RPT that benefiting Proceeding E Book 4A Turky
1408
5.2. Variable Measurement and Data Collection Components corporate governance score, including rights of shareholders and key
ownership functions, the equitable treatment of shareholders, disclosure and transparency, and the responsibilities of the board, are collected from Indonesian
Institute for Corporate Directorship IICD that provides scores for CG components and total CG. The scores are based on an instrument of 117 items on which the
rating for each item poor, fair, and good is based on public information disclosed by a firm e.g., Annual Report, Financial Statements, Website, Corporate
announcements, etc. Total CG score is obtained by adding all components‘ scores adjusted with their weight. The weight for each CG component: Rights of
Shareholders RIS 20, Equitable Treatment of Shareholders ETS 15, Disclosure and Transparency DT 25, and Responsibility of Board RESB 25 of
total CG scores. We employ year 2005 scores as scores for year 2006 and 2007 due to availability of data.
We collect data for majority ownership proportion which is the largest ownership of the firm from information on notes of financial statement about ownership structure.
Due to data availability, we do not calculate Cash-Flow Right and Control Right of the controlling shareholder. We calculate leverage using formula total debt divided
by total debt plus total equity. Because we use leverage as a proxy of external monitoring, then the liabilities included on the leverage calculation are loans from
banks, financial institutions, and other institutions that could monitor the firm. We exclude liabilities from related parties. Liabilities and equity data are collected from
Balance Sheet. Size is measured by log of market capitalization number of outstanding shares multiplied by security price at the end of year. Data for security
1409
price and outstanding shares are collected from Bursa Efek Indonesia BEI or the Indonesian Stock Exchange.
5. Empirical Result and Analysis 5.1 Statistical Analysis
Table 2 provides statistics descriptive of variables employed by the study. Mean scores for RIS and RESB are 51.74 and 54.46, suggesting that on average, in
Indonesia protection of rights of shareholders is not yet adequate while the board is not yet effective in performing its responsibilities and accountability. Similarly, the
average score of 68.1 for DT implies that there are rooms for improving the disclosure and transparency in Indonesia. Surprisingly, ETS appears to be well
performed since the mean score of this component is 83.07. However, examining the items under this component reveals that disclosures of some items are
mandatory by Bapepam-LK and thus the scores for most firms are good. Further, only very few firms are sanctioned by Bapepam-LK in connection with violating rules
related to ETS. On average, majority shareholders‘ ownership of the firms in Indonesia is 49.42, meaning that ownership structure of listed firms is quite
concentrated. The average financial leverage in Indonesia is quite high, with mean value of 41.33.
Table 2 Statistical Descriptive
DUMMYRP T
RIS ETS
DT RESB
PROP LEV
SIZE Mean
0.625767 0.51738
2 0.83067
3 0.68096
0.54457 6
0.49414 7
0.41326 5
27.4274 6
Median 1.000000
0.50724 6
0.83333 3
0.66666 7
0.52381 0.51340
0.44475 4
27.4743 7
Maximum 1.000000 0.62318 1.00000 0.91666 0.92063 0.97950 0.61060 32.3882
1410
8 7
5 7
6 Minimum
0.000000 0.44927
5 0.49275
4 0.46875
0.36507 9
0.07420 0.00000
18.5517 1
Std. Dev. 0.485416
0.04086 9
0.07798 5
0.10593 3
0.12580 2
0.22440 0.13425
7 2.33183
Skewness -0.519779 0.45426
9 -
1.69275 6
0.20436 3
0.70074 3
0.10160 3
- 2.21690
- 0.54170
6 Kurtosis
1.270170 2.73560
5 7.29767
8 2.34859
1 2.61837
1 2.15779
3 7.36432
8 3.88668
1 Jarque-
Bera 27.66240
6.08089 7
203.286 4
4.01653 5
14.3290 8
5.09785 9
262.877 8
13.3115 6
Probability 0.000001 0.04781
3 0.00000
0.13422 1
0.00077 4
0.07816 5
0.00000 0.00128
7 Sum
102.0000 84.3333
3 135.399
8 110.996
5 88.7658
7 80.5459
8 67.3621
4 4470.67
6 Sum Sq.
Dev. 38.17178
0.27058 8
0.98522 5
1.81793 5
2.56383 6
8.15754 1
2.92004 8
880.864 2
Observatio ns
163 163
163 163
163 163
163 163
Table 3 provides the pearson correlation analysis among variables. As expected, correlations among CG components are all significantly positive. Firm size also is
positively correlated with all CG components except Rights of Shareholders. Thus, larger firms tend to be governed better than small firms. ETS and REB have negative
relationship with dummy RPT, supporting the hypothesis, although only ETS that is statistically significant. Other CG components RIS and DT have positive relationships
with the probability of RPT that a priori to expropriate occur but they are significant. Relationship between majority ownership and dummy RPT is negative and significant on
level 5 while Leverage has a positive relationship with dummy RPT but not significant.
