Determination of Executive Compensation in an

Emerging Economy: Evidence from India

Arijit Ghosh*

Indira Gandhi Institute of Development Research

Gen. A.K. Vaidya Marg, Goregaon (East),

Mumbai-400065, India

Email: arijit@igidr.ac.in

* I am thankful to my Ph.D. supervisors Dr. Subrata Sarkar, Dr. Jayati Sarkar and Dr. Bibhas Saha for their help and guidance. I am also thankful to Anuj Arora and the participants of Adam Smith Seminar in University of Hamburg for the helpful comments. I am grateful to Economic and Political Weekly (EPW) Research Foundation, Industrial Development Bank of India (IDBI) and Housing Development Financial Corporation (HDFC) for giving me access to the annual reports of various companies. Without their support this paper would not have been possible. The usual disclaimer applies.

2

Determination of Executive Compensation in an

Emerging Economy: Evidence from India

Abstract Most of the studies regarding the determination of executive compensation are based on developed countries and mainly focused on CEO compensation. Determination of board compensation is relatively ignored in the literature. This paper examines the effect of corporate governance, firm performance and corporate diversification on board as well as CEO compensation and its components in the context of an emerging economy, India, where managerial market is yet to develop. I use panel data of 462 firms from the year 1997-2002 of Indian manufacturing sector. This paper finds that board compensation largely depend on current and past year firm performance and diversification, whereas CEO compensation depends only on current year firm performance. Among the personal attributes of the CEO, only in-firm experience has significant influence on CEO compensation. This finding contradicts the extant studies, where current and past year firm performance, age, experience and education of the CEO are important factors for determining CEO compensation.

JEL classification: J33, G30, L25 Keywords: Executive compensation; Corporate Governance; Firm performance;

Diversification; Relation between CEO and founder.

3

1. Introduction Determination of board and Chief Executive Officer (CEO) compensation has

been a topic of great interest in academics and the business community. Large amount of

theoretical literature have been developed to determine the optimal executive

compensation contracts that link pay with the variation of firm performance. Such

contracts aim to align the interest of managers (agents) with the interest of shareholders

(principals). These theoretical propositions have been spawned by several empirical

studies. CEO looks after the day-to-day management of the firm. All the major decisions

or strategies are taken together by the board, especially, the executive directors of the

board.

CEO is just a part of the board. But, determination of the board compensation is

ignored in the literature. Theoretical justification regarding determination of board

compensation is not very straightforward. Board is the monitor of the firm. Who will

determine the compensation of the monitor? Is the compensation of the board aligned

with performance of the firm, as it is proposed for the CEO? This paper tries to answer

some of these unanswered questions in the context of an emerging economy, where most

of the firms are family owned and large number of board members are related to founder

of the firm. In India, more than 90% of the board compensation goes to the set of

executive/inside directors. Compensation of the directors is determined at the annual

general meeting each year. In this paper I examine the effect of different measures of firm

performance, diversification and board structure on the board compensation, and its

components, and on the CEO compensation in an emerging economy namely, India.

Several well-established stylised facts emerge in the literature on determination of

mostly CEO compensation. Fact 1: Current as well as previous year firm performance

has positive effect on the compensation of the CEO1. Fact 2: When the CEO is Chairman

of the board and/or size of the board is large then compensation of the CEO is

significantly higher2. Fact 3: The relation between the executive compensation and

1 For argument under (1), see Core et al. (1999); Rose and Shepard (1997) etc. All these papers find current as well as past year performance of the firm positively and significantly influence the compensation of CEO, especially the stock based component of compensation. 2 For argument under (2), see Main et al., 1995; Core et al., 1999; Goyal and Park, 2002; Crystal, 1991. For instance, Crystal, 1991 argue If the CEO becomes the chairman of the board then monitoring becomes

4

composition of the board is ambiguous3. Fact 4: The relation between ownership pattern

of the firm and level of CEO compensation is also mixed4. Fact 5: Compensation of the

executive increases with the increase in firm diversification5.

Substantial awareness about the importance of internal monitoring has been

noticed not only in developed countries but also in developing countries in the past few

years. In US from the period of 1971 to 1994, external representative in the corporate

board, level of incentive to the external directors and external pressure on directors by

institutional shareholders increased, whereas average size of the board decreased over the

year (Huson et al. (2001)). Similar to the Cadbury committee report (1992) in UK, in

developing economies, compensation of CEO and other directors has become a matter of

great concern of different committees like Kumar Mangalam Birla committee report

(1999) in India, King committee report (2002) in South Africa etc. These committee

reports time and again argue that all compensation paid to the directors including

independent directors should be fixed by the board of directors and approved by the

shareholders in general meetings. There should be some limit on the each component of

the compensation including stock options. In India, till 2002, there was an upper limit of

Rs.20 thousand for the fees for the non-executive directors (NED). From 2003, this limit

more difficult, because CEO essentially has the power to hire or remove other non-executive directors (NED). Such board members take the role of passive advisors especially when it concerns the compensation of CEO. Main et al. (1995) find if the CEO is appointed before the other directors are appointed, then the levels of compensation will be higher compared to if he/she is appointed after the Board of directors. They argue that when CEO also holds the Chairman post he/she gets higher remuneration due to their higher responsibility. 3 For argument under (3), see Finkelstein and Hambrick (1989); Jensen, (1993); Core et al. (1999). For instance, Core et al. find proportion of NED has positive correlation with the compensation of the CEO. Fama and Jensen (1983) argue as proportion of NED increases CEO compensation should fall theoretically, because of better monitoring. 4 For argument under (4) see Holderness and Sheehan (1998); Core et al. (1999); Ryan and Wiggins (2001). For instance, Core et al. (1999) find that there is a significant negative relation CEO compensation and CEO ownership and existence of external block holders, who owns more than 5 percent share in the company. Whereas, Holderness and Sheehan (1998) find that there is a positive relation between managerial compensation and managerial shareholding in publicly held corporation. 5 For argument under (5) see Aggarwal and Samwick (2003); Jensen and Murphy (1990); Jensen (1986); Shleifer and Vishny (1990); Rose and Shepard (1997); Duru and Reeb (2002). For instance, Rose and Shepard (1997) find that this diversification is positively correlated CEO compensation.

5

has been lifted up to Rs.0.2 million to attract more intelligent and competitive

professional as NED.

Most of the empirical studies on CEO compensation and corporate governance till

date have been with respect to developed countries like US, UK, Canada, Japan, Italy etc.

Several economists have already argued with sufficient force that there are some basic

institutional structural differences in firm structure, market and organisation between

developed and developing countries. In the emerging economies managerial markets are

not well developed; there is too much intervention from the family of the founder;

corporate law like code of corporate governance, bankruptcy law is very weak and

accounting standard is also not up to the mark as compared to international standard and

there is no uniformity in the accounting across the firms. This paper is the first attempt to

make a comprehensive analysis on the determinants of board as well as CEO

compensation in the context of an emerging and newly liberalized economy, India.

This paper tries to analyse four broad issues. The first issue is, whether the level

of executive compensation and its different components is determined on the basis of

firm performance. Accounting measures in developing countries are criticised on the

ground of highly manipulating accounting standards. Therefore, I use both accounting

based (return on assets (ROA)) as well as market based (Tobin’s Q), current as well as

previous year, measures of performance in my analysis. It is also argued that in emerging

economies that there is no clear distinction between ownership and control. In India very

often CEOs are selected from the relatives of the founder and there is a common fear that

they build up their wealth at the cost of shareholders. The second issue is, what is the

effect of size and composition of the board on compensation of the board and CEO?

Added to this, I also find out the effect of identification of the CEO i.e., if the CEO is

relative of the founder, if the CEO is Chairman or there are more than one CEO in the

firm on the compensation of the board and CEO.

A major basis of the board and CEO compensation package, which has received

very less attention in the literature, is informational rent. This informational rent increases

with the increase in operational difficulties of the firm and in-firm experience of the

CEO. The operational difficulties rise with the size and diversification of the firm.

Therefore the third question in the paper is, how the compensation of the board as well as

6

the CEO changes with the different type of diversification. Most of the studies on

diversification and CEO compensation talk about one-way diversification6 i.e., Industry

diversification. In this paper I consider two different measures of diversification: product

as well as geographical simultaneously and find out its effect on board and CEO

compensation. Further, this paper also examines the effects of different personal

attributes of the CEO in determining his/her own compensation (e.g. age education and

experience).

