Top Management Remuneration and Firm Performance

Top Management Remuneration and Firm Performance An Exploratory Analysis Debashish Bhattacherjee S Jairam G Ravi Shanker The advent of liberalisation has clearly changed pay conditions in the performance of the firm, irrespective of its size. Changes in the flows of profits significantly influence the incentive pay rises. With shareholders' wealth, the pay of the CEO increases by 15 paise to I Introduction W H E N the decision-makers regarding the allocation or utilisation of a resource pool are not themselves the owners of the pool, their incentives for decision-making are clearly divergent from the incentives that the owners would have if they themselves had been taking the decisions. The question of sufficient and effective incentive structures and monitoring mechanisms thus becomes very important. This is referred to in the literature as (he 'principal-agent problem'. The conflict of interests between the shareholders of a publicly-owned corporation and the corporation's chief executive officer (CEO) is a classic example of a principalagent problem. The choices that lead to the maximisation of the returns to the principals, i e , the shareholders, are often different from, if not in conflict with, the ones that maximise those of the agents, i e, the professional managers. The link between the returns to shareholders and those to the CEO thus becomes critical. Firms attempt to achieve this link in a number of ways. The most common among the mechanisms adopted are performance-based bonuses, salary revisions, and dismissal decisions. The more sophisticated methods employed include the classic stock options grant and the restricted stock options. The magnitude of the incentives provided by each of these mechanisms determines the degree of alignment of the private and shareholder returns, A quantitative measure of this magnitude is thus of interest for a better understanding of the internal dynamics of organisations. Most previous studies of managerial pay sensitivity to firm performance have been based on data on US firms. Yet, important cross-country differences can arise due to unique configurations of national culture (e g, notions of justice and fairness, work values), power systems, institutional controls, historical traditions, and the like, 1 The

M-10

the firms by making pay more sensitive to level of sales and in the stock of all past every Rs 100 increase in either sales or 22 paise.

motivation of this paper is to empirically estimate for Indian firms, the extent to which the top manager's personal benefit, as determined by his total remuneration, is correlated with the principals' benefits, as determined by the performance of the firm. We estimate how far private sector firms in India align the two benefits and thus attempt to circumvent the principal agent problem. II Conceptual F r a m e w o r k LITERATURE

Pay-performance l i n k s and top management compensation packages have generated a lot of interest among researchers in the past,especially in the US. Management researchers examining these issues have emphasised notions such as fairness, power relationships, networks, and internal structural factors. Agency theorists have emphasised pecuniary incentives and the role of corporate governance. Strategic management researchers have documented correlations between managerial pay, strategy, and performance. Others have argued that contextual factors, such as the market, situational risk, and institutional constraints, play a major role in explaining managerial pay and its organisational consequences. The dominant view taken in these researches is of top management compensation as an incentive for decisionmaking that would influence the long-term viability and profitability of the firm. This view suggests that " i f one abstracts from the effects of CEO risk aversion, compensation policies that lie the CEO's welfare to shareholder wealth help align the private and social costs and benefits of alternate actions and thus provide incentives for CEOs to take appropriate actions" [Jensen and Murphy 1990:226]. 2 The focus of much of this category of research has been the study of the steadily upwardly rising paychecks of CEOs, Different reasons have been suggested

for this steady rise in salaries, The conventional view is that pay increases p r o p o r t i o n a t e l y w i t h the m o u n t i n g responsibilities of the executive. The need for motivating such executives is seen as paramount, Verbal rewards like praise being r e l a t i v e l y ineffective w i t h top level executives, the need arises for specialised and focused organisational structures for motivation, The remuneration to managers can be seen as providing the means to achieve this motivation. This raises the related question of the type of decisions that the managers are motivated to take, given the way their performance is measured. It has often been suggested that the most commonly used performance measurement techniques cause the executives to take decisions that are short-term in nature and hence have a disincentive effect on decision-making that is better for the longer term firm profitability. The realisation that increased investment intensity reduces Rol and cash flows in the short run has led to the redesigning of top managers' compensation systems towards performance measures that give an incentive to managers to work for long-term benefits,3 This goal is again suggested as one of the reasons of spiralling pay-packets. The explosion of salary surveys of top executives have also been suggested as causing the u p w a r d l y ' r a t c h e t i n g ' compensation packages. It has been contended by some researchers that these surveys merely provide company boards with a set of averages (of what other companies are paying) that most boards get an understandable itch to exceed.4 A l l explanations o f r i s i n g C E O compensation however, assume that there is indeed significant motivating power in monetary rewards. Often this is an implicit assumption in related research. Many researchers for example, categorise by empirical study, the companies that have compensation packages which are most sensitive to firm performance and call these,

