Three Essays on Executive Compensation - KOPS - Universität ...

Profit Sharing with Executives
Dividend payout ratio.
Firms with a low dividend payout ratio (fraction of
available cash paid to shareholders) typically retain cash for investment opportunities,
and do not necessarily allocate more cash to the top management. Empirical
studies show that dividend and compensation policies are related through a firm’s
investment opportunities (Smith and Watts, 1992). This calls for a positive relation
between the dividend payout ratio and the top management’s cash-flow share. We
calculate the dividend payout ratio (DPR) as the fraction of OCF BC it (OCF BB it
in regressions for the bonus ratio) dedicated to shareholders as dividend payments:
DP R it =
DIV it
OCF BC it
, where DIV it is the total amount paid as dividends to common
shareholders of firm i in fiscal year t 22 .
To test Hypothesis 2, we measure non-cash compensation as follows:
Long-term incentives. Firms with plenty productive investment opportunities
may choose to grant the top management non-cash compensation and retain cash
for investment. Non-cash compensation consists of long-term incentive (LTI) compensation
such as company stock, options or firm-specific LTI plans. We measure
long-term incentives as the grant-date value of non-cash compensation divided by
total compensation 23 . Hypothesis 2 calls for a negative relation between long-term
incentives and the top management’s cash-flow share.
To test Hypothesis 3, we add the following variable:
Firm size. We measure firm size by total assets at the end of the fiscal year.
Hypothesis 3 suggests a negative relation between firm size and the managerial
cash-flow share.
To test Hypothesis 4, we later add two measures of managerial power:
E-index. The E-index is the entrenchment index developed by Bebchuk et al.
(2009). The index is based on six equally weighted corporate governance provisions
which provide the top management with protection from being removed, or the
consequences of removal, and thus limit the power of shareholders vis-à-vis the top
management. The E-index measures the level of managerial entrenchment on a scale
22 Stock repurchases have become increasingly prominent to reward shareholders in addition to
dividend payments. In a robustness check we find that our results do not change qualitatively when
we add to DIV it a proxy for stock repurchases (we discuss this proxy in the robustness section).
23 Taking the Dollar value instead yields similar results but may -once again- be influenced by
a firm size effect, because typically in large firms the managerial cash-flow share is small and the
Dollar value of non-cash compensation is large.
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