Regarding the compensation of the CEO, according to Security and Exchange

Board of India (SEBI) guidelines and section 217 in the Indian Company Act 1956, firm

reports the compensation of the CEO and other Executive directors along with personnel

details, if the compensation exceeds the threshold level7. Therefore, I used truncated

model for this analysis. To the best of my knowledge this paper is one of the first attempt

to find out the over-all picture on determination of board and CEO compensation for

large number (462) of firms from the year 1997 to 2002 in India based on a primary data

collected from the annual reports by the author himself.

The rest of the paper is organised as follows: Section 2 discuss the literature on the

effect of internal monitoring, CEO characteristics, firm performance and diversification

on board and CEO Compensation. Section 3 discusses the empirical model, methodology

and variables used in this paper. Data and descriptive statistics of the variables as

preliminary data analysis are discussed in section 4. Section 5 presents the preliminary

data analysis. Empirical results are presented in section 6. Section 7 concludes the paper.

2. Theoretical and Empirical Background of Determining CEO and

Board Compensation According to the incentive wage theory under incomplete information on

capability of the CEO, compensation of the CEO mainly depends on five broad factors,

namely internal monitoring, firm performance, firm complexity, personal attributes of the

6 Rose and Shepard (1998) 7 Threshold level is defined like this: for the year 1997 and1998 it was Rs.0.3 million per annum, for 1999 and 2000 it was Rs.0.6 million per annum and for 2001 and 2002 it was Rs.1.2 million per annum. According to SEBI guidelines if the employees remuneration is less than the threshold level then firm may not report the personal details of that employee in the Annual Report. Each year represents the period from 1st April of previous year to 31st March of current year. As of 30th April 2004 1US$ = Rs.44.37.

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CEO and other firm-specific characteristics. Therefore, we can represent board and CEO

compensation as

Board Compensation = f (firm performance, internal monitoring, firm complexity, other

firm characters) (1)

CEO Compensation = l (firm performance, internal monitoring, firm complexity,

personal attributes of the CEO, other firm characters) (2)

Other firm characters include R&D expenditure, advertisement expenditure, firm age etc.

2.1. Firm performance

Most of the earlier studies on determinant of managerial pay are focused on role

of firm size on the compensation of the CEO. As the firm become larger in size the

complexity in operation also increases. Rosen (1992) provides a theoretical justification

for the positive relation between pay and firm size. There are several evidences in the

literature, which prove the above proposition8.

Relatively recent literature is focused on the effect of firm performance on the

compensation of the CEO. It has now become empirically proven fact that CEO pay

increases with the increase in the performance of the firm9. For instance Rose and

Shepard 1997; Brick et al. 2002 used current as well as past performance of the firm to

study its influence on the compensation of the CEO. In Indian context, Bhattacherjee et

al. (1998) find that accounting based performance measure is not a significant

determinant of the change in compensation of the CEO. Rather market based measures

such as present and past value of Tobin’s Q have significant effect on the change in

Compensation of the CEO. They also find that pay performance sensitivity rises after the

liberalisation for the large firms. Therefore, I have taken both accounting as well as

market based firm performance measure in the current and past year.

Firm specific risk is another potential determinant of board and CEO

compensation. I have taken standard deviation of stock return of last 30 days of the

financial year of the firm (RISK). There are lots of window dressing go on during the last

month of the financial year and it has significant effect on setting the compensation of

8 Roberts 1956; Murphy 1985; Zhou 2000; Ryan and Wiggins 2001. 9 Lewellen and Huntsman 1970; Masson 1971; Jensen and Murphy 1990.

8

board as well as CEO. It is expected that as the RISK of the firm increase the

compensation of the board as well as CEO would decline10.

Firm performance = m (ROAt, Tobin’s Qt, ROAt-1, Tobin’s Qt-1, Sales, Risk) (3)

2.2. Internal Monitoring

The board of directors are primarily responsible for internal monitoring. They

help to resolve the agency problem that arises due to separation of ownership and control

of the firm. Outside directors are supposed to be more efficient monitors of management

and are the key decision makers especially when it concerns the compensation of the

CEO. They are quite concerned about their reputation (Fama and Jensen (1983)). On the

other hand inside directors are less likely to be the efficient monitor, because their

interest is tied up with the CEO and all board members (Weisbach (1988)). A set of

empirical studies argues that proportion of outside directors has positive effect on the

compensation of the CEO. For instance, Core et al. (1999) find that if the proportion of

‘gray’ outside directors, non-executive directors (NED) appointed by CEO, increases

then the compensation of the CEO also increases. Finkelstein and Hambrick (1989) do

not find any significant relation between proportion of outside directors and

compensation. There is also argument in the literature that due to peer culture of the

directors, board avoids any conflicts with CEO and as a result CEOs determine the

business strategy on their own (Jensen, 1993). Small board operate more efficiently than

the larger board and thus, monitor more effectively (Jensen (1993) and Yermack (1996)).

In emerging economies, India, corporate board in most of the firms are not

independent. These boards are highly influenced by the founder(s). Therefore, the effect

of size and composition of the board on the compensation of the CEO and board may not

be similar to that of in the context of developed countries. In the emerging economies

management and ownership are not very distinct. Very often there are multiple number of

CEO in the board and some of them are related to the founder of the firm also.

Monitoring the CEO also becomes difficult and as a result the compensation of the CEO

cum Chairman increases (Brickley et al. 1997), however Ryan and Wiggins (2001) do not

10 Brick et al. 2002 find cash flow risk has negative significant association with cash compensation of the CEO;

9

find any significant increase in compensation when the CEO holds the additional

responsibility of Chairman. So, it can be expected that compensation of the CEO as well

as board will be influenced if CEO is related to the founder, if CEO is holding the

Chairman position or if there are multiple number of CEOs, but not size and composition

of the board. Therefore, we can represent the internal monitoring as

Internal monitoring = g(board size, proportion of NED, if CEO is relative of the founder,

if CEO is the Chairman, if there are more than one CEO) (4)

2.3. Complexity of the firm

The effect of firm diversification on managerial compensation has got relatively

less attention in the literature. The literature finds product diversification and

geographical diversification of the firm to have positive effect on CEO compensation11.

There are broadly two motivations for diversification for the CEO, managerial

entrenchment and matching model.

Managerial entrenchment explanations argue that diversification frequently

undertaken by self-serving managers for increasing their compensation packages, even

though diversification reduces the value of the firm. If the CEO’s compensation is

positively related to firm size CEO(s) may have an incentive to diversify the firm, even

when it does not contribute to shareholders’ wealth. Diversification increases the

complexity of the resource allocation and strategic thinking in business competition.

CEO(s) may need to face different type of customers, different types of industry structure

and its rules and regulations. CEO(s) have to increase his/her ability to realize the

potential synergies involving facilitating coordination and communications across

business groups in the industry. So, there is greater information asymmetry between

shareholders and managers about the investment in new lines of business. So, managers

get greater discretion to fix their compensation. According to this argument executive

will have greater compensation as diversification increases. So, industrial diversification

and executive compensation move in the same direction.

According to matching model argument, CEO creates a good match by

diversifying the firm. CEO(s) sometime diversify the firm in such a way that it makes a

11Rose and Shepard (1997); Reeb et al. (1998) and Duru and Reeb (2002)

10

unique match with their talents. Now by increasing the value of the firm with her

uniquely suited human capital, the CEO(s) can prove his/her ability and can negotiate for

higher wages. So, in this way they can extract rent from the firm through diversification.

If CEO replacement is costless then matching models implies that each time

diversification will lead to replacement of the current CEO with more talented and

optimally matched one. But CEO turnover is costly to both the firm and the CEO. So,

there will be no change in CEO until and unless mismatch is too severe i.e. it decreases

the value of the firm by large amount. So, there will be always a bargaining between

board of directors of the firm and CEO. Compensation will be less for incumbent CEO

than a perfect match CEO. For instance, Rose and Shepard (1997) calculated a

diversification index with unique 4-digit SIC code and find that this diversification index

is positively correlated with salary and bonus as well as total compensation. Reeb and

Duru (2002) calculate factor score of geographical diversification by ratio of foreign

assets to total assets, foreign sales to total sales and number of geographical segments and

find that geographical diversification has positive effect on CEO compensation.