Economic and Political Weekly

February 28, 1998

implicitly if not in as many words, the 'good' companies.5 This premise itself is not without its critics. Empirical studies to find the relationship between the sensitivity of CEO pay (to firm performance) and the actual performance of the firm have at times revealed that there is no significant difference between the performance levels of companies with the 'best' and the 'worst' incentive structures ' The issue of ethical ambivalence is put forward as another c r i t i c i s m of using monetary rewards for motivational purposes. Often, the behaviours, attitudes and norms that are shaped and maintained by the organisational reward systems conflict with the behaviour, attitudes and norms congruent with the ethical values and judgments of organisational stakeholders. Organisational reward systems thus exert upward pressure on managers to behave 'unethically'. 7 Principal among these 'unethical' behavioural responses is that of excessive executive concern with short-term earnings which affect their perceived importance of and involvement with, long-term parameters like market analysis and R and D.8 Such ethical ambivalence manifests itself not merely in the conventional performance-based-bonus systems but also in the relatively sophisticated incentive packages like stock options and 'golden parachutes'. Studies have implied in the past that executives offered stock options are concerned less w i t h how to improve stock performance and more with when to 'dump' their stock and reap the greatest benefits without incurring too many risks. 9 Golden parachutes intend to improve or maintain firm performance through giving the executive incentives to not oppose plans for mergers when they are beneficial to the shareholders. These have often been questioned on their effectiveness, and even on their entire approach of reward for ceasing contribution to the f i r m . 1 0 Even the most sophisticated version of the incentive system, the restricted stock options, have been shown at times to be ineffective.11 The final criticism of top management compensation for motivation has been on the 'hidden' agenda behind the various compensation schemes. As union feather-bedding is often blamed for reduced productivity and high labour costs, it has been contended that golden parachutes, generous settlements for dismissed top executives and compensation not directly related to a company's long-term performance are all forms of 'management feather-bedding' that result in increased corporate costs.12

then, the study of monetary compensation schemes is procedurally much more amenable than that of the non-monetary ones. The reported gross salaries of executives are of course likely to be underestimates of the actual managerial remuneration, but we expect them to reflect more or less accurately the relative remunerations earned by managers in organisations. Thus, the salary structures provide an authentic picture of the incentive structure in these organisations. In the Indian context of course' the question of non-monetary reward and incentive systems becomes even more secondary given the limited understanding of any incentive system being adopted by firms for top

management. That being the case, a found understanding of the fundamental incentive structures being tried in Indian firms is a prerequisite for any further study of a more involved nature. This paper is an empirical attempt to provide this understanding. THE STUDY

We deal with three basic issues in the attempt to understand incentive structures in Indian organisations: firm profitability' the effect of firm size, and the effects of the economic liberalisation programme. Managerial compensation and firm profitability: We measure empirically, the sensitivity of top management pay to the

Against this backdrop of criticisms, it has also to be realised that it is by no means enough to restrict ourselves solely to monetary rewards if we attempt to understand incentive systems in firms. The other benefits enjoyed by the executives- luxury, furnished apartments, free car, children's educational expenditure, etc, - are just as important. But


