship between the firm size, performance and
the composition of the board and the affect they have on CEO compensation. His data
consisted of 83 listed firms on the Lahore stock exchange for the years 2007-2009.
According to the results of his study, it was concluded that size of the firm is a major
determinant of CEO compensation.

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Theoretical Framework

CEO compensation is the dependent variable. As discussed earlier, CEO compensation

consists of basic pay, bonuses, share/stock options and other managerial perks. Annual
reports, however, do not break down CEO compensation into the above stated
components; hence, the values of CEO remuneration as a whole were taken for the
dependent variable. As per literature and to reduce heteroscedasticity the natural log of
the independent variable is used. This technique was previously used by Shah, Javed, and
Abbass (2009), Zeshan Anjum (2010), The first independent variable is the size of the
firm. Practically all the previous literature has recommended size of the firm as an
independent variable, identically Zohu (2000), Bebchuk and Grinstein (2005), Shah,
Javed, and Abbas (2009) measured firm size as the natural log of net sales and firm
performance as second independent variable for determinant of CEO compensation.
Masson (1971), Murphy & Jensen (1990), Kato & Kubo (2003), In this research, the
performance of the firm is measured by Return on Equity.
Statistical Model:

lnYit= + lnX1it+X2it+e

Where: lnY= log of CEO Compensation (Dependent Variable), lnX1= log of Net Sales
(1st Independent Variable) and X2= Return on Equity (2nd Independent Variable)
Numerous statistical tools and techniques applied on the panel data in order to draw
empirical inferences. The basic aim of the methods applied is to find out the CEO
compensation determinants and establish a relationship between shareholders interests
and firm CEOs.

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XY Scatter Diagram (LNY and LNX1)

LNY versus LNX1 (with least squares fit)
11.5

Y = 5.85 + 0.341X

11

10.5

10

LNY

9.5

8.5

7.5

6.5
6

10

11

LNX1

XY scatter diagram shows the relationship between the variables LNX (natural log of
size of the firm) and LNY (natural log of CEO remuneration). The variable LNY is
represented on the Y-axis while the variable LNX is represented on the X-axis. As
can be seen from the scatter diagram, the firm size and CEO compensation is
positively related. i.e. CEO compensation increases with the increase in the size of
the firm.
Scatter Diagram (Between LNY and LNX2)
11.5

11

10.5

10

LNY

9.5

8.5

7.5

6.5
0

0.1

0.2

0.3

0.4

0.5

X2

Figure depicts the relationship between LNY (CEO compensation natural log),
represented at the Y-axis and X2 (performance of the firm, ROE) represented on the
X-axis. As can be seen from the scatter diagram, there is no line running from the
mean values of the two variables and there is no relationship, neither positive nor
negative, between CEO compensation and the performance of the firm.
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Descriptive Statistics
A summary of statistics for the variables LNY, LNX1 and X2 is depicted in the table
below, which was obtained using gretl:
Table: Descriptive Statistics
Variable