Firm complexity = h (product diversification, geographical diversification) (5)

2.4. Personal attributes of the CEO

Age, experience and educational qualification are the key identifier of competent

and talented CEO, therefore, important determinants of CEO compensation.

Age: Compensation of the CEO increases with his. Gibbons and Murphy (1991), Dechow

and Sloan (1991) argue that older CEOs have the incentive to choose the project, which

will mature before their retirement i.e., they go for long-term project, which is relatively

safe. For sake of reputation younger CEOs focus on short-term and relatively riskier

project (Hirshleifer (1993)). Rayan and Wiggins (2001) find a concave relation between

cash and bonus payment and age of the CEO.

Experience: Murphy (1985) suggests that the ability of a manager at the beginning of the

career is not known. As he progresses he becomes more experienced and the

compensation of the manager or CEO also increases. Palia (2001) find that the

compensation of the CEO increases exponentially with the increase in number of years

the CEO has been working as CEO. Since, most of the CEOs in India are related to the

11

founder of the firm they start their career from the same firm or some other firm but from

the same business group. Therefore, I take the number of years the CEO is working in the

firm, in-firm experience, as a proxy for experience. There is one more advantage of

taking in firm experience into consideration. This gives the idea about the rent for having

internal information about the firm compared to a new comer. In Indian context very

limited studies has been done in the context of Mincerian earning function. Datta and Rao

(1985) found that education and experience are important factor in determining the

compensation of managers.

Education: Compensation of the CEO could potentially depends on the level of

education. In this paper I consider total year of schooling as a proxy for level of

education. I calculate the level of education as the years of education = age – experience

– 6, as a typical Indian child starts schooling at the age of 6. This method has been used

by Saha and Sarkar (1999). Sarkar and Sen (1996) do not find any one-to-one monotonic

function between educational qualification and earning of managers.

personal = k (age, experience, education) (6)

2.5. Research and Development expenditure and Advertisement Expenditure

Managers have larger interest in short term performance rather than long term

performance of the firm. Therefore, opportunistic managers reduce the expenditure on

R&D due to two reasons12: (1) Horizontal Problem: when CEO is close to retirement he

is least interested in investing in long term investment. (2) Cover-up Problem: When the

firm faces loss, mangers quickly cut down the R&D expenditure to cover the loss.

Therefore, to reduce the opportunistic reduction in R&D expenditure, shareholders are

expected to reward the CEO for R&D spending, because it also gives some tax

exemption.

Similarly I also included intensity of advertisement expenditure as another

intangible asset, advertisement expenditure. In the literature intensity of advertisement

expenditure has positive effect on the compensation of the CEO as well as board (e.g.

Palia 2001; Brick et al. 2002).

12 Cheng 2002; Brick et al. 2002 find R&D expenditure has positive effect on CEO and board compensation.

12

Other firm character = n(R&D Expenditure, Advertisement Expenditure, Firm Age) (7)

Substituting equations (3), (4), (5), (6) and (7) in equation (1) and (2) we get:

Board Compensation = F (ROAt, Tobin’s Qt, ROAt-1, Tobin’s Qt-1, board size, proportion

of NED, if CEO is relative of the founder, if CEO is the Chairman, if there are

more than one CEO, product diversification, geographical diversification, Sales,

Risk, R&D Expenditure, Advertisement Expenditure, Firm Age) (8)

CEO Compensation = L (ROAt, Tobin’s Qt, ROAt-1, Tobin’s Qt-1, board size, proportion

of NED, if CEO is relative of the founder, if CEO is the Chairman, if there are

more than one CEO, product diversification, geographical diversification, Sales,

Risk, age, experience, education, R&D Expenditure, Advertisement Expenditure,

Firm Age) (9)

3. Data:

Data on the compensation of the board as well as CEO and other executives of

Indian firm are not available in any database. So I collected directly from the primary

source i.e., the annual reports of the firms. For this purpose I gained access to the annual

reports of 462 firms from the 1996-97 to 2001-02 from different sources. The data on the

compensation of the board along with its different component are reported in the

expenditure section of the annual report. Data on gross remuneration of CEO and other

personnel details are available in Annexure B of Directors’ Report under section 217

2(A), Company Act 1956.

Data on Corporate Governance variables are also not available on time series

basis in any database in India. Thus, I also collected all the information on board of

directors from the list of the name of the directors along with designation in the annual

reports. The detail information about the CEO and other directors are available in the

section of Corporate Governance or Directors’ Report in the annual reports. All other

data on the performance of the firm, diversification and other economic indicators are

collected from the database called Prowess produced by Centre for Monitoring Indian

Economy (CMIE).

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Variables Description:

Dependent Variables:

COMPENSATION: This refers to the total compensation of the board or total

compensation of the CEO. Component of total compensation of board, namely Salary,

Commission, Perquisites (this includes other benefits also) and Sitting fees are also used

as dependent variables for the analysis. In India, under section 139 Indian Company Act

1956, upto one percent of the net profit can be given as commission to the board. Sitting

fees are paid only to the Non-Executive Directors. Salary and Perks are payable only to

Executive Directors. Commission is payable to all the member of the Board. All these

variables are deflated by the GNP deflator and expressed at constant price of 1993-94.

Independent Variables:

Firm Performance: Two measures of firm performance are used in the analysis to check

the effect of different accounting measures on COMPENSATION. The first measure is

Return on Assets (ROA), an accounting based measure and the second measure is

Adjusted Tobin’s Q (ADJQ), a market based measure of performance. ROA is defined as

the ratio of gross profit (i.e., profit before depreciation, interest and taxes) to book value

of total assets. Tobin’s Q is defined as the ratio of market value of equity and market

value debt to replacement costs of firm’s assets. In India, as some other developing

countries, there is no active market for debt. Thus instead of market value of debt, book

value of debt had to be used in the computation in the computation of Tobin’s Q

(Adjusted)13. I used both current as well as previous years of both measure of firm

performance14 for this analysis.

Characteristics of the Board: Board character has been taken into account through five

variables as proxy for corporate governance in India. First one is size of the board

(BOARD SIZE) i.e., total number of directors in the board. The second is the proportion

of non-executive directors in the board (PROP_NED) i.e., ratio of number of non-

executive directors to total number of directors in the board. Third measures is, whether

CEO of the firm is also the Chairman of the board as captured by the dummy variable

D_CH. The fourth measure is, if CEO is relative to the founder of the firm, captured by

13 Sarkar and Sarkar (2000); Khanna and Palepu (1999) used to measure the performance of Indian firm.

14

another dummy variable D_REL. Finally the fifth measure is also a dummy variable

D_MORE_CEO, which takes the value 1 if number of CEO in the firm is more than one.

Measurement of Diversification: In this paper I consider mainly three types of

diversification measures. The first measure is, COUNT i.e., number of unique three digit

products that a firm produces each year. This is the simplest measure of diversification.

The second measure is DIVERSE. This is a more involving index, constructed by

following Rose and Shepard (1997), where I define the DIVERSE as follows:

DIVERSEit = 1 - ∑=

COUNT

j it

ijt

salesTotalsalesproduct

1

2

__

The third measure of diversification is LOCATION i.e., the total number of places/sites,

where the firm has plants. These indicate how much the firm is geographically diversified

within the domestic territory.

Other economic determinants of level of compensation: Other than the above

variables of interest compensation of the board as well as CEO are also dependent on

many other variables. Large firms have greater complexity and growth opportunity.

These firms demand more competitive CEO and other directors so, it is expected that

compensation of the directors in large firm will be higher than relatively smaller one.

Thus I take log of sales (LSALES) as a control for size of the firm. Firm risk regarding

the share price in the stock market is also a potential economic determinant15 of the level

of compensation so, I included standard deviation of the stock return of the last month of

the financial year (RISK) as another control variable. To take care of firm specific

heterogeneity, ADVINT (ratio of advertisement expenditure to sales), R&DINT (ratio of

Research and Development expenditure to sales) and age of the firm (FIRM_AGE) are

included16. To see the differential effect of the firms belongs to business group I also

included group dummy (D_GROUP), which take the value 1 if the firm is from business

group. Finally, I included nineteen industry specific dummy variables as controls for

industry specific differences in demand for managerial talents.