February 28, 1998

M-11

profitability of the firm. In dealing with this and both subsequent issues, we measure the profitability of the firm in terms of its accounting profitability. There are two main reasons for this choice. The first of these has to do with the stage of development of the capital markets in India and the other with a priori knowledge of the attitude of firms in India to their incentive schemes. The 'maturity' of the capital markets in India has often been debated and it has been argued that the performance of a firm in the stock market is not a true measure of its performance but to a large extent the effect of forces like the firm's own influence, governmental regulations and policies, and investor forecasts about the state of the economy in general This criticism implies that linking the pay of a manager to a market-capitalisation based performance measure would be not merely unfair but would also provide him with an incentive to concentrate on the wrong issues. The second, and much more important reason for the selection of accounting profitability criteria for measuring the performance of firm, is the faith reposed by various firms in their accounting profit performance. This is clearly shown in the typical salary structure of many Indian firms which mention this information in their corporate reports. The typical remuneration package of top executives in India has a salary component, perquisites whose monetary value adds up to less than the yearly salary of the executive, and some performance linked pay or commissions, which are in terms of a certain percentage of the net profit earned by the company in that year. The last of these also has a ceiling on it which is typically 50 per cent of the yearly pay of the executive. If in any financial year the company has no profits or its profits are inadequate, the remuneration including perquisites but excluding the commission on profits is paid to the executive as minimum remuneration in terms of section 198 of the companies act, 1956. The important thing to note in this whole description of the pay structure is that there is no mention of the performance of the firm in the share markets or other such for a of interaction with the principals. The only profits that are relevant are those that are shown to the shareholders in the annual report. The choice to take accounting profits as the determinant of incentive pay in Indian firms does not settle the question of measuring profitability completely. This is so because there are a variety of measures of the accounting profitability of the firm too. We take up some of them and test whether they have a significant effect on the incentive pay paid to the executive. The paper deals with these various measures and their effect on compensation. We test the significance of profit after taxes (PAT) and shareholders'

M-12

wealth (SW) as determinants of pay rise. We also use a size measure, i e, sales, to test for significance as an explanatory variable. Finally, we test for the sensitivity of pay to changes in the important profitability ratios of return on investment (Rot) and return on net worth (RNW). We test for the significance of these predictors both in the year of context and the lagged values of these variables. The measurement of CEO remuneration is the next methodological issue involved. We take the total remuneration as the all inclusive gross salary of the executive excluding stock options. The previously mentioned relevance of gross salaries as a measure of incentive effects because of their relative magnitude within the firm is the justification for the use of salaries as total remuneration. As far as stock options are concerned, they have been left out of the analysis as they have not yet become common and viable alternative incentive instruments in India, This is so for three reasons: (a) the unwillingness of the parent bodies in MNCs to dilute their stock by accommodating stock options, (b) high market prices of the shares make stock options too expensive for firms, and (c) the concept of owner managers, which makes stock options redundant.13 The effect of economic liberalisation on pay performance sensitivity: The economic liberalisation agenda has left no part of private enterprise in India untouched. To see whether the sensitivity of top management pay to the performance of the firm has changed with the advent of the liberalisation programme, we compare the sensitivities of pay before and after the first steps of liberalisation. For this purpose we take 1991 as the year of transition and measure the change in managerial remuneration per unit change in various profitability measures of the firms before 1991 and the same after 1991. The effects of size: It can be argued that small firms in India are likely to be run by owner managers and hence the need for a sensitive pay package is less intense. In a very large firm by contrast, where the manager is very unlikely to be an owner, the need for a compensation package that aligns his benefits to the principals' is more acute. If this is indeed the case, then we expect to find different sensitivities of pay to performance between the small and the large firms. We analyse this hypothesis and test its validity by taking sales as the measure of the size of firms and by using Rs 500 crore as a the cut-off size between large and small firms. To our knowledge, little work of this nature has been carried out with Indian firm level data. The one exception is Sen and Sarkar14 which deals with the slightly different issue of comparing managerial remuneration between and within firms according to the post held by the manager in the managerial hierarchy. The direct motivation of this paper

comes from Jensen and Murphy. 15 and we attempt here to replicate statistical relationships of a nature similar to the ones they developed for US firms.

III Data and Methodology The primary data sources for the analysis are the annual reports of the respective companies. By section 217 (2a) of the companies act, 1956, read with the companies (particulars of employees) rules, 1975, Indian firms are required to provide information about their employees earning income above a certain l i m i t , which is revised every few years. In 1991, this l i m i t was Rs 1,44,000 per annum. The particulars, generally provided as a separate annexure to the directors' report, are rich sources of information on white-collar workers. The particulars provided include information on (i) name, (ii) age, (iii) qualification, (iv) total experience, (v) date of commencement of employment in the firm, (vi) designation and nature of duties, and ( v i i ) gross remuneration received. The data on the CEO of the firm was obtained by taking the particulars of the manager holding the highest executive post in the organisation. The particulars of any CEO in any year are treated as independent of any other. This implies that we are assuming that the data points all have a single intercept on drawing the regression line. This might be objected to as unrealistic as the regression lines for different firms and different years would probably yield different intercepts.


