Description
This paper aims to investigate the incidence of remunerating Australian Securities
Exchange (ASX)-listed non-executive directors (NEDs) with options and to determine whether
companies that fail to adhere to NED remuneration recommendations share a common corporate
governance profile. Despite corporate regulators condemning the practice of remunerating NEDs with
stock options, there is a paucity of evidence regarding its prevalence in Australia.
Accounting Research Journal
Remunerating non-executive directors with stock options: who is ignoring the
regulator?
Michael Seamer Adrian Melia
Article information:
To cite this document:
Michael Seamer Adrian Melia , (2015),"Remunerating non-executive directors with stock options: who
is ignoring the regulator?", Accounting Research J ournal, Vol. 28 Iss 3 pp. 251 - 267
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Remunerating non-executive
directors with stock options:
who is ignoring the regulator?
Michael Seamer and Adrian Melia
Newcastle Business School, Faculty of Business and Law,
The University of Newcastle, Callaghan, Australia
Abstract
Purpose – This paper aims to investigate the incidence of remunerating Australian Securities
Exchange (ASX)-listed non-executive directors (NEDs) with options and to determine whether
companies that fail to adhere to NED remuneration recommendations share a common corporate
governance profle. Despite corporate regulators condemning the practice of remunerating NEDs with
stock options, there is a paucity of evidence regarding its prevalence in Australia.
Design/methodology/approach – Focusing on ASX400 companies during 2008, a series of
hypotheses relating NEDstock option remuneration and corporate governance are tested using logistic
regression.
Findings – The study shows that the prevalence and quantum of NED option payments during 2008
was considerable with 73 of the ASX400 companies, including options in NED remuneration (option
payers). Comparison of the corporate governance characteristics of option payers to that of a matched
control group (non-option payers) highlighted both the existence and independence of the remuneration
committee as critical in ensuring NEDremuneration practices comply with regulator recommendations.
Research limitations/implications – These results provide regulators and stakeholder groups
with additional evidence to continue to call for corporate governance reforms to ensure that corporate
remuneration practices are in the best interest of shareholders.
Originality/value – This study is the frst to highlight the extent to which Australian-listed company
NED remuneration practices fail to comply with regulator recommendations and adds to the limited
research on remuneration committee effectiveness.
Keywords Corporate governance, Non-executive remuneration, Stock options
Paper type Research paper
1. Introduction
Despite a lack of consensus in the literature regarding the economic consequences of
remunerating non-executive directors (NEDs) with options, there is widespread
international regulator opposition to the practice. Ferrarini et al. (2009) refer to the
European Commission (2009, p. 46) Roundtable on Directors’ Remuneration
recommendation against remunerating NEDs with options and observe that most
European member states have similar recommendations in place. They explain that
regulators believe remunerating NEDs with options leads to a:
Confict of interest risks, particularly where non-executive directors are called on to evaluate
accounting practices or to take other decisions with a possible bearing on the company’s
reported earnings, given that such earnings or evaluations could have an impact on their
The current issue and full text archive of this journal is available on Emerald Insight at:
www.emeraldinsight.com/1030-9616.htm
Remunerating
non-executive
directors
251
Received10 December 2013
Revised16 June 2014
Accepted15 August 2014
Accounting Research Journal
Vol. 28 No. 3, 2015
pp. 251-267
©Emerald Group Publishing Limited
1030-9616
DOI 10.1108/ARJ-12-2013-0092
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income. High remuneration for non-executive directors may also jeopardise their
independence.
The Australian Securities Exchange (ASX) (2007, p. 37) also discourages granting
options to NEDs with Guideline 8.2 of the ASX Corporate Governance Principles and
Recommendations prescribing: “Non-executive directors should not receive options or
bonus payments”. These recommendations are also supported by the Australian
Institute of Company Directors (AICD) (2003 p. 4), the principle advocacy group
representing Australian directors:
AICD does not support the granting of options to non-executive directors […] Any
arrangement, that affects the independence or the perception of independence of non-executive
directors, should be discouraged.