Table 3 Pearson Correlation
Dumm y
RPTmt Prop
size RiS
EtS DT
ResB Lev
1411
Dumm y
RPTmt Pearson
Correlatio n
1 -
,159 -,092
,106 -
,171 ,012
-,101 ,08
3 Sig. 2-
tailed ,044
,244 ,178
,029 ,878
,201 ,29
3 N
163 160
163 163
163 163
163 163 Prop
Pearson Correlatio
n -
,159 1
,051 -
,342 ,103
-,054 ,069
- ,12
9 Sig. 2-
tailed ,044
,524 ,000
,197 ,500
,384 ,10
4 N
160 160
160 160
160 160
160 160 lnsize
Pearson Correlatio
n -,092
,051 1
,078 ,205
,557 ,424
,00 7
Sig. 2- tailed
,244 ,524
,323 ,009
,000 ,000
,92 6
N 163
160 163
163 163
163 163 163
RiS Pearson
Correlatio n
,106 -
,342 ,078
1 -
,527 ,178
,231 -
,13 9
Sig. 2- tailed
,178 ,000
,323 ,000
,023 ,003
,07 8
N 163
160 163
163 163
163 163 163
EtS Pearson
Correlatio n
- ,171
,103 ,205
- ,527
1 ,130
,144 ,05
Sig. 2- tailed
,029 ,197
,009 ,000
,097 ,066
,52 6
N 163
160 163
163 163
163 163 163
DT Pearson
Correlatio n
,012 -,054
,557 ,178
,130 1
,604 ,04
Sig. 2- tailed
,878 ,500
,000 ,023
,097 ,000
,60 9
N 163
160 163
163 163
163 163 163
ResB Pearson
Correlatio n
-,101 ,069
,424 ,231
,144 ,604
1 -
,06 1
Sig. 2- tailed
,201 ,384
,000 ,003
,066 ,000
,43 8
N 163
160 163
163 163
163 163 163
Lev Pearson
Correlatio n
,083 -,129
,007 -,139
,050 ,040
-,061 1
Sig. 2- tailed
,293 ,104
,926 ,078
,526 ,609
,438 N
163 160
163 163
163 163
163 163 Correlation is significant at the 0.05 level 2-tailed.
Correlation is significant at the 0.01 level 2-tailed.
1412
5.2 Regression Result In the first model, we use CG components as proxies of internal monitoring, and the
results can be seen in Table 5. Table 5
Regression of Determinants Affecting Probability of RPTE Dependent Variable: Dummy RPTmt
Method: ML – Binary Logit Quadratic hill climbing
Sample: 1 – 163
Variable Coefficient
Std. Error z - Statistic
Prob. VIF
RIS 0.231129
1.010041 0.228831
0.4095 1.618445
ETS -3.535646
3.039755 -1.163135
0.1224 1.608769
DT 2.975157
2.287771 1.300461
0.0967 1.966186
RESB -2.388398
1.769147 -1.350028
0.0885 1.730433
PROP -1.122747
0.770095 -1.457933
0.1449 1.044129
LEV 1.200784
1.269641 0.945767
0.1722 1.041111
SIZE -0.084824
0.090161 -0.940806
0.3468 1.521063
C 5.013984
2.912212 1.721710
0.0851 McFadden R-squared
0.062918 LR Statistic
13.56144 Prob LR statistic
0.059555 We find that RESB is significantly negative affecting the probability of RPTE at 90
confidence level. This finding confirms the hypothesis that the more responsible and accountable the board is then the lower is the probability occurrence of RPT that a priori
to expropriate. Thus, responsible and accountable board will control and manage potential conflict of interest between a firm and management, directors or controlling
shareholders. As expected, the coefficient for Equitable Treatment of Shareholders ETS is negative, but it is only marginally significant at 85 confidence level. Protection
of shareholders rights RIS does not affect the probability of RPTE. The possible reason
1413
for this insignificant result is that this principle concerns with shareholders rights in general, including controlling shareholders right, while monitoring of RPT primarily is to
protect the rights of non-controlling shareholders. Contrary to the expectation, Disclosure and Transparency DT is significantly positive affecting the probability of RPT that a
priori to expropriate occur, meaning that the more firms disclose their activities then the higher probability that the firm will engage the RPT that a priori to expropriate. The
reason for this opposite finding might be that if RPT is a priori to expropriate, then the firm will be required to disclose more detailed about the RPT that they‘re engage. As
shown in Table 1, RPTs that involve cash received, subsidiaries relation, and joint venture are those a priori to benefit a company, while these types of transactions that
require less disclosure requirement.
Proportion of Majority Ownership PROP marginally has a negative influence on the probability of RPTE. The result implies that firms with higher ownership of controlling
shareholders tend to engage in more beneficial RPT. On the other hand, Financial Leverage LEV does not significantly affect the probability of RPTE. Thus, in Indonesia,
monitoring role from external parties is not yet effective in reducing the probability of RPT a priori to expropriate to occur.
In the second model we use Total CG as the proxy for internal monitoring and the results are shown in Table 6.
1414
Table 6 Regression Total CG
Dependent Variable: Dummy RPTmt
Method: ML – Binary Logit Quadratic hill climbing
Sample: 1 – 163
Variable Coefficient
Std. Error z
– Statistic Prob. TOTAL CG
-2.021187 3.463304
-0.583601 0.27975
PROP -1.482867
0.749420 -1.978685
0.0479 LEV
1.068480 1.209749
0.883224 0.18855
SIZE -0.049142
0.087342 -0.562637
0.5737 C
3.253544 2.128624
1.528473 0.1264
McFadden R-squared 0.031200
LR Statistic 6.724789
Prob LR statistic 0.151167
The second regression shows that TOTAL CG has no relation with the probability of RPTE. This finding confirms our expectation that to examine the influence of CG practice
to the probability of RPTE, we must employ more specific components of CG practice. The finding for Proportion of Majority Ownership PROP is consistent with the previous
regression, i.e., this variable is significantly negative affecting the probability of RPTE. Thus, more concentrated ownership does not necessarily mean that the majority
shareholder will engage in RPT that a priori to expropriate the minority shareholders. The results for Financial Leverage and Size are not significant, consistent with the first
regression.
The correlation analysis in Table 3 shows that the CG components are correlated to each other. To investigate the impact of each component without taking into account
other components, next we regress these variables independently. The result were shown on table 7 below.