February 28, 1998

But the fact that we are interested in the average pay sensitivity in all Indian Finns implies that such differences, if any are best ignored as a first approximation. The particulars of two consecutive years taken together give us one data point with the information about current and previous year salaries, profitability in both years, sales figures in both years, etc. This data yields us all relevant variable values for one 'current' data point. For a 'lagged' data point, i e, one w i t h values of the previous year and the year before last, and their effect on the pay changes affected this year, three consecutive years' annual reports are used. The sample size is thus smaller for the models which use a lagged variable in them. The total sample size is 237 for the current data points and 160 for the lagged ones and includes data from the year 1986 to the year 1997. A l l these data points deal almost exclusively with private sector firms only. This is because of the a priori expectation that these firms would be the ones to show any pay sensitivity at all to performance. The public sector firms would show gradual and pre-set pay increases which are not the focus of our study. A couple of exceptions to this general rule have been consciously made with the inclusion of firms like HDFC which are professionally run, even though their stakeholder is the government. The appendix gives a listing of the firms used for analysis and the number of years of each firm used in the same. Since we have assumed same intercepts for all data points, each of these years yields us one CEO-year, which is the unit of analysis. The pay-performance sensitivities are taken as the sum of the statistically significant co efficients (i e, b values) of all regression equations of the type; A(CEO Remuneration) = a + b1 Δ(performance measure 1) + b2 Δ(performance measure 2) We thus assume linear relationships between all explanatory and explained variables.

firm performance as measured by change in the firm's PAT. Column (1) reports estimated coefficients from the least squares regression: Δ(CEO Remuneration) 1 = a + b Δ(PAT), ...(1) PAT is defined as the accounting P A T The sign A indicates change values, i e, the differences in the value of the variable between two years. The subscript 't' implies that the changes in the CEO compensation and the PAT are taken as that of this year over the previous year. The low value of R 2 shows that there are factors beyond those considered in the model

which explain most of the variation in the independent variable. The insignificant overall F also shows that the regression is unable to explain any variations in the depen dent variable. The other factors not considered here but affecting the changes in pay of course have to do with the size of the firm, the firm's compensation history, the experi ence of the executive in the firm, the average pay in the industry, etc. The coefficient of the changes in PAT variable is statistically insignificant, indicating no significant correlation between the changes in PAT and changes in the managerial compensation.

IV Results The table presents the results of the various regression runs in the form of the OLS estimates of the coefficients of the regression equations. MANAGERIAL COMPENSATION AND FIRM PROFITABILITY

The pay-performance s e n s i t i v i t y is measured for all 237 CEO-yean of data used. We match the compensation data with the corporate performance data of the same and previous year for various measures of firm performance. Incentives generated by profits after taxes (PAT): Columns (1) and (2) of Table 1 sum marise the estimates of the relation between changes in top managers' compensation and


February 28, 1998

M-13

Column (2) of Table 1 reports coefficients from the regression equation Δ(CEO Remuneration) t = a + b1, Δ(PAT) t + b2 Δ(PAT)1-1 ...(2) This equation allows current pay rise to be based on better P A T performance either this year or the previous year, All other parameters of the equation are the same as in (1). The sample size for this regression is a reduced 160 as three-year data is required to generate one data point of this kind. The table shows that the coefficient of the changes in PAT in this and the previous year are both statistically insignificant. This implies that changes in P A T either in this or the previous year have no effect on the changes in the compensation paid to the CEO. Incentives generated by shareholders' wealth (SW): Columns (3), (4), and (5) of Table I summarise the estimates of the relation between changes in managerial compensation and firm performance as measured by changes in the firm's accounting shareholders' wealth. Column (3) of the table reports estimated coefficients from the least squares regression: Δ(CEO Remuneration) t =a+b Δ(SW) t ... (3) The shareholders' wealth is defined as the equity base of the firm and the reserves and surpluses of the firm. The table shows the co efficient of the variable indicating change in shareholders' wealth to be 0.15982 which is significant at 5 per cent level. Thus CEO pay in Indian firms is sensitive to share holders' wealth defined in accounting terms, The level of incentive effect this has is of interest. The value of the coefficient suggests that for every Rs 100 increase in the share holders' wealth of an Indian firm, the CEO's compensation increases by roughly 16 paise. This estimate can be compared to the estimates made for executives in the US. Jensen and Murphy estimate the sensitivity of pay of top executives in Fortune 500 companies to be $3.25 for every $ 1,000change in shareholder wealth, 16 The CEO of an organisation might feel justified in calling the overall perfor mance of the firm the result of his effort. If indeed that is the case, our estimate raises the question of whether at all an incentive system that provides the CEO 0.16 per cent of the returns of the firm is enough to act as an incentive. Column (4) of the table reports coefficients from the regression equation Δ(CEO Remuneration) t = a + b1 Δ(SW) 1 + b2