Mean

Median

Minimum

Maximum

X2
LNX1
LNY

0.217970
8.76803
8.83783

0.191110
8.51739
8.79467

0.000831117
6.06379
6.93245

0.512241
11.5099
11.0211

Variable
X2
LNX1
LNY

Std. Dev.
0.143638
1.33288
0.918884

C.V.
0.658978
0.152016
0.103972

Skewness
0.519521
0.103277
0.266279

Ex. kurtosis
-0.677681
-0.667097
-0.499467

Summary Statistics, where X2 is performance of the firm, LNX1 is natural log of size of
the firm and LNY is natural log of CEO compensation.
Interpretation
Table shows the Mean, Median, and Mode of the variables in the data set; the mean value
of X2 (performance measured as ROE) is 0.217970, LNX1 (natural log of net sales) is
8.76803, and LNY (natural log of CEO compensation) is 8.83783. When the values have
been arranged in order of magnitude i.e. from smallest to the largest value the middle
value of data set is Median. The median for X2, LNX1 and LNY is 0.191110, 8.51739,
and 8.79467 respectively. In order for data to be normal, their mean and median should
be the same. From table we can see that the mean and median of each of the variables is
almost the same, hence our data is normal. Minimum is simply the minimum value in a
data set. The minimum values of X2, LNX1 and LNY are 0.000831117, 6.06379, and
6.93245 respectively. Maximum is simply the maximum value in a data set. The
maximum values of X2, LNX1 and LNY are 0.512241, 11.5099, and 11.0211
respectively. The values of standard deviation for the given variables are low; hence the
values in the data set are close to the mean. The lower the value of CV the closer the data
is to the mean and the higher the value of CV the higher is the dispersion of data from the
mean. Above table shows that X2 (size of the firm) has the highest dispersion. The
skewness of the all variables in table is positive. The kurtosis of all the variables is
negative, which indicates a flatter distribution with high variance.
Correlation Matrix
LNY

LNX1

X2

1.0000

0.4946
1.0000

-0.2007
-0.3381
1.0000

LNY
LNX1
LNX2
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Correlation matrix, where X2 is performance of the firm, LNX1 is natural log of size of
the firm and LNY is natural log of CEO compensation
Interpretation
Table represents the correlation between the different variables. If the correlation
between two independent variables is very high i.e. greater than 0.9 or less than -0.9, this
indicates a problem of multicollinearity. The correlation of a variable with itself is always
equal to one. The negative or positive sign with the correlation figures indicates the
direction of the relationship i.e. negative or positive. The correlation between the
variables X2 and LNX1 is not high, i.e -0.3381, hence there is no problem of
multicollinearity between the two independent variables. The correlation matrix also
shows that the independent variable LNX1 (firm size natural log) is related positively to
the dependent variable, LNY (CEO compensation natural log). The matrix also exhibits
the relationship of LNY (CEO compensation natural log) and X2 (firm performance) is
weaker than the relationship between the variables LNY (CEO compensation natural log)
and LNX1 (firm size).
Model: Pooled OLS

Coefficient

Std. Error

t-ratio

p-value

Const

5.97805

0.954179

6.2651

<0.00001

***

LNX1

0.332166

0.0981558

3.3841

0.00156

***

X2

-0.241641

0.910836

-0.2653

0.79208

R-squared

0.245886

Adjusted R-squared

0.209975

F(2, 42)

6.847234

P-value(F)

0.002668

Dependent variable: LNY

Interpretation
As can be seen from coefficient of independent variable LNX1 shows that with every one
unit increase in LNX1, the dependent variable LNY increases by 0.332166, holding all
other independent variables constant. The coefficient positive sign exhibits the effect
direction and indicates a positive relationship between the variables LNX1 and LNY,
hence, we can say that there is a significant relationship between the independent variable
LNX1 and dependent variable LNY. The t- statistic also indicates the significance of the
relationship between the independent variable LNX1 (natural log of size of the firm) and
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the dependent variable LNY (natural log of CEO compensation). The critical value of the
t-statistic is 2 and since the value of t-statistic for LNX1 is greater than 2, it proves a
significant relationship between CEO compensation (LNY) and size of the firm (LNX1).
The p-value of LNX1 (size of the firm) is 0.00156 which shows that the independent
variable size of the firm has a significant relationship with dependent variable, CEO
compensation. X2 (performance of the firm) has a high standard error, an insignificant tstatistic and a very high p-value, thus, from this we can conclude that there is nonsignificant association between firm performance and CEO rewards. In above data table
R-squared value is 0.245886, which means that variation in CEO compensation
(dependent variable) is almost 25%, due to firm size and performance (independent
variables). Adjusted R-squared is similar to R-squared, except that it calculates R-squared
while penalizing for the increase in the value of R-squared by increasing the independent
variables observations. According to adjusted R-squared value, almost 21% of the change
in CEO compensation (dependent variable) is due to firm size and performance
(independent variables). The F-value illustrate model overall significance. The F-value in
table is 6.8, almost 7 which is greater than the tabulated value of 4, at which the model is
considered significant. Hence, at an F-value of 7 we can say that the overall model is
statistically significant.
Fixed or Common Effect Model
Model : Fixed-effects, using 45 observations
Included 15 cross-sectional units
Time-series length = 3
Dependent variable: LNY