1415
Table 7. Regression Results with CG Components Run Separately Variable
Dummy RPT
mt
RIS 0.239203
0.3678 ETS
-4.706522 0.0345
DT 1.503110
0.2203 RESB
-1.083681 0.2269
PROP -1.332771
0.0389 -1.311229
0.0416 -1.392671
0.03185 -1.441447
0.0268 LEV
1.323385 0.1456
1.212428 0.1632
1.035162 0.1966
1.010196 0.2023
SIZE -0.088542
0.2274 -0.048019
0.5162 -0.120315
0.1936 -0.052585
0.5087 C
2.916726 0.1676
5.928005 0.0267
3.073507 0.1494
2.862002 0.1663
McFadden R-squared 0.043647
0.047158 0.032426
0.032223 LR Statistic
9.407810 10.16452
6.989102 6.945399
Prob LR statistic 0.051676
0.037746 0.136465
0.138802 When regressed separately, the findings are that CG components i.e., RIS, DT, and
RESB are not significantly affecting the probability of RPTE. However, ETS is significantly and negatively affecting the probability of RPTE. This result supports the
hypothesis that more equitable treatment of shareholders reduces the probability of wealth expropriation through RPT.
6. Conclusion RPT can be employed to benefit a firm or to expropriate wealth of minority shareholders.
We investigate determinants that could affect the type of RPT. The determinants are
1416
internal and external monitoring mechanism as well as ownership by majority shareholders.
We find that a. a responsible and accountable board and b. more equitable treatment of shareholders could reduce the probability of RPT a priori being used to expropriate
wealth of minority shareholders. Protection of shareholders rights does not have any influence on the type of RPT conducted while contrary to expectation, higher disclosure
level associates with more RPT that a priori is to expropriate. The reason for this finding might be that if RPT is a priori to expropriate, then firms are required to provide more
disclosure about the RPT that they‘re engage. Further, we document that CG practice as a whole does not affect the probability of RPT a priori being employed to expropriate.
This finding implies that to examine the influence of CG practice to the probability of an a priori abusive RPT, researcher must employ more specific components of CG practice.
For external monitoring role for RPT we find that Financial Leverage does not significantly affect the probability of the occurrence of RPT a priori to expropriate.
Therefore, in Indonesia, monitoring role from external parties is not yet effective in reducing the probability of RPT a priori to expropriate to occur. Finally we find that
proportion of majority ownership reduces the possibility of an a priori abusive RPT. The result implies that firms with higher ownership of controlling shareholders tend to engage
in more beneficial RPT. Their higher stakes at the company may reduce their incentive to engage in activities such as RPT that cause loss to the company.
REFERENCES
Capulong, M. Virginita, David Edwards, David Webb, and Juzhong Zhuang 2000. Corporate Governance and Finance in East Asia : A Study of Indonesia,
1417
Republic of Korea, Malaysia, Philippines, and Thailand, Volume One A Consolidated Report,
www.adb.orgdocumentsbookscorporate_governance .
Cheung, Rau, and Stouraitis 2006. Tunneling, Propping, and Expropriation: Evidence From Connected Party Transactions In Hongkong, Journal of Financial
Economics, 82, 343-386. Utama, Cynthia 2006. The Influence of Internal Transactions, Corporate Governance,
Status Conglomeration, And Ownership Structure on Stock Market Reaction In Investment Decision Announcements, working paper, University of Indonesia.
Gordon, A Elizabeth, Elaine Henry, and Darius Palia 2003. Related Party Transactions: Associations With Corporate Governance And Firm Value. papers.ssrn.com.
Mark Kohlbeck, and Brian Mayhew 2004 Related Party Transactions. papers.ssrn.com. Masruroh 2000. Dampak Pengumuman Right Issue Terhadap Shareholders Wealth di
BEJ, Thesis tidak dipublikasikan. Program Pasca Sarjana Bidang Ilmu Ekonomi Universitas Indonesia.
McCahery, Joseph A, and Vermeulen, Erik P. M, 2006. Corporate Governance Crises And Related Party Transactions: A Post Parmalat Agenda. papers.ssrn.com.
Methodology For Assessing The Implementation Of The OECD Principles On Corporate Governance 2006.
www.oecd.org Michael Ryngaert, and Shawn Thomas 2007. RPT: Their Origins and Wealth Effects.
papers.ssrn.com. The OECD Principles Of Corporate Governance 2004.
www.oecd.org Utama, Sidharta 2008, National Experiences With Managing Related Party Transaction,
The 2008 Asian Roundtable On Corporate Governance, OECD.
1418
THE INFLUENCE OF BOARD AND OWNERSHIP STRUCTURE ON PAY PERFORMANCE BASED AND NON-PAY PERFORMANCE BASED
COMPANIES IN MALAYSIA
Basariah Salim and Wan Nordin Wan Hussin
Abstract: We examine the influence of board and ownership structure on pay performance based and non-pay performance based of 158 companies listed on
Bursa Malaysia for years 2003 to 2005. The results reveal that there is a significant difference of mean between companies which assert that their pay is
linked to performance or otherwise. Among the variables are institutional shareholder, board score, and remuneration score, return on asset, return on
performance, total asset and total debt. Furthermore, this study finds that adoption of pay-for performance as recommended by the Code is influence by
ownership structure in particular the percentage of managerial ownership, local institutional ownership and foreign ownership. On the aspect board
characteristics, remuneration score seems to show a strong influence on the adoption while board score is insignificant.
Introduction
Executive remuneration has become one of the most significant issues in contemporary corporate governance Hill, 2006
243
. Central to the debate is whether an exorbitant pay to executive directors is justified given the economic performance of the
company involved. Some shareholders are of the opinion that executive directors are
243
This issue has been long criticized and one of the topics that caught the attention of business magazines and alike in-developed countries especially US Jensen and Murphy, 2004.