Despite the importance of the issue to both regulators and advocacy groups, fewstudies
have attempted to gauge the prevalence and quantum to which NEDs serving on
Australian boards are remunerated with options. This study seeks to address this
paucity of evidence and also determine whether companies that fail to adhere to NED
remuneration recommendations share a common corporate governance profle.
We examine the top 400 ASX-listed companies and fnd 73 companies (18.25 per cent)
remunerated their NEDs with substantial values of stock options (option payers). The
quantum of option remuneration value was higher than expected with some extremes
observed. For example, one frm ranked in the ASX Top 300 issued options worth on
average $115.9 million per NED. For the remainder of the sample, the average value of
options paid per NED totalled $357,515 which was 4.65 times the average cash salary
per NED of $76,903. Comparison of this group to a control group (non-option payers)
matched on the basis of size and industry showed that the practice is more common
among smaller frms and is more prevalent in certain industries. Further analysis of the
two group’s corporate governance environments showed that, when compared to
non-option payers, option payers were less likely to establish a remuneration committee,
and where they did, it was less likely to be independent from management.
2. Literature review and hypothesis development
Two competing theories dominate the literature regarding the appropriate structure of
director remuneration contracts, particularly with regards to the use of stock option
grants. Optimal contracting theory posits that by giving directors compensation that is
sensitive to frmperformance, frmowners can incentivise their agents to work harder to
maximise frm value (Holmstrom, 1979; Hart and Holmstrom, 1987). However,
proponents of managerial power theory, such as Jensen et al. (2004, p. 2), posit that rather
than solving agency problems, issuing options to directors can in fact lead to greater
agency costs. They argue that remuneration contracts that feature stock option grants
have the potential to: “encourage managers to ignore the cost of capital, manage
earnings in a way that destroys value and take action to deceive investors and capital
markets”.
Considerable empirical evidence supports the contention that stock options motivate
directors to engage in opportunistic behaviour aimed at increasing the value of their
holdings. For example, Bizjak et al. (2009), Heron and Lie (2007), Chauvin and Shenoy
(2001), Aboody and Kasznik (2000) and Yermack (1997) all fnd directors manipulate the
timing of stock option grants to their advantage, receiving them either prior to good
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news announcements or after bad newannouncements. Miller and Piotroski (2000) also
fnd managers of poor performing frms are more likely to provide earnings forecasts if
they have higher stock compensation at risk, while Nagar et al. (2003) report both
disclosure frequency and quality are positively related to the proportion of CEO
compensation based on stock price. Studies have also shown a link between director
option holding and fraudulent manipulation of fnancial disclosures. For example, Peng
and Roell (2006) report a positive relationship between the granting of options to
executives and the probability of securities legislation prosecution, while Efendi et al.
(2007) fnd strong links between CEO option holdings and the likelihood of misstated
fnancial statements. Johnson et al. (2009) also show that executives at frms
experiencing management perpetrated fraud have signifcantly larger equity-based
compensation than those at frms free from management perpetrated fraud.
However, the main focus of empirical research has been on stock option grants to
executive directors, particularly the CEO. Fewer studies examine the impact option
grants have on NED motivation to monitor management. Bryan and Klein’s (2004, p. 7)
review of the NED remuneration literature concludes that it “is sparse and divided”. A
similar theoretical divide between optimal contracting and managerial power theorists
exists with respect to issuing NEDs with options. For example, Bhagat et al. (1999) argue
options provide NEDs with greater personal fnancial incentives to ensure management
are maximising frmvalue. Bhagat and Bolton (2008) and Perry (2000) provide empirical
evidence with their fndings of a positive link between independent board members’
option holdings and the likelihood of a CEO being dismissed if the frm is performing
poorly. Ertugrul and Hedge (2008), Linn and Park (2005) and Fich and Shivdasani (2004)
also argue granting options to NEDs provides them with incentives to adequately
monitor management’s risk-taking and investment activities.
Managerial power theorists however argue that issuingNEDs withstockoptions is more
likely to align NED interests with those of managers rather than shareholders. They claim
thisconvergenceof interest resultsinNEDsmimickingexecutiveself-servingbehaviour and
compromises their monitoring of the fnancial reporting process (Boumosleh, 2009).