14 Core et al. (1999); Rose and Shepard (1997) 15 Brick et al. (2002).

15

4. Empirical Model and methodology:

I have used pooled model with the industry specific and time specific fixed effect

for determining the total board compensation and for determination of CEO

compensation, I have used truncated model with time and industry fixed effect. For

determining different components of board compensation, I used seemingly unrelated

regression (SUR) model. The null hypothesis of this paper is whether board

characteristics, firm characteristics and firm diversification have any effect on total as

well as different component of compensation of board and CEO. In section 6, I use the

following generic model to estimate the level of compensation of the board:

BOARD COMPENSATIONit = α + αt + β1ROAit + β2ADJQit + β3ROAit-1 + β4ADJQit-1

+ β5RISKit + β6BOD_SIZEit + β7PROP_NEDit + β8D_CHit + β9D_RELit +

β10D_MORE_CEOit + β11COUNTit + β12DIVERSEit + β13LOCATIONit +

β14LSALESit + β15ADVINTit + β16R&DINTit + β17FIRM_AGEit +

β18D_GROUPit + ∑=

19

2g(β19g(INDUSTRY_DUMMYit)) + εit (10)

where i denotes the firm and t denotes the year. α is the intercept. All these equations are

estimated through fixed effect in time and Industry unbalanced panel method. αt is the

time varying intercept.

The compensation paid to the board is broadly divided into five components:

salary, commission (performance based incentives), provident fund (retirement benefits),

perquisites (other benefits) and sitting fees (paid to non-executive directors). Increase in

one component of compensation can lead to decrease in one or all other components of

compensation. Therefore, this paper determines log of salary, commission, perquisites

and sitting fees by SUR method.

But in this paper the problem of determination of CEO compensation is little

different. According to Company Act, 1956, in India companies have to report the

remuneration of all the employees in the annual reports, whose remuneration are above

the threshold level, along with other personnel details under section 217(2A). Thus, there

are three types of companies in Indian corporate sector, type A, B and C. Type A are

16 Palia (2001) and Brick et al. (2002).

16

those firms who report the Remuneration of the all the employee in the annual reports,

whose remuneration are above the threshold level, along with other personnel details.

Type B firms are those who have no employee who have remuneration more than the

threshold level. Therefore we do not have any information about the compensation, age,

education and experience of the CEO. Type C firms do not supply the section of

personnel details, in the annual reports. Instead they write if any shareholder is interested

about this information then latter should write to the Company Secretary. Last two types

of firms have no information about the gross remuneration of the CEO and other

personnel details. Let the compensation of the CEO, Y* is a latent variable,

Y* = β’X + U where Ui ~N(0,σ2) and E(β’X) = µ.

Therefore, Y* ~ N(µ,σ2). However, in a set of n CEO compensation (y1*, y2

*, ….

yn*), only those compensation, say m, which are above c, i.e., yi

*>c will be observed in

the annual reports. X is the vector of explanatory variables explained in equation (9).

Therefore, I am using truncated model to estimate the CEO compensation.

yi = yi* if yi

* > c, where yi is the observed CEO

compensation. The threshold level, c, varies overtime.

Therefore, the likelihood function would be:

( ) ∏>

′−Φ−

′−

=cy i

ii

iXc

Xy

yL* 1

1

|, 2

σβ

σβφ

σσµ

5. Preliminary Data analysis: Prior to regression analysis, lets analyse the data on the basis of descriptive

statistics of the variables and Pearson correlation coefficient matrix between important

variables. The rows of Table 1 show the mean statistics of the variables. Standard

deviations of the variables are shown in the parenthesis. Table 2 shows the Pearson

Correlation Coefficient Matrix between the dummy variables for business group

(D_GROUP), large firms (D_LARGE), COMPENSATION, COUNT, LOCATION,

PROP_NED, BOD_SIZE, and dummies for the CEO if he is also chairman of the firm

and if the CEO related to the founder of the firm or group.

17

I break the entire set of companies under seven mutually not exclusive cases.

These cases are represented by the column of Table 1. The first column show the case,

where I have taken all the firms together, followed by column 2 and 3 for large firm and

small firm cases. If the sale of a firm is larger than Rs.2 billion, I consider it as a large

firm. All the CEOs in India can be broadly classified into two categories: relative of the

founder of the firm and non-relative. The fourth column shows the cases where CEO is

relative of the founder group. The last three columns i.e., column fifth to seventh, give

the descriptive statistic of the sample, which is divided according to the number of

products produced by firms (COUNT). In fifth column I consider the sample of firms

where COUNT ≤ 3. In sixth column I consider the sample of firms where 3<COUNT ≤ 9.

In the final column I consider the case where COUNT > 9.

Overall average total compensation of the board for my sample of firms is around

Rs.5.3 million, for the large firms it is Rs.7.6 million and for the small firms it is only

Rs.2.5 million. If we convert the compensation as a percentage of sales, then small firm’s

compensation is not small. When the CEO is relative of the founders then board receives

higher compensation, Rs.6.9 million. Average proportion of salary and commission to the

total compensation of the board in all firms case are 52 percent and 18 percent

respectively. Except proportion of commission, all other components of compensation are

almost same between small and large firms. Proportion of commission is higher for large

firms. Therefore, it indicates, on average, large firm’s board compensation is more tied

up with firm performance. Table 1 also depicts that, when CEO is relative of the founder

of the firm, not only whole board compensation increases but also proportion of

commission increases (22.5 percent) and other fixed components of compensation

decreases. Therefore, it indicates that in the presence of representative of the founder in

the board as CEO, board compensation is more tied up with the performance of the firm.

Average total compensation of the board as well as the total commission paid to

the board are the highest for the sample, where COUNT > 9, Rs.8.0 million and Rs.3.44

million respectively. When number of products below 9 the total board compensation is

quite less and it varies from Rs.4.4-4.7 million. This indicates the fact that board get

some advantage through diversification in terms of compensation.

18

Average size of the board (SIZE) of my sample is 11 for all the firms. For the

small and large firms average board size are 9 and 12 respectively. Similarly for the

cases, where COUNT ≤ 3, in between 4 and 9 and > 9, mean board size are 10, 11 and 12

respectively. This implies that board size board size increases with the increases in

diversification because monitoring becomes difficult for large diversified firms. On

average total number of NED in the board for large and small firms 7 and 6 respectively.

On average two-third of the board is occupied by NED. Large firms have lesser

proportion of NED (62 percent) in the board than the small firms (66 percent). But the

proportion of NED is quite less when the CEO of the board is related to the founder (58

percent). This indicates that small firms and the firms where CEO comes from outside

have better monitoring norm than others and as a consequence total compensation to the

board especially to the executive directors, including CEO, decreases. This is supported

by the high negative correlation coefficient between PROP_NED and D_LARGE and

D_REL in Table 2.

All the measures of diversification are more for the large firms than the small

firms, which is quite natural. Means of the number of product produced by the firm

(COUNT) for the all, large and small firms cases are 8, 9 and 5. For the firms where CEO

is relative of the founder group, average COUNT is 7. Product diversification index

(DIVERSE) is also more for the large firms than the small firms. DIVERSE for the all,

large and small firms cases are 0.431, 0.487 and 0.362 respectively. Similarly, for

geographical diversification (LOCATION), number of plant in different geographical

location, is more for the large firms. Obviously all the measures of diversification is

higher for the case where COUNT > 9. One interesting point to note is stock return

volatility is lower for the case of large firms and COUNT>9 cases only.

From Table 2 some more interesting features of Indian corporate sector came out

very clearly and also support the findings from descriptive statistics. There is significant

positive correlation between large firms and the group-affiliated firms i.e., most of the

large firms in India belong to business group. Large firms and firms belong to business

group have a positive correlation with diversification of the firm. In other words as the

firm become larger, it diversifies more. There is also strong positive correlation between

product diversification (COUNT or DIVERSE) and geographical diversification

19

(LOCATION). Level of diversification and size of the board has positive correlation but

level of diversification and proportion of NED in the board has negative correlation. If

the CEO is Chairman or related to the founder then diversification is quite less.