Besides, Dalton and Dalton 2005 note that up to this date, this is one of the favorite topics being studied in corporate governance discipline. Murphy 1999 claimed that CEO remuneration
research has grown even faster than CEO paychecks, skyrocketing from one to two papers per year prior to 1985 to 60 papers in 1995. In addition, Barkema and Gomez-Mejia 1998 and
Gomez-Mejia and Wiseman 1997 assert that this issue has been studied 70 years ago and is still debated till today due to the mixed result of the relationship. They claim that a total of more
than 300 studies on remuneration have been accumulated during the years. Email of correspondence author: Basa1189uum.edu.my
1419
overpaid compared to their contributions to the companies and excessive remuneration ultimately comes out of the shareholders‘ pocket. The perception that directors are
excessively paid is also shared by the Malaysian public particularly the shareholders. Latest news and cases highlighted in Malaysian business magazines continues to attract
attention on the issue of excessive pay
244
. The absence of strong link between pay and performance as evidenced by
previous studies i.e. Jensen and Murphy, 1990 indicated that the incentive mechanism i.e. remuneration on its own does not effective in aligning the interest of shareholders
and executives. It is difficult to deny the importance of incentive mechanism in motivating and retaining talented executives or terminating bad executives. Thus, in
ensuring that incentive mechanism really works as what is expected by shareholders, agency theorists suggested on integration of incentive mechanism and other governance
mechanisms such as board of director and ownership structure. However, to what extent can the shareholders rely on the board particularly the remuneration committee to
act on their behalf? The situation is worst when the executives who are family members sit on the remuneration committee.
Recent developments in corporate governance particularly executive remuneration have heightened the need to study this issue comprehensively and
244
Transmile Group, the air cargo carrier, attracted attention in the early part of 2007 when its external audi
tor Deloitte Touche blew the whistle after discovering irregularities in prior years‘ audited financial statements, involving unsubstantiated sales of more than RM600 million from
2004 to 2006. Subsequently, Transmile Group restated its financial statements from a profit of RM158 million to a loss of RM126 million for the year ended December 2006. In July and
November 2007, its former CEO, CFO and two non-executive directors were charged in court with abetting the company in providing misleading financial statements. At the AGM held in
September 2007, more than two third of the shareholders voted against the payment of director fees for 2006 totalling RM145, 000. The non-executive Chairman of Transmile Group, who is an
ex-Transport Minister, resigned shortly before the said AGM. He joined the board of Transmile Group in 2004 when the Kuok Group emerged as a new controlling shareholder.
1420 systematically. Furthermore, Denis and McConnell 2003 claim that for many
countries in the world there is only limited empirical evidence regarding issues related to the effectiveness of boards of directors and of the compensation plans,
they put in place; for some there is no evidence at all. These are useful avenue for further research. In addition, boards of directors and executive remuneration
cannot be viewed in isolation. The interrelationship between board composition, executive compensation, and other corporate governance mechanisms remains
a fruitful area for research worldwide.
In this context, Malaysia provides a unique setting in exploring the issues of executive remuneration and corporate governance. Following the introduction
of the voluntary Malaysian Code on Corporate Governance thereafter is referred as the Code in 2000, companies listed on Bursa Malaysia are required to make
public the Statement of Corporate Governance incorporating disclosure on directors‘ remuneration. The Code emphasizes the following principles on
directors‘ remuneration. First, in the case of executive directors, remuneration should be structured so as to link rewards to corporate and individual
performance. Second, companies should establish a formal and transparent procedure for developing policy on executive remuneration and for fixing the
remuneration packages of individual directors. And third, company‘s annual report should contain details of the remuneration of each director. Under best
practices in corporate governance, the Code recommends companies to establish a remuneration committee consisting of wholly or mainly of non-
executive directors. The committee will monitor, supervise and advice the
1421 board
‘s decision regarding executive remuneration. The committee is allowed to
get an advice from consultant relating to executive directors‘ remuneration and recommend to the board an appropriate remuneration for the executive directors.
Hence, specifically, this study attempts to examine the influence of board and ownership structure on companies which assert that their pay is based on
performance as compared to companies which are non-pay performance based.
Incentive pay
Incentive pay or pay-for-performance has long been used in aligning the interest of shareholder and manager. The pay-for-performance model is based on agency
theory which works on the basis of how to structure the contractual relation including remuneration incentives between the principal and agent to provide appropriate
incen tives for the agent to make choices which will maximize the principal‘s welfare,
given that uncertainty and imperfect monitoring exist Jensen and Meckling, 1976. In this relationship, shareholder expects the executive to put their greatest effort to
ma ximize firm value, which in turn increases the shareholder‘s wealth. In doing so, the
executive in return also expects rewards, which is worth their effort. Thus, based on that argument, agency theory posits that aligning remuneration and performance is the
optimum solution in satisfying the interest of the principal and agent. Further to the point, number of researchers e.g., Gibbon and Murphy, 1990; Jensen and Murphy,
1990a and Gregg et al., 1993 suggest that reward for the agent is dependent on a va
riable that the principal is interested in, such as shareholders‘ returns. The shareholders‘ returns depend largely on the performance of the company under the
1422
agent or executive‘s management. The above explanation provides rationale for linking the executive remuneration and company performance.
Board Structure
The important of good corporate governance in monitoring the optimal contract between shareholder and manager has long being raised by Jensen and
Meckling 1976. They argue that wages by itself does not necessarily promote decision-making that enhances value for shareholders. They further argue that
agency cost could be minimized by means of a variety of governance structures, which reduce the scope for managerial discretion. Among the elements of
structure are incentive, board of director and ownership collectively known as internal mechanism. Company is considered as a better govern company if the
company has a large shareholders, split role of chairman and CEO, low CEO tenure, small board sizes, and boards composed with majority of outside
directors Jensen 1993, Core et al. 1999 and Bertrand and Mullainathan 2001. Here, particularly the board of director functions as an information system those
stockholders within large corporations could use to monitor the opportunism of top executives. Information systems inform the principal about what the agent is
actually doing that they are likely to restrain agent opportunism as the agent becomes conscious that he or she cannot mislead the principal.
In relation to above suggestions, Fama and Jensen 1983a propose that decision management initiation of decisions and implementation of ratified
1423 decisions and decision control ratification and monitoring of decisions should
be separated and diffused across agents. They suggest three devices for separating decision management and decision control. In brief, the devices are
decision hierarchies, functions of board of directors and incentive structures that encourages mutual monitoring among decision agents. They also suggest that
within the context of agency theory, employment contracts are important means by which the principal andor their representatives, non-executive directors can
control the activities of the agents.