Boumosleh (2009) provides empirical evidence by reporting a positive relationship between
NEDs option compensation and higher levels of earnings management. Minnick and Zhao
(2009); Collins et al. (2009) and Bebchuk et al. (2010) all fnd that the incidence of frms
covertly backdating option grants increases when NEDs receive option grants on the same
date as executive directors. They argue NEDs are less likely to object to illicit backdating
when they stand to share in the benefts.
2.1 Research questions
The research focus of this study is twofold. Firstly, it attempts to address the paucity of
evidence regarding the prevalence of Australia-listed frms remunerating their NEDs with
stock options. Secondly, it investigates whether corporate governance plays a role in frm
decisions to adopt remuneration practices discouraged by regulators. The literature
acknowledges that as director remuneration can be both a solution to and a cause of agency
confict, corporate governance mechanisms are important in mitigating agency costs
associated with the remuneration process. For example, Jensen et al. (2004, p. 22) argue:
[…] corporate governance and remuneration policies are highly inter-related: bad governance
can easily lead to value-destroying pay practices, and many notorious excesses in pay can be
traced to poor governance.
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Extensive empirical evidence exists linking inadequate corporate governance with
levels of director compensation that are inversely related to frmperformance (Core et al.,
1999).
This study will focus on the following corporate governance mechanisms shown in
the literature to impact on the director remuneration setting process:
• independence of the board of directors;
• CEO/board chair duality; and
• existence and independence of a remuneration committee.
2.1.1 Independence of the board. Studies have consistently shown a strong negative
relationship between the proportion of independent directors on the board and the
over-consumption of benefts by management[1]. For example, Core et al. (1999),
Sridharan (1996) and Brickley and James (1987) all report CEOs of frms with
management-dominated boards receive higher comparative remuneration than CEOs of
frms with independent boards. Minnick and Zhao (2009) and Collins et al. (2009) also
fnd that frms covertly backdating CEO option grants have less independent boards
than frms which did not backdate CEOoptions. Bebchuk et al. (2010) also suggest CEOs
are more likely to receive option grants exercisable at the lowest possible share price
when the board does not have a majority of outside directors.
Given that the literature shows that independent boards are effective in reducing
excess executive remuneration, it is expected that the independence of the board of
directors will have the same positive effect in ensuring NEDs are not remunerated with
stock options. Therefore, this study tests the following hypothesis:
H1. Companies with a higher proportion of non-independent directors on the board
are more likely to remunerate their NEDs with stock options than companies
with a lower proportion of non-independent directors on the board.
2.1.2 CEO/chair duality. Bebchuk and Fried (2006) argue that by controlling the director
selection process and serving on the compensation committee, CEOs can create
“managerial power” that allows them infuence over their remuneration levels.
“Managerial power” is strongest when the CEO also holds the position of board chair.
Jensen et al. (2004, p. 54) note:
The critical job of the Board Chair is to run the process that evaluates, compensates, hires and
fres the CEO and top management team. The CEO cannot perform that job adequately.
Empirical support is provided by Collins et al. (2009) and Bizjak et al. (2009) who report
that frms that covertly backdate CEO option grants have a higher incidence of CEO/
chair duality than frms which do not backdate CEOoption grants. Bebchuk et al. (2007)
also report a strong correlation between CEOdomination of the board and the likelihood
of the CEO receiving options granted at the lowest monthly equity price or receiving
personal bonuses as a result solely of positive industry-wide events. Sridharan (1996)
also fnds a signifcant positive relationship between CEO infuence over the board and
the level of CEO salary and bonuses.
Given that the literature shows frms dominated by the CEOare more likely to adopt
inappropriate remuneration policies, it is expected that the existence of CEO/chair
duality will be associated with NEDs receiving stock option remuneration. This study
tests the following hypothesis:
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H2. Companies that combine the roles of CEO and board chair are more likely to
remunerate their NEDs with stock options than companies that segregate the
roles of CEO and board chair.