Δ(SW) T - 1

...(4)

The second variable denotes the change in shareholders' wealth that was achieved last year over that in the year previous to that. The table shows that the coefficient of the lagged change in shareholders' wealth is significant but that of the variable denoting change in the current financial year now becomes insignificant. This indicates that the performance evaluation of a CEO in this

M-14

financial year depends upon the performance of the firm in the previous year more than it does on the performance in this year. The value of the coefficient shows that the com pensation to the CEO increases by 18 paise for every Rs 100 increase in shareholders' wealth in the previous year. This is of the same order as that found with only the current year's performance as the variable. Column (5) of Table I reports coefficients from the regression equation Δ(CEO Remuneration) t = a + b Δ(SW)t-1, ...(5) The result suggested by the regression (4) gave the motivation for a regression with only the previous year's performance as a variable. The table suggests that this regres' sion yields a coefficient of the lagged variable as b = 0,2208 and is significant at the 5 per cent level. The absolute value of the coefficient is slightly higher than the ones found in the earlier two regressions but still of the same order. This value denotes a rise of 22 paise for every Rs 100 increase in the shareholders' wealth in the previous year. Incentives generated by profitability ratios (Rot and RNW): Profitability ratios have long been considered to be the most tangible measures of corporate profitability, In measuring the responsiveness of executive pay to changes in these ratios, an attempt was made to measure the sensitivity if any, of the changes in executive compensation w i t h changes in the critical profitability ratios. Column (6) of Table 1 shows the coeffi cients in the regression equation Δ(CEO Remuneration) t = a + b Δ(RoI)1, ...(6) The Return on Investment (Rol) is defined as (EBIT/Total Assets), where E B I T is the Earnings Before Interest and Taxes. The table indicates that the coefficient of the variable indicating the percentage point change in R o l is b = -0.0655 and is insignificant at the 10 per cent level. No significant predictor capacity of R o l is thus suggested. Column (7) summarises the results of the regression with Return on Net Worth (RNW) as the measure of profitability. The following regression equation was fitted. Δ(CEO Remuneration) = a + b Δ(RNW) 1 ...(7) Again, the table indicates that the coefficient of the variable denoting change in the R N W is not statistically significant at the 10 per cent level. Once again, the indication is that measures of financial ratios are not significant predictors of changes in the remuneration of the CEOs. EFFECT OF ECONOMIC LIBERALISATION ON PAY-PERFORMANCE SENSITIVITY

To study the effect of liberalisation on the sensitivity of CEO pay to firm per formance, dummy variables were defined based on whether the CEO-year lay in the