However, there are arguments that perceived board as does not acting at arm‘s
length in selecting the compensation arrangement that maximizes shareholder value Bebchuk et al. 2002 2004. The managerial power proponents argue
that managers influence the appointment of independent directors, which in many cases enables them to block the appointment of directors who are likely to
try to bargain with the managers at arm‘s length. Second, once appointed, independent directors are influence by board dynamics that make it difficult for
them to deal with managers in a truly arm‘s length way, especially if other directors have no interest in confronting the managers over their pay. Finally,
even if directors were otherwise inclined to challenge managers on the issue of executive compensation, they would likely have neither the financial incentive nor
sufficient information to do so.
The functions of board as what being raised and recommended by Jensen and Meckling 1976 and Fama and Jensen 1983a has been formalized in 1992 with
1424 the introduction of Cadbury Report in UK Mallin, 2004. Many countries
including Malaysia follow suits the implementation of the report recommendations. The Code clearly highlights on the important of having an effective and efficient
board in monitoring the activities of managers in running the company. The Code focuses on board responsibilities, composition and structure in enhancing
the board effectiveness and efficiency. In addition to that, the Code specifically emphasizes on director remuneration and the establishment of remuneration
committee in handling matters related to director remuneration. Jensen and Murphy 2004 propose a number of recommendations particularly on the roles
and functions of remuneration committee in pay-setting process. Among the recommendation are remuneration committees must take full control of the
remuneration process, policies and practices, the committees should employ their own professional contracting agents when hiring new top-level managers.
With the issuance of the Code, board of director is expected to be more efficient and effective in monitoring the executives particularly in the issue of executive
remuneration which might reflect whether the executive being rewards based on their performance as expected by the shareholder.
Ownership Structure
In addition to board effectiveness, ownership structure is also important in aligning the interest of shareholders and executives from an agency theory
perspective Jensen and Meckling, 1976; Fama and Jensen, 1983a; Jensen and
1425 Murphy, 1990b and Hart, 1995. Agency theorists Jensen and Meckling, 1976;
Fama and Jensen, 1983a; and Jensen and Murphy, 1990b argue that the provision of ownership rights reduces the incentive for agents adverse selection
and moral hazard since it makes their compensation dependent on their performance. They further argue that stock ownership by management in
particular could reduce agency problems. As their stakes rise, managers pay a larger share of agency costs and, therefore, are less likely to expropriate wealth
from other stockholders. Moreover, as the owner- executive‘s portion of the
equity decreases, his incentive to devote significant effort to creative activities such as searching out new profitable ventures falls. He may in fact avoid such
ventures simply because it requires too much trouble or effort on his part to manage or to learn about new technologies. Avoidance of these personal costs
and the anxieties that go with them also represent a source of on-the-job utility to him and it can result in the value of the firm being substantially lower than it
otherwise could be. Their argument is evidence by numbers of studies below.
Numbers of studies in US Lambert et al., 1993; Core et al., 1999 and Brick et al., 2006 fi
nd that CEO compensation is lower when the CEO‘s ownership is higher. Similarly, study in UK by Ozkan 2007b and Australia by
Chalmers et al. 2006 also show that level of CEO pay is negatively associated to percentage of share own by the CEO. On the other aspect, Mehran 1995 on
US data reveals that companies with higher percentage shares held by inside use less equity-based remuneration. However, there are studies in US show that
1426 managers did entrench from shareholder when they hold a significant share in
the company Holderness and Sheehan, 1988; Zingales, 1995; Wan, 2004 and Stammerjohan 2004.
For the last few years, there is a growing literature that looks at the association between managerial ownership and remuneration in countries with
high family ownership. Firth et al. 1999, using Hong Kong data, show that family group of companies are associated with lower compensation level.
Another study on Hong Kong data by Cheng and Firth 2005 also finds that director‘s ownership moderate top management remuneration. Both studies
suggested that this might be due to the lesser need of direct cash remuneration since the directors receive their rewards by means of dividends and capital
appreciation.
Further to the discussion, Hart 1995 suggests that one way to improve corporate governance is by having a large shareholder. The large shareholder
who might turn out to be the controlling shareholder is important as a mechanism in mitigating agency problem. Large or controlling shareholder could be
institutions, individualfamilies, states or other corporations either financial or non-financial Denis and McConnell, 2003 and Claessens et al., 1999ab. Hart
1995 further argues that, in the case where a large shareholder owns less than 100 of the company, agency problems may be reduced, but they are not limited.
First, a large shareholder will still underperform monitoring and intervention activities since he does not receive 100 of the gains. Second, a large
1427 shareholder may use his voting power to improve his own position at the
expense of other shareholders. Finally, the large shareholder may simply become management, i.e. he may run the company himself. In addition, Alchian
and Demsetz 1972 argue that controlling shareholder is important since the information asymmetry between controlling shareholders and managers may be
reduced since controlling shareholders are likely to be actively engaged on the board of directors.
Numbers of studies evidence that institutional shareholder plays an importance role in a family concentrated ownership as well by dispersing
ownership and control of the family in a company Ozkan,2007b; Cheng and Firth, 2005; Khan et al., 2005; Hartzell and Starks, 2003 and Firth et al., 1999. Their
results suggest that the institutional serve a monitoring role in mitigating the agency problem between shareholders and executives. In addition, Core et al.,
1999 and Cordeiro and Veliyath, 2003 show a negative effect of block holders holding more than 5 of the outstanding shares with remuneration. In the case
of Malaysia, this study expects that ownership structure in particular the managerial ownership might influence the pay-performance relationship. This is
because significant portion of Malaysian companies as other East Asian countries are control by family Claessens et al., 2000ab.