Const
LNX1
X2

Coefficient

Std. Error

t-ratio

p-value

2.82697
0.669585
0.641896

2.67449
0.318206
1.08112

1.0570
2.1042
0.5937

0.29954
0.04446
0.55746

**

R-squared

0.904465

Adjusted R-squared

0.849873

F(16, 28)

16.56786

P-value(F)

3.19e-10

Test for differing group intercepts Null hypothesis: The groups have a common intercept
Test statistic: F(14, 28) = 13.7872
with p-value = P(F(14, 28) > 13.7872) = 5.0025e-009

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Fixed or Common Effect Model, where X2 is performance of the firm, LNX1 is natural
log of size of the firm and LNY is natural log of CEO compensation
Interpretation
In above table the p - value of the independent variable LNX1 (firm size) is 0.04 which is
less than 0.05; which indicates a significant relationship between size of firm
(independent variable) LNX1 and CEO compensation (dependent variable) LNY. The
coefficient of independent variable LNX1 shows that with every one unit increase in
LNX1, the dependent variable LNY increases by 0.669585, holding all other independent
variables constant. The t-statistic value is 2.1042, which is greater than the t-tabulated 2,
which shows a significant relationship between LNX1 (firm size) and LNY (CEO
compensation). In comparison to pooled OLS, the value of R-squared is higher in the
fixed effect model. The value of R-squared in table represents 90% of dependent variable
(CEO compensation) variation is caused by the independent variables (firm size and
performance). The F-statistic shows the overall validity of the model. The F-value of this
model is 16.56786 and F-statistic p-value is 3.19e-10. The low p-value of the F-statistic
shows that the overall model is valid. The results for variable X2 (firm performance) are
insignificant and indicates non-significant relationship between firm performance and
CEO compensation.
Conclusion
Researchers are keen on finding out the reasons behind the dramatic increase in the
compensation that executives receive. There have been hundreds of studies conducted on
CEO compensation in the past two decades and there is extensive literature available on
the topic. However, the results of most of the researches are controversial and there are
two major schools of thought when it comes to the major determinants of CEO
compensation. Many studies point towards performance being the major determinant for
executives rewards whereas; many more indicate the firm size as a key determinant for
CEO compensation. This research was based on the common variables recommended by
literature review, which included firm Performance (measure by ROE), firm size
(measured by net-sales) and CEO remuneration. From the empirical analysis and the
results obtained, it can be concluded that:

CEO compensation and firm performance have insignificant relationship in Pakistan.

Firm size is the major determinant for CEO compensation in Pakistan.

These results are consistent with the previous studies conducted in Pakistan, i.e. studies
conducted by Shah, Javed, & Abbas (2009), and Anjum (2010). The findings are also
consistent with some overseas researches e.g. Zohu (2000), Bebchuk & Grinstein (2005),
Chhaochharia & Grinstein, (2009).

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References:
Anjum, Z. (2010). Determinants of Ceo Compensation in Pakistan from the year 2007-2009.
Bebchuk, L., & Grinstein, Y. (2005). Firm Expansion and CEO Pay.
COOPER, M., RAU, P., & GULEN, H. (2009). Performance for Pay? The Relationship between
CEO Incentive, Compensation and Future .
Kato, T., & Kubo, K. (2003). Ceo compensation and firm performance in japan.
Masson, R. T. (1971). Executive Motivations, Earnings and Consequent Equity Performance. The
Journal of Political Economy , Volume 79, 15.
Murphy, K., & Jensen, M. (1990). CEO Incentives-Its not how much you pay, but how.
Foundations of Organizational Strategy, 36.
Parthasarathy, A., Menon, K., & Bhattacherjee, D. (2006). Executive Compensation, Firm
Performance and Corporate Governance: An Empirical Analysis. 35.
Shah, S. A., Javed, T., & Abbas, M. (2009). Determinants of CEO Compensation. 11.
Tiessen, T. W. (n.d.). Human Capital, Performance, and Executive Compensation.
Wiley. (2009). Fixed-Effect Versus Random-Effects. 27.
Xianming Zhou (2000), CEO pay, firm size, and corporate performance: evidence from Canada.

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