Diversification of the firm decreases with the increase in the proportion of NED in the

board.

6. Empirical Results

6.1. Determination of Board Compensation Descriptive statistics and the correlation matrix show some light on the relation

between board compensation and other economic indicators of the firm in bivariate form.

But it needs to be confirmed in multivariate framework. In this section, in Table 3, I

analyse the determinant of board compensation by using fixed effect OLS and for

determining different components of compensation in Table 4, I use seemingly unrelated

regression (SUR) after checking for auto-correlation and hetroscedasticity.

A. Firm Performance

Table 3 shows that ROA of current year as well as previous year have positive

and significant effect on the total compensation (TC) of the board for all the five panels

i.e., all firms, large firms, small firms group-affiliated firms and standalone firms. For 1

percent increase in ROA in the current and previous year, compensation of the board

increases by 1.8 percent and 2.05 percent respectively. This implies that past year

performance has greater influence on determining the board compensation than the

current year performance of the firm, especially for the small firms’ sample. For the large

firms, only current year performance, in terms of ROA, has positive significant effect on

total compensation. For 1 percent increase in current year ROA, total compensation of

the board increase by 1.84 percent. Neither current year nor the past year Adjusted

Tobin’s Q (ADJQ) has any significant effect in determining the board compensation for

large as well as small firms.

For the firms belong to business group in India receive less amount of board

compensation. The dummy D_GROUP has negative significant effect on board

compensation. Current year as well as past year firm performance in terms of both ROA

and ADJQ have positive significant effect in determining the board compensation. For 1

20

percent increase in ADJQ in both current and past year, compensation of the board

increases by 1.4 percent. For this sample of firms, current as well as past year ROA also

have significant positive influence on board compensation. Past year ROA has greater

influence (2.13 percent) than current year ROA (1.8 percent) on determining the board

compensation. For the sample of standalone firms, only current and past year ROA of the

firm has positive significant effect on board compensation. From this analysis we can

conclude that compensation of Indian corporate board significantly (at 95% level)

depends on current and past year performance of the firm, especially for the group

affiliated firm.

Though total board compensation is tied up with firm performance but all the

components of board compensation do not depend on the firm performance. Table 4

shows only salary and commission components of the board compensation are tied up

with firm performance. Salary is apparently the largest component of compensation,

which is payable to only executive directors. Table 4, in this analysis shows, for 1 percent

increase in ROA in current and previous year, salary, payable to only executive directors

increases by 1 percent and 1.5 percent respectively. Similarly for 1 percent increase in

ADJQ in both current and previous year, salary of the executive directors in the board

increases by 1 percent. For 1 percent increase in ROA in current and previous year,

commission of the board 4.9 percent and 2.3 percent respectively. ADJQ has no

significant effect on determining the commission of the board. Intuition is, commission,

payable to whole board, is calculated on the basis current year accounting based profit,

whereas, salary is determined on the basis of overall performance of the firm. Therefore,

current year accounting based performance measure of the firm has greater influence on

determining the commission of the board. Firm performance has no significant influence

on perquisites and sitting fees of the board. Past year ROA of the firm has positive

influence on determining the current year sitting fees, payable to outside directors, of the

board. This implies that if the firm perform better in the previous year, firm increase

sitting fees to the outside director.

Risk is another indicator of firm performance. As the volatility or standard

deviation of the stock return (RISK) of the last month of the financial year increases, the

compensation of the board falls for all firms irrespective of size or affiliation from the

21

group. The percentage of decrease in board compensation is more for large firms or firms

belong to business group due to increase in RISK. RISK also adversely affects the

different components of executive directors compensation i.e., salary commission and

perquisites. I have tried with the volatility of stock return for full year instead of volatility

of last month of the financial year. But it has no significant effect on board

compensation. Adverse impact of the volatility of the stock return on the compensation

indicates the fact that shareholders are risk averse and they do not have long-term or

persisting memory of stock price on setting the compensation. Only the volatility of the

stock-price during the last month of the financial year has effect on the setting of

compensation.

B. Internal Monitoring

As the number of directors in the board (BOD_SIZE) increases, total

compensation of the board also increases which is quite obvious. But this result can be

interpreted in two ways. One interpretation is, as the board size increases free riding

problem also increases and as an immediate consequence monitoring decreases.

Therefore, all the executive directors increase their compensation, especially the fixed

components. Other interpretation can be, as the size of the board increases, monitoring of

the board also increases. Therefore, firm performance also improved and as a rewards

compensation of the board increases. Table 3 shows as the board size increases by one

member, board compensation increases by 8.2%. For the large firm, it is 7.6%. For the

group-affiliated firms, for increase in one member in the board, the increase in board

compensation is highest (9.2%) and for the standalone firms it is the lowest (6.5%). Table

4 shows, as the board member increases, both fixed as well as variable components of

compensation (commission) increase. Salary, commission and perquisites increase by

7.1%, 8.2% and 8.7% respectively. Sitting fees, payable to the NED, also increase by

6.9%. Therefore, from this analysis one can conclude that as the board size increase

compensation for both executive and non-executive director increases. Not only fixed

components of the compensation increase, but performance based component of

compensation also increases. This implies that this increase in compensation is mainly

due to increase in performance of the firm.

22

As the proportion of NED increases, Table 3 shows, board compensation

decreases significantly for the small firm and group affiliated firms. For one percent

increase in proportion of NED in the board, compensation of the board decreases by

0.62% and 0.40% for small and group affiliated firm respectively. For increase in

proportion of NED fixed components, especially salary, decreases but the compensation

to the NED i.e., sitting fees increases significantly. Table 4 shows that for one percent

increase in proportion of NED, salary decreases by 0.71% but sitting fees increase by

1.04%. Other components do not change significantly.

Identification of the CEO has great influence in determining the compensation. If

the CEO of the firm is also the Chairman of the firm, board compensation increases by

16.4%, especially for the small firms and group-affiliated firms. Table 3 shows, as the

CEO become the Chairman of the of the board compensation for the small firm or group-

affiliated firm increase by 21%. Different components of the compensation do not get

influenced by whether the CEO is Chairman. When the CEO is related to the founder

data reveals that most of the other executives or NED are also related to the founder. In

this case, Table 3 shows, compensation increase by 26% and for the large firm it is

57.6%. For the group-affiliated firm, it increases by 34%. Interestingly, this huge amount

of increase in compensation is done by mostly increase in commission i.e., performance

based component of compensation. Table 4 shows when CEO is relative of the founder

commission increase by 53%. If there is more than one CEO in the board then also

compensation increase by around 27%. In this case, compensation increases through

fixed components only. Both the fixed components of compensation increase by around

26%. This implies that free riding problem along with moral hazard problem kicks in

when there is more than one CEO in the board.

In India the data on the equity holding by individuals like CEO or managers are

not reported. Therefore, I cannot extend this analysis by incorporation the CEO

ownership variables. But we have data on equity holding by Founders/Promoter17,

Government, Private Corporate Bodies, Institutional Investors and Others. In the

17 According to Company Act 1956, Promoter is defined as the person who are instrumental in the formation of the company or programme pursuant to which the shares were offered to the public and has over-all control of the company.

23

Appendix, I consider four more variables on ownership pattern in India, percentage of

holding by Indian promoter, foreign promoter, government and private corporate bodies.

Table A1 shows with the increase in shareholding by the promoter, total compensation

increases, especially for the foreign promoter. For one percent increase in foreign

promoter shareholding, total compensation increases by 0.7%, out of that, salary

component increases by 0.9%. With the increase in government shareholding not only

total compensation, but also all the major components of compensation fall significantly.

Same thing holds for private corporate body’s shareholding.

C. Corporate Diversification

Corporate diversification is a very important factor in setting the compensation of

the board. Table 3 shows that as the number of product produced by the firm increases

the board compensation falls. But for increase in diversification index (DIVERSE),

which is better measure for diversification than product count, compensation of the board

increase. This implies that compensation does not increase with the increase in number of

product, but it increases as the production of all those products become more uniform.