2.1.3 Remuneration committee. Perkins and Hendry’s (2005, p. 144) survey of the
remuneration committee literature concludes that the evidence suggests that “the
composition of the company’s compensation committee is important in the closer
alignment of management pay and corporate performance”. For example, Newman and
Mozes (1999) report the relationship between CEO compensation and performance is
biased in the CEO’s favour when insiders sit on the compensation committee, while
Conyon and Peck (1998) report a closer alignment of executive remuneration and
performance when outsiders dominate the remuneration committee. Newman and
Wright (1996) also fnd that CEOs of frms with remuneration committees containing at
least one executive were paid 20 per cent more than CEOs whose remuneration was set
by an independent committee. Klein (2002) reports earnings management is higher in
frms where the CEO also serves on the board’s remuneration committee while
Stathopoulos et al. (2004) report that executive presence on the remuneration committee
has a positive impact on the time to maturity and, hence, the value of executive options.
However, the empirical evidence regarding the effectiveness of remuneration
committees is not unanimous. For example, Conyon and Peck (1998) fnd that the
presence of an independent remuneration committee did not result in lower top
management compensation, as they hypothesised, but in higher pay. Anderson and
Bizjak (2003) also fnd little evidence that lack of independence on the remuneration
committee impacts executive pay levels. In the Australian context, Cybinski and
Windsor (2013) report no link between remuneration committee independence, CEO
remuneration and frm performance[2].
Given that evidence suggests that remuneration committees are effective in reducing
inappropriate executive remuneration, it is expected that the existence and
independence of the remuneration committee will have a positive effect in ensuring
NEDs are not remunerated with stock options. This study tests the following related
hypotheses:
H3a. Companies without a remuneration committee are more likely to remunerate
their NEDs with stock options than companies with a remuneration
committee.
H3b. Companies with less independent remuneration committees are more likely to
remunerate their NEDs with stock options than companies with more
independent remuneration committees.
3. Research method
This study focuses on the largest 400 Australian-listed companies for the 2008 year.
Analysis of the remuneration reports contained in the annual reports of these companies
revealed 79 that remunerated NEDs with stock options. Excluding those companies
where NEDs on average received less than 10 per cent of their total remuneration in
options resulted in a fnal group of 73 frms (option payers). Both ASXlisting regulations
and the Corporations’ Law(2001) require detailed disclosure of director remuneration in
listed company annual reports. Details of options included in NED remuneration were
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obtained from the remuneration report required in the company’s annual report by
Section 300A of the Corporation’s Law (2001). This section requires disclosure of:
[…] the value (worked out as at the time they are granted and in accordance with any
applicable accounting standards) of options that are granted to each director during the year as
part of their remuneration and the percentage of the value of the person’s remuneration for the
fnancial year that consists of options.
Acompany is also required to disclose in its directors’ report whether each director is an
executive director or NED. Given that the value of options disclosed must be determined
in accordance with accounting standards and calculations must be audited by the
company auditor, it is presumed that the disclosed values are relevant and reliable.
To test the hypotheses previously outlined, the corporate governance characteristics
of the sample were compared to a control group of companies that did not pay options as
remuneration to NEDs. To control for variables shown in the literature to infuence both
a company’s remuneration policy and its corporate governance environment, each
company in the sample was matched with a control company that was its closest in
terms of size, industry and fnancial reporting period[3].
The relative size of an organisation has been shown to infuence both an entity’s
corporate governance environment and its remuneration policies. Menon and Deahl
Williams (1994) assert that larger frms have incentives to monitor the greater
complexities associated with size and can better carry the signifcant costs of
establishing and operating corporate governance mechanisms such as remuneration
committees. Bryan and Klein (2004) also fnd larger frms are less likely to issue options
to non-management directors while Lie (2005) fnds that smaller frms are more likely
than larger frms to covertly backdate CEO options. Cybinski and Windsor (2013) also
indicate frm size as an infuential factor in aligning Australian CEO remuneration
levels with frm performance. This study uses the company’s market capitalisation at
the end of the 2008 year as a measure of size. Market capitalisation data were collected
from the annual market capitalisation rankings of all Australian-listed companies as
published by ASX.