pre- or post-liberalisation period. Taking 1991 as the dividing year, we define a dummy variable 'd' which takes the value 1 if the year is post-1991, and 0 if it is pre-1991. Using this dummy variable, we define the pre- and post-liberalisation variables as: Pre-Var = (1-d) * Var, and Post-Var = d * Var Using these variables, we first regress changes in executive compensation on pre- and post' l i b e r a l i s a t i o n values o f changes i n shareholders' wealth. Incentives generated by shareholders' wealth: Column (1) of Table 2 summarises the results of the regression Δ(CEO Remuneration) 1 = a + b1 post-lib (Δ(SW) 1 ) + b 2 pre-lib (Δ(SW) 1 ...(8) The table indicates that the co-efficients of the post- and pre-liberalisation values of changes in shareholders' wealth are b 1 = 0,1600 and b 2 =-0'0286. The former is signi ficant at the 5 per cent level while the latter is not significant at the 10 per cent l e v e l The sensitivity of executive compensation to changes in shareholders' wealth was thus insignificant before liberalisation and became significant after liberalisation. The regression thus shows that after the advent of libera lisation, CEO pay has shown an increase of 16 paise for every Rs 100 rise in the share holders' wealth, whereas pre-liberalisation the relationship was insignificant. This verifies the intuitively held general opinion that liberalisation has had a positive effect on the sensitivity of top management pay to the performance of the firm. Column (2) of the table shows the least square estimates of the regression equation Δ(CEO Remuneration) t = a + b 1 post-lib ( Δ ( S W ) t - 1 )+ b 2 pre-lib (Δ(SW) t - 1 ) ...(9) In equation (9), we allow the change in remune ration in this financial year to be influenced by changes in shareholders' wealth taking place the previous year. The table shows that once again, there is a statistically significant correlation between the changes in share holders' wealth and changes in the compensa tion package of the CEO and an insignificant relation before liberalisation. Thus, before liberalisation there was no significant sensi tivity of managerial pay with performance, while after liberalisation, the top manager gets a return of 15 paise for every Rs 100 increase in shareholders' wealth in the previous year. Incentives generated by sales: Column (3) in Table 2 summarises the result of the regression Δ(CEO Remuneration) 1 = a + b1 post-lib (Δ(Sales) t-1 ) + b 2 pre-lib (Δ(Sales) t-1 ) ...(10) In this equation, we take different variables to denote the pre- and post-liberalisation values of changes in sales in the previous year (over the year before that). Once again,

Economic and Political Weekly,

February 26, 1998

the result as tabulated in Table 2 shows a significant correlation after liberalisation and none before it. After liberalisation, we see a return of 15 paise for every Rs 100 increase in sales the previous year over the year before. THE EFFECTS OF SIZE

To test whether large organisations are any more or less likely to have compensa tion packages which are sensitive to per formance of the firm, we define large com panies as those which have sales in excess of Rs 500 crore. Regressions are carried out w i t h dummy variables being used for whether or not the firm has sales higher than this figure. Incentives generated by shareholders' wealth: Column (4) in Table 2 summarises the results of the regression Δ(CEO Remuneration)! = a + b 1 lar (Δ(SW) 1 ) + b 2 sm (Δ(SW) 1 ) ...(11) At the 5 per cent level we find that small companies have a significant sensitivity of their pay to performance. The same is not true for large companies at the same level. But at the 10 per cent level, the large com panies too showed a significant coefficient. Thus we can conclude that the sensitivity of pay to performance as measured by change in shareholders' wealth does not depend significantly upon the size of the firm. Incentives generated by sales: Column (1) in Table 3 shows the results of the regression Δ(CEO Remuneration) 1 = a + b1 lar (Δ(Sls) 1 ) + b 2 sm (Δ(Sls)1) ,,,(12) At the 10 percent level, neither of the variables shows a significant coefficient, thus rein forcing our earlier conclusion that there is no effect of size on the sensitivity of CEO compensation to f i r m performance. T H E COMPLETE M O D E L

To study the effects of firm performance, liberalisation, and the size of the firm together on the sensitivity of the CEO pay packet, the following regression was run: Δ(CEO Remuneration) 1 = a + b1 pre-lar (Δ(SW)t-1) + b2 post-Iar (Δ(SW) t - 1 ) + b3 pre-sm (Δ(SW)t-1) + b4

post-sm

(Δ(SW)T-1)

...(13)

The results as shown in column 2 of Table 3 show that even though both large and small companies showed insignificant correlation between change in firm performance measu red on the basis of change in shareholders' wealth, the remuneration in large companies becomes statistically significant postliberalisation. The coefficients show that after liberalisation, the average C E O in a large company in India has had an increase of 22 paise for every Rs 100 increase in the shareholders' wealth of his company' This results runs contrary to the finding regarding