Table 3 shows that for one percent increase in diversification index, compensation of the

board increase by 0.53%. For the large firm, it increases by 0.87%. For the small firms,

diversification does not give any extra compensation to the board. For one percent

increase of DIVERSE, board compensation of the group affiliated firm increase by

0.65%, and for the standalone firm, it increase by 0.46% but not very significantly (at

95% confidence level) different from zero.

With the increase in diversification index compensation of the board increases

mainly through fixed components of compensation. Table 4 shows for one percent

increase in DIVERSE salary and perquisites increase by 0.52% and 0.50% respectively.

Commission increases by 0.40%, but that too is not very significant (at 95% confidence

level). Intuition is, as the literature argued18 that the value of the firm decreases with the

increase in number of products. But as the amount of production of different products

become more uniform, rather than highly skewed, diversification index increases and as a

consequence operational complexity and risk of the firm increases. Therefore,

18 See Aggarwal and Samwick (2003) for the relevant literature.

24

compensation of the board increases, but mostly through fixed components of

compensation.

As the total number of plants of the firm in different location i.e. geographical

diversification increases, compensation of the board increases, especially for the firm

belongs to business group. Again Table 3 shows that for one unit increase in geographical

diversification (LOCATION), board compensation of the group affiliated firm increases

by 1.6%. This increase in board compensation is done only through increase in fixed

components of compensation. Table 4 shows for one unit increase in geographical

diversification (LOCATION), salary and perquisites increase by 1.6% and 2.1%

respectively whereas, sitting fees of the NED in the board decreases by 1.8%. Overall

analysis of this section depicts the fact that with the increase in diversification (product or

geographical or both), board of director especially executive directors get the scope to

increase their compensation, especially the fixed components of compensation. Through

the product diversification (DIVERSE) they try to show their capability of work under

complex and challenging environment and through geographical diversification

(LOCATION) they try to show their dynamisms. And in both the cases mostly fixed

components of compensation only increase.

6.2. Determination of CEO compensation:

This section analyses the determinants of CEO compensation. Table 5, shows the

regression result of truncated model, which is quite different from determination of board

compensation. It shows that only current year accounting based performance of the firm

has positive and marginally significant effect on determining the compensation of the

CEO(s). For one percent increase in ROA, CEO compensation increases by 0.47%. This

implies that board compensation as a whole, is more tied up with firm performance than

the CEO’s individual compensation. My finding is little different from the findings by

Rose and Shepard (1997); Brick et al. (2002), who find current and past year market

based as well as accounting based performance measure has significant effect on

compensation of the CEO in US firms. In India this holds true only for the board

compensation in group-affiliated firms.

25

In India, CEO compensation does not get affected significantly with the increase

in board size. Table 5 shows, for one percent increase in proportion of NED in the board

CEO compensation increases by 0.21%. My finding supports the finding of Core et al.

(1999), who also find positive correlation between proportion of NED and CEO

compensation. In India, it is very hard to distinguish between independent NED and NED

but not independent. In fact, most of the NEDs are not independent, because they come

from the family of the founder of the firm. If the CEO is endowed with additional

responsibility of Chairman of the board, compensation of the CEO increases by 7.3%.

This also supports the finding of Brickley et al. (1997). In India CEO(s) are often

selected from the relative of the founder group of the firm. If the CEO(s) are related to

the founder of the firm, compensation of the CEO increases by 7.9%. In the above Table

3, we have seen if the CEO is relative of the founder, board compensation increase by

26%. This implies when CEO is relative of the founder not only CEO compensation

increase, but compensation of other board member also increases simultaneously.

Table 5 also shows that as the number of product increases compensation of the

CEO falls. But CEO compensation increases with the increase in geographical

diversification (LOCATION). Intuition is, as the number of product increases risk for the

firm increase and it reveals the self-professing characteristics of the CEO. Therefore, the

compensation of the CEO falls. However, as the geographical diversification increases, it

reveals the dynamism characteristic of the CEO and this helps the CEO to bargain for

better compensation from the firm. As the firm become bigger operational complexity

increases and as a consequence compensation of the CEO increases very significantly.

Elasticity of CEO compensation with respect to sales is 0.14. Table 5 reveals the fact size

of the firm and total number geographical locations of plants are more important factors

in determining the compensation of CEO than compare to firm performance.

In the previous studies of India it is found that managerial compensation depends

positively on the age, experience and education or schooling year of the managers19. This

paper finds the result, different from the previous studies, which is shown in Table 5. I

did not find AGE and EDUCATION has any significant (at 95% level) effect on the

compensation of the CEO. Rather I have found that infirm-experience (INFIRM_EXP) of

19 Saha and Sarkar (1999 )

26

the CEO i.e., number of years that he/she (may not be as CEO) serves the firm has a

positive significant effect on the compensation. But the relation between infirm-

experience and CEO compensation is non-linear in nature. Compensation of the CEO

increases with the increase in infirm-experience but at decreasing rate. The interpretation

is that informational rent plays a crucial role in determination of the CEO compensation.

If the CEO worked for larger periods in the firm he/she has more information about the

firm and he/she can capitalised this information to increase his/her payoff. In India most

of the firms are family based. CEOs of these firms are mostly related to the founder

groups. For these CEOs, age does not matter, educational background of most of these

CEOs are commerce graduate. They start their career from own family owned firm. This

is the reason that infirm-experience turns out to be one of the most important factor in

determining the compensation of the CEO.

Table 5 also shows that compensation of the CEO increases with the increase in

the intensity of the R&D expenditure. This supports the finding of Cheng (2002), who

finds R&D expenditure has positive effect on CEO compensation. CEOs are rewarded for

spending for R&D, because it is an investment on future growth prospect of the firm.

This increase in compensation is a reward to the CEO for being an honest and not

covering up the losses by reducing the R&D expenditure.

7. Conclusion: This paper examines the effect of possible factors those determine the

compensation of the board and its components as well as compensation of the CEO(s).

The determinants of compensation used in this paper can be classified into four

categories: performance of the firm, internal monitoring, firm diversification and other

firm specific economic factors. This paper provides the evidence that current as well as

previous year accounting based measure of firm performance (ROA) has positive

significant effect on the board compensation. Market based measure of firm performance

also has positive significant effect on board compensation but only for the group

affiliated firms. This paper also provides the evidence that as size of the board increases

total compensation of the board as well as its different components also increase.

Proportion of NED has significant negative effect on total compensation of the board as

27

well as the salary component. If the CEO is Chairman of the board then it helps to

increase the compensation of the board for the small and the group-affiliated firms only.

When CEO is selected from the relative of the founder group or if there is more than one

CEO in the board then it helps to increase the board compensation. Compensation of the

board increases with the increase in the diversification index of the firm.

Regarding CEO compensation, this paper shows that size of the firm is more

significant important factor for determining the CEO compensation than the performance

of the firm. Compensation of the CEO increases with the increase in proportion of NED.

Among the personnel attributes, CEO compensation increases with the increase in infirm

experience of the firm but at a decreasing rate. This shows that board compensation as a

whole is more tied up with the performance of the firm than the CEO compensation.

This paper can be further enriched if one can get the data on the employee stock

option plan (ESOP). Till 2002 it was not mandatory for the firm to report the stock

holding by the CEO and other directors in the board. In future it is expected to have this

data in the annual reports and therefore, this work can be extended with this data.