Sample and data
1428 The executive remuneration, board characteristics and ownership data are
taken from the annual reports of the selected Bursa Malaysia listed companies for years 2003 to 2005. The 2003-2005 periods is chosen because the
disclosures as required under the MCCG are effective for annual reports after June 2001. As at January 2006, slightly over 1,000 companies were listed on
Bursa Malaysia comprising 646 on Main Board, 269 on Second Board and 110 on MESDAQ
245
. This study excludes MESDAQ, PN4
246
and PN17
247
companies. MESDAQ companies are excluded since their issued and paid-up capital is
considered small compared to companies on Main and Second Boards
248
. In addition, PN4 and PN17 companies are excluded due to their adverse financial
conditions.
Out of the 876 remaining companies, a further 409 companies are eliminated due to changes of financial year end, de-listing, incomplete annual
245
The MESDAQ market was created in March, 2002 as a unique market with a separate identity from the Bursa Malaysia Main and Second Boards, specifically for the capital-raising needs of
technology and high-growth potential companies. The minimum paid up capital is RM2 million for technology and non-technology companies, and a minimum of RM20 million for technology
incubator companies.
246
PN4 companies are companies which failed to meet the criteria set out under the Bursa Malaysias Practice Note No. 042001 as follows:
v. The company failed to report the deficit in its combined shareholders funds;
vi. Receivers or Managers have been appointed to manage the asset of the relevant company its
subsidiaries properties associate companies; vii.
Auditors have given a disclaimer opinion regarding the companies outlook in the companys latest accounts;
viii. A special manager has been appointed as provided for under the Danaharta Nasional Berhad
Management Act 1998.
247
PN17 companies are PN4 companies which are being restructured and get into trouble again and the situation is not rectified.
248
Issued and paid-up capital for Main Board and Second Board must have a minimum of RM60 million and RM40 million respectively.
1429 reports for the three consecutive years 2003 to 2005, difficulties in assessing the
annual reports online, and anomalous data. The sample of 476 remaining companies is further reduced if there is unclear or no separation between
executive and non-executive remuneration in the annual report. This segregation is important since this study focuses on the executive remuneration where the
bulk of total directors pay goes to the executive directors
249
. Taking this into consideration, 372 companies are used as a sampling frame for this study. Due
to the intensive and time consuming nature of hand collecting the executive remuneration and corporate governance data, 200 companies are chosen out of
the 372 companies. Due to unavailability of data from Datastream or conflicting data between Datastream and annual reports, the final sample is reduced to 158
companies.
Finding and Discussion
Sample Characteristics
A number of 158 companies from Bursa Malaysia had been used as a sample of this study. Table 1 below shows a breakdown of 158 companies according to their
board category and sector classification. About 76 or 120 out of 158 companies are from Main Board and the remaining which is about 24 or 38 companies is from Second
Board of Bursa Malaysia. The sample is dominated by Main Board companies due to
249
Non-executive director remuneration which basically comes from fee is also taken during data collection process. Our data show that on average, 90 of director remuneration is from
executive directors and about 10 from non-executive directors.
1430
their large population compared to Second Board companies
250
. Furthermore, the companies are divided into several sectors such as construction and properties,
consumer product, industrial product, plantation, trading and other finance, infrastructure, mining and technology as classified by Bursa Malaysia The Star,
December 21, 2005. Table 1 also shows that sample of this study can be considered as well distributed within industries. Out of the total 158 companies, 46 or 29.11 of
them are from the industrial product which is the largest sector for the sample. The second largest sector is construction and properties which comprises 32 representing
20.25 of the total sample of companies. This is followed by consumer product and trading sector 27 companies or 17.09 for both sectors. Further, it is followed by
plantation sector which around 16 companies or 10.13. The remaining companies are finance, infrastructure, mining and technology which are grouped under other category.
Table 1: Breakdown of companies by board category and sector
Sector Board Category
Total Number of
Companies Percentage
Main Second
Industrial Product 24
22 46
29.11 ConstructionProperties
29 3
32 20.25
Consumer Product 22
5 27
17.09 Trading
23 4
27 17.09
Plantation 15
1 16
10.13 Other
7 3
10 6.33
Total 120
38 158
100.00 Other include finance, infrastructure, and mining and technology sectors
250
As at January 2006, there are about 1,025 companies listed on the Bursa Malaysia; 646 on Main Board; 269 on Second Board and 110 on MESDAQ.
1431
Executive Remuneration in Malaysia
This study collects total cash executive remuneration data from 158 companies of 2003 to 2005 annual reports
251
. The data provides a better understanding on the nature and trend of executive remuneration in Malaysia. Among the useful findings are
the components of executive remuneration, trend of the components for the three years of study and remuneration level for the executive director. Figure 1 illustrates that
component of executive remuneration in Malaysia consist of salary and bonus, fee i.e. attendance fee for board meeting, benefit in kinds i.e. car and medical insurance,
retirement i.e. pension, Employee Provident Fund EPF and define contribution plan, allowance and others i.e. ex-gratia, retirement benefit, performance incentive and
commission. These components are very much similar to the world-wide practices Murpy, 1999 and Conyon, 2006. Figure 1 clearly indicates that salary and bonus is the
main component of executive remuneration in Malaysia. In addition, the finding also depicts that there is a huge gap of pay between the components.
251
Numbers of survey have been conducted concerning director remuneration in Malaysia; however, none of the survey specifically explores the nature and trend of executive remuneration
in Malaysia. For example, annual survey by Malaysian Business and TheEdge focus on the highest paid director in Malaysia including of executive and non-executive director. Whilst,
survey that conducted by Uitm and MSWG 2007 focus on the level of compliance with the
corporate governance principles and best practices on directors‘ remuneration. εeanwhile, PricewaterhouseCoopers which conducted a yearly survey focus on board remuneration
practices in relation to board effectiveness [PricewaterhouseCoopers 2005, 2001]. Hence, as far as this study concern, this is a first study that comprehensively compiles remuneration data
primarily on executive director. At the beginning, this study tries to focus on CEO pay only as what being studied in other countries such as US, UK and Hong Kong. However, this study
discovers that only few companies disclosed an individual director remuneration including the executive director. Based on data gathered, this study reports that only 14 out of 474 firm years
or about 7 companies disclosed individual director remuneration Table 2. This finding is consistent with Standard and Poor 2005 survey. They report that only 15 out of 100
companies disclosed the exact remuneration received by each executive and non-executive director. Therefore, concerning the constraint of data unavailability on CEO pay, this study
focuses on executive remuneration.