the effects of size when size alone was taken as a variable. We find now that the relatively larger companies have shown greater sensitivity of their pay structure towards performance of the firm after liberalisation. The smaller companies continue to show insignificant sensitivity, V Conclusions a n d Caveats On the basis of the above, some conclu sions can clearly be drawn. Firstly, absolute measures of profitability like PAT are not significant determinants of the changes in pay of the top managers of Indian firms. The same is the case with profitability ratios like R o l and RNW. What do significantly influence the incentive pay rises are changes in the level of sales and in the stock of all past flows of profits, i e, the net worth of the firm. We see that with every Rs 100 increase in either sales or shareholders' wealth, the pay of the CEO increases by 15 paise to 22 paise' depending upon the measure used as the explanatory variable. This clearly may not be an adequate enough incentive for a top executive to cause him to make choices that are in alignment with those desirable for the long-term viability of the firm, The advent of the era of liberalisation has clearly changed pay conditions in the firms by making pay more sensitive to the performance of the firm. On all variables which show significant correlation with the changes in the pay level, the level of sensitivity is seen to increase significantly w i t h liberalisation. The argument that relatively larger companies would face the principal-agent problem more acutely and hence would show a more sensitive pay structure was found to be baseless. Based on size alone, firms of all sizes were found to be equally responsive in terms of pay to the performance of the firm in the previous and the current finan cial year. When taken together with libera lisation, it was seen that the relatively larger firms had a more performance sen sitive pay structure after the advent of liberalisation. This study is a preliminary and exploratory one using data from Indian firms. It thus has some limitations. Firstly, we have ignored, based on prior knowledge, the sensitivity of pay to market capitalisation-based per formance measures. Before thus dismissing the possibility, this sensitivity has to be assessed empirically and the results compared to those presented in this study. Secondly, the non-monetary incentives provided to executives have not been taken into account in the study. An analysis based on incentives which are not pay based is also essential for a better understanding of the incentive effects in organisations. Stock options and other

February 28, 1998

such long-term incentives must also be studied. The third and major limitation of the study is the inability to take into account the fact that the prevalence or owner managers in India, even in the relatively large com panies, complicates the issue of incentives still further. We cannot talk of incentives in the form of increases in the overall compen sation package until we understand the incen' tive effects implicit in the owner manager setup. But in spite of these limitations, the study provides an initial estimate of the magnitude of performance based pay incen tives that are being provided in Indian firms. It thus furnishes a starting point for more sophisticated and involved studies that can enrich our understanding of the performancepay links in the private coroprate labour market in India.

Notes 1 Invitation to the workshop on 'Managerial Compensation and Firm Performance', invitational conference organised by Harry Barkema (Tilburg University) and Luis R Gomez-Mejiat Arizona Slate University) June 13-14, 1997. 2 Jensen' M C and K J Murphy, 'Performance Pay and Top Management Incentivei', Journal of Political Economy, vol 98, 1990, pp 225-64. 3 Aggarwal S, "Rewarding Top Managers for Companies' Success', Journal of General Management, vol 7, Autumn 1991, pp 80-89. 4 Williams M J, Why Chief Executives' Pay Keeps Rising?', Fortune, April 1, 1985, pp 40-47. 5 Jensen MC, and K J Murphy.'CEO Incentives - It Is Not How Much You Pay But How', Harvard Business Review. May-June 1992. pp 138-53. 6 Crystal G S, 'The Great CEO Pay Sweepstakes', Fortune, June 18, 1990. pp 62-67. 7 Jansen E and M A von Glinow, 'Ethical Ambivalence and Organisational Reward Systems', Academy of Management Review, vol 10, no 4, 1985. pp 814-22. 8 Hise R T and S W McDaniel. American Competitiveness and the CEO - Who is Minding the Shop?', Stoan Management Review' Winter 1988, pp 49-55. 9 Patton A, 'The Making of Multimillion Dollar 1 Executives , Business Horizons. May-June 1994, pp 32-39. 10 Scotese P G, 'Fold Up Those Golden Parachutes', Harvard Business Review, January-February 1985, pp 168-73. 11 Crystal G S, Incentive Pay That Doesn't Work', Fortune. August 28,1989, pp 69-70. 12 Myers, C A. T o p Management FeatherBedding? ', SMR Forum. Sloan Management Review, Summer 1983, pp 55-58. 13 Sen A, and S Sarkar, 'Age, Experience, Qualification and Remuneration of Manager' in Some Large Indian Firms', Indian Journal of Labour Economics, vol 39, no 1, 1996, pp 111-28, 14 Sen A and S Sarkar, op cit. 15 Jensen, M C and K J Murphy, ibid 1990. 16 Jensen, M C, and K J Murphy, ibid 1990.

M-15