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30

Table 1: Descriptive Statistics Columns 1 to 7 are the different cases under which mean and standard deviation of the variables are calculated. The Cases are: All firms, Large firms, Small firms, CEO cum Relative, number of products produced by the firm upto 3, in between 4 and 9 and greater than 9 respectively. Variables Total Compensation, Salary, Commission, Perks, Fees, ROA, ADJQ and SALES are in Rs. million. Note: All the nominal variables have been deflated and measured at constant price of 1993-94. The figures in the parenthesis are the standard deviation of the variables. Variable All firms Large Firms Small Firms CEO cum REL Count ≤ 3 3 < Count ≤ 9 Count > 9

TOTAL_COMP 5.35 (1.080)

7.63 (1.382)

2.55 (0.339)

6.92 (1.448)

4.71 (0.909)

4.38 (0.530)

8.00 (1.792)

SALARY 2.12 (0.271)

2.87 (0.325)

1.20 (0.137)

2.28 (0.268)

1.77 (0.269)

1.92 (0.197)

2.91 (0.367)

COMMISSION 2.09 (0.839)

3.21 (1.094)

0.73 (0.262)

3.41 (1.194)

2.22 (0.766)

1.33 (0.339)

3.44 (1.403)

PERKS 0.74 (0.129)

1.05 (0.162)

0.38 (0.050)

0.85 (0.156)

0.47 (0.078)

0.69 (0.115)

1.16 (0.183)

FEES 0.14 (0.044)

0.18 (0.054)

0.09 (0.026)

0.16 (0.057)

0.09 (0.021)

0.16 (0.056)

0.16 (0.034)

PROP_SAL 0.520 (0.244)

0.504 (0.054)

0.541 (0.249)

0.504 (0.250)

0.518 (0.267)

0.526 (0.235)

0.511 (0.233)

PROP_COMM 0.182 (0.242)

0.210 (0.254)

0.148 (0.221)

0.225 (0.273)

0.202 (0.271)

0.166 (0.222)

0.192 (0.243)

PROP_PERK 0.157 (0.135)

0.157 (0.134)

0.158 (0.137)

0.155 (0.131)

0.138 (0.138)

0.164 (0.132)

0.166 (0.137)

PROP_FEE 0.072 (0.182)

0.062 (0.153)

0.085 (0.211)

0.052 (0.136)

0.084 (0.220)

0.071 (0.176)

0.061 (0.138)

ROA 0.142 (0.127)

0.146 (0.084)

0.138 (0.166)

0.156 (0.087)

0.158 (0.199)

0.138 (0.079)

0.133 (0.087)

ADJQ 1.912 (6.356)

1.778 (5.744)

2.101 (7.127)

2.188 (7.065)

2.973 (8.770)

1.474 (4.344)

1.597 (6.343)

RISK 5.127 (3.038)

4.667 (2.171)

5.755 (3.839)

5.450 (3.556)

5.361 (3.360)

5.310 (3.292)

4.534 (1.902)

BOD SIZE 10.565 (3.167)

11.501 (3.309)

9.416 (2.553)

10.459 (2.968)

9.736 (2.832)

10.583 (3.219)

11.506 (3.177)

NED 6.765 (2.683)

7.149 (2.894)

6.285 (2.307)

6.121 (2.436)

6.420 (2.461)

6.690 (2.733)

7.305 (2.755)

PROP_NED 0.638 (3.167)

0.619 (0.171)

0.661 (0.163)

0.582 (0.151)

0.655 (0.175)

0.632 (0.163)

0.631 (0.172)

COUNT 7.538 (6.158)

9.241 (6.973)

5.466 (4.139)

7.041 (4.953)

2.167 (0.809)

6.173 (1.685)

15.368 (7.034)

DIVERSE 0.431 (0.277)

0.487 (0.273)

0.362 (0.265)

0.433 (0.260)

0.130 (0.175)

0.449 (0.215)

0.686 (0.165)

LOCATION 7.476 (7.120)

9.064 (7.638)

5.525 (5.870)

7.155 (6.212)

3.853 (5.484)

6.392 (4.391)

13.845 (8.835)

SALES 8145.97 (3246.13)

13693.40 (4251.66)

1045.64 (42.62)

5095.64 (1751.16)

3402.65 (677.87)

8207.62 (4066.46)

13503.20 (3144.98)

ADVINT 0.016 (0.207)

0.012 (0.024)

0.020 (0.312)

0.009 (0.018)

0.030 (0.390)

0.011 (0.025)

0.008 (0.015)

R&DINT 0.004 (0.009)

0.005 (0.010)

0.003 (0.007)

0.005 (0.011)

0.003 (0.008)

0.004 (0.009)

0.005 (0.011)

FIRM_AGE 35.827 (23.821)

38.607 (23.230)

32.413 (24.110)

31.285 (21.683)

28.318 (21.393)

37.460 (23.809)

41.471 (24.439)

N 1435 791 644 664 409 678 348

31

Table 2: Pearson Correlation Coefficients Matrix.

Prob > |r| under H0: Rho=0. In the parenthesis the p-value is given.

D_GROUP D_LARGE TOTAL_COMP COUNT LOCATION DIVERSE PROP_NED SIZE D_CH D_REL

1.000 D_GROUP

0.236 1.000 D_LARGE (<.0001)

0.023 0.234 1.000 TOTAL_ COMP (0.378) (<.0001)

0.143 0.307 0.140 1.000 COUNT (<.0001) (<.0001) (<.0001)

0.142 0.258 0.237 0.691 1.000 LOCATION (<.0001) (<.0001) (<.0001) (<.0001)

0.059 0.219 0.100 0.638 0.472 1.000 DIVERSE (0.006) (<.0001) (0.000) (<.0001) (<.0001) 0.013 -0.121 -0.082 -0.051 -0.032 -0.047 1.000 PROP_NED

(0.611) (<.0001) (0.002) (0.059) (0.223) (0.080) 0.151 0.328 0.191 0.274 0.242 0.121 0.000 1.000 BOD SIZE

(<.0001) (<.0001) (<.0001) (<.0001) (<.0001) (<.0001) (0.990) -0.035 -0.067 0.076 -0.100 -0.113 -0.031 -0.247 -0.129 1.000 D_CH (0.190) (0.011) (0.004) (0.000) (<.0001) (0.258) (<.0001) (<.0001) -0.040 -0.112 0.135 -0.075 -0.042 0.008 -0.307 -0.031 0.436 1.000 D_REL (0.128) (<.0001) (<.0001) (0.006) (0.113) (0.762) (<.0001) (0.240) (<.0001)

32

Table 3: Regression results of log of board compensation.

Five columns in this table show the regression results for the sample of all firms, large firms, small firms,

group affiliated firms and standalone firms. If the sales of the firm are more than Rs.2 billion then those

firms are recognised as large firms otherwise small firms. The first column of each panel shows the

estimated value of the parameters and the second column gives the p-value. This table shows the regression

results of log of total board compensation on current and previous year ROA and ADJQ, risk of the firm

measure in terms of standard deviation of stock return, board size, proportion of NED in the board, total

number of variety of products produced by the firm, product diversification index, total number locations of

plant of the firm, three dummies as a proxy for identification of CEO e.g. Chairman, Relative, more than

one CEO in the firm, and other control variables such as sales, advertisement intensity and R&D intensity,

firm age dummy for the firms belong to business group. All the regressions include time and industry fixed

effects. The sample covers the period from 1997 to 2002.

All Firms Large firms Small Firms Group Firms Standalone firms

Variable Estimate Probt Estimate Probt Estimate Probt Estimate Probt Estimate Probt

INTERCEPT -4.552 <.0001 -3.981 <.0001 -3.673 <.0001 -5.161 <.0001 -4.569 <.0001

ROA 1.795 0.000 1.841 0.018 1.914 0.002 1.805 0.004 1.766 0.025

ADJQ 0.009 0.117 0.010 0.187 0.007 0.388 0.014 0.049 -0.002 0.826

ROAt-1 2.051 <.0001 0.958 0.234 2.676 <.0001 2.135 0.001 2.292 0.008

ADJQt-1 0.007 0.209 0.009 0.299 0.009 0.169 0.014 0.066 0.000 0.984

RISK -0.060 <.0001 -0.138 <.0001 -0.033 0.002 -0.065 <.0001 -0.039 0.036

BOD SIZE 0.082 <.0001 0.076 <.0001 0.081 <.0001 0.092 <.0001 0.065 0.001

PROP_NED -0.408 0.028 -0.247 0.327 -0.618 0.022 -0.402 0.059 -0.353 0.342

D_CH 0.164 0.019 0.159 0.122 0.211 0.024 0.211 0.012 -0.096 0.439

D_REL 0.259 0.000 0.576 <.0001 -0.103 0.256 0.338 <.0001 -0.046 0.747

D_MORE_MD 0.269 0.000 0.405 <.0001 0.251 0.010 0.279 0.001 0.330 0.010

COUNT -0.024 0.001 -0.025 0.010 -0.028 0.062 -0.031 0.000 -0.023 0.258

DIVERSE 0.530 0.000 0.869 <.0001 0.261 0.203 0.651 0.000 0.459 0.096

LOCATION 0.008 0.199 0.002 0.798 0.012 0.183 0.016 0.021 0.016 0.157

LSALES 0.297 <.0001 0.298 <.0001 0.126 0.177 0.235 <.0001 0.423 <.0001

ADVINT 7.604 <.0001 6.267 0.001 7.041 0.003 10.562 <.0001 2.295 0.185

R&DINT 18.450 <.0001 15.193 0.000 19.913 0.005 17.543 <.0001 15.637 0.020

FIRM_AGE -0.001 0.708 0.002 0.257 -0.002 0.302 -0.001 0.414 -0.002 0.365

D_GROUP -0.132 0.086 -0.479 0.000 0.112 0.208

R-Square 0.44 0.45 0.40 0.44 0.62

Adj R-Sq 0.43 0.41 0.34 0.41 0.57

F Value 23.64 14.02 7.63 18.92 10.76

N 1193 701 491 938 254

33

Table 4: Regression results of log of different components of board compensation.