1432 Figure 1 below shows the trends in each of the components of executive
remuneration from 2003 to 2005. It is quite clear that salary and bonus component had been slowly decreased from 2003 to 2005 although in a small
percentage. The salary and bonus component percentages of 2003, 2004 and 2005 are 85, 80 and 79 respectively. Furthermore, the figure also shows
that the retirement and others components are increased from 2003 to 2005 although relatively in a small percentage. On the other hand, fee and benefits
appear to be static over the periods. This finding seems to suggest that Malaysia companies are trying to shift from rewarding their executive based on fixed salary
to other alternative. Apparently, this finding also implies that retirement and others components is increasing from year to year for although in a small
momentum.
Figure 1: Components of Executive Remuneration – Trends from 2003 to
2005
Components of Executive Remuneration - Trends from 2003-2005
79 80
85
3 3
33 4
3 4
8 9
1 4
5 7
50000000 100000000
150000000 200000000
250000000 300000000
350000000 400000000
2005 2004
2003
Years
To ta
l R em
un er
at ion
R M
f or
15 8
com pa
ni es
Salarybonus Fee
Benefits Retirement
Allowance Others
1433 Besides components and trends, this study also explores the level of executive
remuneration in Malaysia. Figure 2 illustrates the frequencies of executive pay size for the sample. The figure explicates that majority of Malaysian executive
director being compensated in the range of RM50,000.00 to RM1,500,000.00 43.67. Furthermore, 12.87 receives between RM1,500,000.00 to below
RM2,000,000.00. About 22.36 receives in the range of RM2,000,000.00 to below RM5,000,000.00. Moreover, the figure also shows that only about 8.86
being compensated over than RM5,000,000.00. However, the figure also reveals that 12.24 obtains below than RM50,000.00. In addition, this study
discovers that a lot of companies disclosed information on director remuneration in corporate governance statement at company level whilst information disclosed
in notes to account in the financial statements is at group level.
Figure 2: Frequencies of Executive Pay Size
Frequencies of Executive Pay Size
12.24 22.15
21.52
12.87 11.18
11.18 5.27
3.59 20
40 60
80 100
120
Below 0.50
0.50 - 0.99
1.00 - 1.49
1.50 - 1.99
2.00 - 2.99
3.00 - 4.99
5.00 - 9.99
10 and above
Executive Remuneration RM million N
o o
f O
b se
rv at
io n
1434 Based on the executive remuneration information above, this study can
confidently claim that executive director is being remunerated based on fixed salary rather than performance based i.e. bonus. This can be evidenced by
referring to Figure 1 which depicted that salary and bonus as the most important component of remuneration for executive director
252
. In addition, the gap of pay between salary and bonus component with other components is huge. Besides,
this study also reveals that on average Malaysian executive director has being paid in the range of RM50,000.00 to RM1,500,000.00 per year. Moreover, only
about 10 firm-years companies receive more than RM5,000,000.00.
Ownership Structure
474 firm- years have been classified according to the largest ownership group 10 cut-off point. Figure 3 depicts that 65 of 474 firm- years belong to
managerial ownership which representing the largest shareholder in this study. Furthermore, the figure shows that 14 of the 474 firm- years, which is the
second largest shareholder is belong to local institutional shareholders. It is then followed by foreign investors which are around 10 of the total shares.
Nevertheless, non-executive directors also have significant amount of shares which is around 9 from the total shares. In addition, Figure 4 shows that about
30 of the firm-years have managerial ownership less than 10, whereas about
252
With regard to share option figure is not disclosed, this study reports that out of 474 firm-years, 45 or 217 granted share option to their executive director while 55 or 257 do not grant an option to their
executives. This finding support a survey by PricewaterhouseCoopers survey 2005 that 40 out of 105 companies granted share option to their executive directors.
1435 28 of the firm-years have managerial ownership between 10 to 35.
Slightly more than 40 of our firm-years have managerial ownership above 35.
Based on evidence shown in Figures 3, this study concludes that large number of Malaysian companies is owned by the executive directors and their
family members. Even so, non-executive directors, local institutions and foreign investors are also the significant shareholders in some Malaysian companies as
well. Findings of this study are consistent with other studies in Malaysia on ownership structures. For example, Abdul Samad 2002 finds the means for the
largest shareholder and the five largest shareholders to be about 30 and 60 respectively. His finding is support by Haniffa and Hudaib 2006, where they
report the mean shareholdings of the single largest shareholder and the five
largest shareholders are 31 and 62 respectively.
1436
Figure 4: Breakdown of Sample by Level of Managerial Ownership
Board and Remuneration Matters
Table 2 shows a descriptive statistic for thirty seven attributes of board and remuneration for a three years period of 2003 to 2005. Part A consist of 22
Freq MANAGERIAL
309 65.19
NED 43
9.07 LOCAL
66 13.92
FOREIGN 45
9.49 OTHER
11 2.32
Total 474
100
MANAGERIAL NED
LOCAL FOREIGN
OTHER
Figure 3: Breakdown of Samples by Category of Largest Shareholders
Managerial Ownership below 10 30
Managerial Ownership of 10 to 35 28
Managerial ownership above 35 42
1437 attributes show the mean, maximum, minimum and standard deviation for board
matters. It is followed by Part B with another 15 attributes of remuneration matters. Board matters concentrate on composition, structure, functionactivity
and training of board member. Part A of Table 2 shows that on average companies have eight members on their board for the observation years of 2003
to 2005. The maximum number is 15 persons while the minimum number is 4 persons. This finding is consistent with a survey by Standard and Poor 2005
and Haniffa and Hudaib 2006 for companies in Malaysia. Standard and Poor 2005 reports of 9 members whilst Haniffa and Hudaib 2006 reports of 8
members. In addition, this finding is in line with a suggestion by Lipton and Lorch 1992, where to be an effective board; the board size should be between 8 and
9 members. With regard to directors‘ independency, the descriptive statistic of Part A shows that about 60 of companies had more than one-third of
independent director on board. This statistic imply that more than half of Malaysian companies have successfully follow the recommendation of The Code
by having more than one-third of independent director on board. In addition the statistic results show that about 12 of companies had independent directors
more than one-half of the board members and only about 5 companies had independent directors more than two-third of the board members. However,
although not tabulated in Table 2, this study also figures out that about 11 54 observations had less than one-third of independent directors on board.
1438
Table 2 evidences that on average, 80 of observations do separate the role of chairman and CEO of their companies. This finding is consistent with Haniffa and
Hudaib 2006 where they report around 74 for the entire period of 1996 to 2000. They also claim that there is an increasing trend on role duality. They report that role
duality has increased from 17 in 1996 to 30 in 2000. This finding is quite similar to the finding of Standard and Poor 2005, where, they report that about 94 companies
separate the role. Further study on this attribute reveals that only about 67 of companies in fact separated the role of chairman and CEO of their
companies. This observable fact is due to the family relationship among the board members. There are companies where the father is the chairman whilst the son or the
son in law is the CEO of the company e.g. CheeWah Berhad, YTL Corporation Berhad, MTD Capital Berhad. The Table also discloses that only 16 of observations allow the
board members to have an access to company senior management. Statistic on accessing to company senior management does imply that companies still prevent
board members from getting firsthand information directly from senior management.
Statistic of Table 2 shows that on average 5 board meetings had been held for a year. The maximum board meeting is 18 times Public Bank Berhad whilst the
minimum is 1 time Lysaght Berhad a year. Further to that, this study also compiles data on the frequency of board meeting which being divided into four categories. The
statistic shows that almost 70 of observations held meeting at least 4 times a year as recommends by The Code on best practices. In addition, 18 of the boards met more
than 6 times a year, 6 for more than 8 times and 1 above 12 times. On the other hand, although not tabulated in Table 2, this study also discovers that at least 9
observations 2 held meeting less than 4 times a year. Furthermore, the Table
1439
confirms that almost all of the companies disclose aggregate board attendance and attendance of individual director. Attendance at board meetings is one of the indicators
of a director‘s contribution to the company although it does not show whether a director actually contributes actively to board discussions.
With regard to training, 86 of directors had attended a mandatory training program as required by The Listing. Moreover, 28 of the observations had an
orientation program for new director and about 15 incorporated business and corporate governance practices in their orientation program. Overall, the statistic
clarifies that the mean of board score is a bit reduced from 2003 to 2004 6.82 to 6.70, however, notably rose from 2004 to 2005 6.70 to 7.42.
Remuneration Matters
There are two aspects focus by remuneration matters. First, it is relating to the formation, composition, meeting and attendance and functions or duties of remuneration
committee. Second, it is concerning to the remuneration elements such as using market comparison or consultant in determining remuneration, link pay to either individual or
corporate performance, preventing executive director in determining their own pay, long term incentives, compliance with RM50,000.00 band, disclosure of individual pay and
components of pay.
1440 Part B of Table 2 depicts that out of 474 observations, 88 n=420 had a
remuneration committee. Based on 420 observations, 70 of the remuneration committee had majority independent member and just about 13 had all
independent member. In addition to that, 61 admit that their remuneration committee is chaired by independent member. Meanwhile, on the meeting
aspect, only γ8 disclose their remuneration committee‘s meeting and roughly 17 disclose their attendance in remuneration committee meeting in their annual
report. With regard to remuneration committee function, 80 acknowledge that their remuneration committee recommends remuneration framework to the board.
However, only 23 reports that their remuneration committee reviews all aspect of the remuneration. Statistical results on formation and remuneration committee
independency seem to advocate that Malaysian companies have a convincing corporate governance structure particularly on remuneration committee as
recommended by The Code and international corporate governance best practices.
Further, Part B of Table 2 reveals that on average 33 of observations n=474 had a possibility of using market comparison or consultant in determining
executive remuneration. The statistic also exhibits that 61 link executive director remuneration to individual or company performance. Additionally, 55
asserts that their executive director is prevented from determining their own remuneration. Besides, about 45 state that their executive director
remuneration including of long term incentives and on average, 82 claim that
1441 they comply with the RM50,000.00 bands. However, the statistic also makes
clear that only 14 disclose of individual director remuneration. On the other hand, 81 state that they disclose remuneration components which analyzed by
salaries, bonuses, option and long term incentives. Furthermore, the statistic shows a steady increase for remuneration score from 2003 to 2005 although in
small magnitude. The remuneration score means are 7.11, 7.15 and 7.23 respectively.
1442
Table 2: Descriptive Statistics of Governance Attributes Board and Remuneration Matters from 2003 to 2005
1 2
3 4
1 2
3 4
1 2
3 4
1 2
3 4
No Variables
Mean Maximum
Minimum Std. Deviation
N 158
158 158
474 158
158 158
474 158
158 158
474 158
158 158
474 Part A
1 Board size
7.89 7.72
7.66 7.76
13 15
15 15
4 5
5 4
1.91 1.84
1.91 1.89
2 of executive director on board
0.38 0.38
0.36 0.37
0.71 0.73
0.71 0.73
0.08 0.08
0.09 0.08
0.17 0.18
0.18 0.18
3 of non-executive director on board
0.21 0.21
0.22 0.21
0.6 0.6
0.6 0.6
0.17 0.17
0.17 0.17
4 of independent director on board
0.41 0.41
0.42 0.41
0.88 0.75
0.78 0.88