Panels A, B, C and D of the table show the regression results of log of salary, commission, perquisites and

sitting fees. The estimation method is seemingly unrelated regression (SUR). The regressors are same as I

have discussed in Table 3. The first column of each panel shows the estimated value of the parameters and

the second column gives the p-value. All the regressions include time and industry fixed effects. The

sample covers the period from 1997 to 2002.

Panel A Panel B Panel C Panel D

Log(Salary) Log(Commission) Log(Perquisites) Log(Sitting Fees) Variable

Estimate P-Value Estimate P-Value Estimate P-Value Estimate P-Value

INTERCEPT -5.252 <.0001 -7.111 <.0001 -6.289 <.0001 -8.870 <.0001

ROA 1.025 0.017 4.912 <.0001 0.380 0.594 0.759 0.261

ADJQ 0.010 0.030 0.001 0.940 -0.001 0.895 0.001 0.901

ROAt-1 1.457 0.001 2.275 0.006 1.076 0.140 1.239 0.073

ADJQt-1 0.010 0.025 -0.004 0.663 0.000 0.994 -0.002 0.772

RISK -0.038 <.0001 -0.068 <.0001 -0.059 <.0001 0.002 0.880

BOD SIZE 0.071 <.0001 0.082 <.0001 0.087 <.0001 0.069 <.0001

PROP_NED -0.714 <.0001 0.085 0.773 -0.122 0.642 1.042 <.0001

D_CH 0.059 0.324 0.102 0.367 -0.022 0.825 -0.010 0.915

D_REL 0.051 0.380 0.529 <.0001 0.179 0.065 -0.040 0.666

D_MORE_MD 0.265 <.0001 -0.191 0.085 0.261 0.008 -0.168 0.072

COUNT -0.037 <.0001 -0.030 0.011 -0.029 0.007 0.003 0.799

DIVERSE 0.518 <.0001 0.396 0.073 0.495 0.012 0.116 0.534

LOCATION 0.016 0.001 0.005 0.582 0.021 0.010 -0.018 0.018

LSALES 0.279 <.0001 0.241 <.0001 0.264 <.0001 0.232 <.0001

ADVINT 8.511 <.0001 6.854 0.001 10.285 <.0001 -1.202 0.497

R&DINT 14.528 <.0001 25.099 <.0001 7.398 0.113 11.462 0.010

FIRM_AGE 0.001 0.586 -0.002 0.267 0.000 0.838 0.003 0.149

D_GROUP -0.175 0.007 0.099 0.415 -0.127 0.235 0.397 <.0001 System Weighted R-Square 0.29

34

Table 5: Determination of log of CEO compensation.

This table shows the regression results of CEO compensation on the same set of regressors that have been

described in Table 3 and added to the age of the CEO, education level of the CEO and infirm experience of

the CEO and it’s square. The estimation method is truncated regression model. Education is measured by

total number of schooling years. Infirm experiences measures by subtracting the year of joining from the

current year. First column gives the name of the regressors and second and third column gives the

estimated value of the corresponding parameters ant its p-value respectively. All the regressions include

time and industry fixed effects. The sample covers the period from 1997 to 2002.

Variable Estimate Probt INTERCEPT -1.403 <.0001 ROA 0.468 0.064 ADJQ 0.000 0.985 ROAt-1 0.262 0.308 ADJQt-1 -0.001 0.854 RISK -0.002 0.757 BOD_SIZE 0.002 0.637 PROP_NED 0.209 0.043 D_CH 0.073 0.043 D_REL 0.079 0.019 D_MORE_MD -0.005 0.869 COUNT -0.008 0.038 DIVERSE -0.018 0.800 LOCATION 0.014 <.0001 AGE -0.001 0.728 EDU 0.009 0.070 INFIRM_EXP 0.016 0.000 (INFIRM_EXP)2 -0.001 <.0001 LSALES 0.142 <.0001 ADVINT 0.175 0.831 R&DINT 5.667 0.000 FIRM_AGE -0.002 0.001 D_GROUP -0.020 0.604 Log Likelihood -139.67 N 600

35

Appendix Table A1: Effect of shareholding pattern in determining the log of board compensation and its components.

Panels A, B, C and D of the table show the regression results of log of total board compensation, salary,

commission and sitting fees. Explanatory variables are same as explained in Table 3 and four more

variables on the shareholding patterns namely, equity holding by Indian promoter, foreign promoter,

government and other private corporate bodies. The data on the equity holding is available for only 2001

and 2002 so, this regression is done for the period of 2001 and 2002 only The first column of each panel

shows the estimated value of the parameters and the second column gives the p-value. All the regressions

include time and industry fixed effects.

Panel A Panel B Panel C Panel D Log (Total Compensation) Log (Salary) Log (Commission) Log (Sitting Fees) Variable

Estimate P-Value Estimate P-Value Estimate P-Value Estimate P-Value INTERCEPT -5.026 <.0001 -5.097 <.0001 -6.047 <.0001 -7.676 <.0001 ROA 2.667 0.001 1.576 0.032 4.665 0.001 1.844 0.126 ADJQ 0.001 0.912 0.015 0.150 -0.035 0.092 0.011 0.511 ROAt-1 0.098 0.897 0.583 0.404 3.279 0.017 -1.685 0.140 ADJQt-1 0.013 0.072 0.008 0.214 0.017 0.167 0.000 0.977 RISK -0.070 <.0001 -0.052 0.000 -0.096 0.001 -0.026 0.270 BOD SIZE 0.078 <.0001 0.075 <.0001 0.080 0.006 0.040 0.112 PROP_NED -0.075 0.794 -0.472 0.076 -0.551 0.287 1.035 0.018 D_CH 0.310 0.003 0.272 0.005 0.168 0.376 0.052 0.754 D_REL 0.170 0.126 -0.086 0.406 0.554 0.007 -0.120 0.479 D_MORE_MD 0.317 0.002 0.286 0.003 -0.195 0.291 -0.014 0.927 IND_PROM 0.003 0.378 0.003 0.214 -0.001 0.895 -0.006 0.140 FOR_PROM 0.007 0.054 0.009 0.003 -0.001 0.884 -0.002 0.695 GOVT_HOLD -0.016 <.0001 -0.010 0.002 -0.025 <.0001 -0.013 0.029 PCBS -0.012 0.055 -0.009 0.106 -0.014 0.228 -0.019 0.045 COUNT -0.018 0.096 -0.027 0.007 -0.006 0.748 0.003 0.847 DIVERSE 0.511 0.014 0.550 0.004 0.083 0.824 0.122 0.705 LOCATION 0.014 0.135 0.013 0.133 0.013 0.416 -0.015 0.264 LSALES 0.336 <.0001 0.306 <.0001 0.223 0.011 0.294 0.000 ADVINT 5.801 0.002 5.048 0.004 6.276 0.062 0.808 0.772 R&DINT 16.689 0.001 10.532 0.023 17.422 0.054 12.820 0.105 FIRM_AGE -0.001 0.592 -0.001 0.717 -0.003 0.437 0.003 0.303 D_GROUP 0.058 0.640 -0.158 0.171 0.287 0.203 0.614 0.001 R-Square 0.56 0.53 0.41 0.29 Adj R-Sq 0.52 0.49 0.36 0.21 F Value 13.19 11.45 7.13 3.91 N 414 410 409 394