The industry in which a company operates has also been identifed as a factor that
affects both a frm’s corporate governance and remuneration policy[4]. For example,
Stathopoulos et al. (2004) fnd that stock options are more likely to be granted to NEDs
of “New Economy” (e-commerce and dot.com) frms compared to “Old Economy”
traditional retail frms who tend to remunerate in cash. Bryan and Klein (2004) also fnd
marked variations in the use of stock option grants for NEDs across US industries
varying from one-third or less for energy and utility frms to over 70 per cent for
manufacturing, mining and service frms. Collins et al. (2009) also report frms with
greater return volatility and frms in high technology industries exhibit greater evidence
of allowing CEO option grants to be backdated. Control companies for this study were
selected on the basis of the four-digit S & P Global Industry codes, as adopted by ASX.
In addition to matching the control group on the basis of industry and size, it is
imperative that further comparison is performed with respect to the same time period.
The matching process resulted in a fnal sample size of 146 companies (73 option payers
paired with 73 non-option payers). Overall matched pairs showed a relatively low
variance in market capitalisation of 7 per cent, with option paying frms being, on
average, 7 per cent larger than non-option paying frms. Beasley (1996) argued the 20 per
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cent variance in size between his sample of frms reporting corporate fraud and a
matched control group was tolerable.
3.1 Control variables
The literature suggests other factors that may infuence company remuneration
practices. These are listed belowand are used as control variables in the research model:
• block-holder equity ownership;
• executive director equity ownership;
• auditor quality; and
• frm cash reserves[5].
Matolcsy and Wright’s (2011) study of CEOremuneration practices in Australia reports
that both executive share ownership and the presence of outside block-holders are
signifcant determinants of compensation structure. They fnd that frms where the CEO
owns more shares are more likely to offer equity-based compensation, whereas frms
with greater outside block-holders are more likely to remunerate using cash. Ertugrul
and Hedge (2008) also argue that executive director shareholdings infuence a frm’s risk
profle. The empirical evidence also suggests that frms audited by “top-tier” auditors[6]
are more likely than frms audited by non-top-tier auditors to adopt appropriate
remuneration structures. For example, Carson (2002) reports Australian-listed
companies are more likely to establish a remuneration committee when they are audited
by a top-tier auditor while Collins et al. (2009) fnd frms audited by top-tier auditors
exhibit a lower incidence of covertly backdating CEOoption grants. Firmcash levels are
included to control for liquidity differences that may drive the decision to remunerate
NEDs with options.
3.2 Research methodology
Logistic regression analysis is used to compare the characteristics of option payers with
the non-option payer control group. The hypotheses previously outlined will be tested,
frstly, using a series of univariate regressions, followed by multivariate regression. The
equations for the univariate regressions are as follows:
OPTION
i
? ? ? ?
1
INDDIR
i
? ?
i
(1)
OPTION
i
? ? ? ?
2
REMCOM
i
? ?
i
(2)
OPTION
i
? ? ? ?
3
CEODOM
i
? ?
i
(3)
OPTION
i
? ? ? ?
4
AUDIT
i
? ?
i
(4)
OPTION
i
? ? ? ?
5
BLOCK
i
? ?
i
(5)
OPTION
i
? ? ? ?
6
EXECSHARE
i
? ?
i
(6)
OPTION
i
? ? ? ?
7
CASH
i
? ?
i
(7)
Variables found to be signifcant at the univariate level are then tested using the
following multivariate regression defned as follows:
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OPTION
i
? ? ? ?
1
INDDIR
i
? ?
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REMCOM
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? ?
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CEODOM
i
? ?
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AUDIT
i
? ?
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BLOCK
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? ?
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EXECSHARE
i
? ?
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CASH
i
? ?
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Where
i ?Company 1 through 146;
OPTION ? dependent dichotomous variable with the value of 1 when a
company paid its NEDs on average more than 10 per cent of their
remuneration in options and a value of 0 otherwise;
INDDIR ?the percentage of board members who are independent;and
REMCOM ?a value of zero when a company has no remuneration committee:
A value of 1 when it discloses the existence of a remuneration
committee with no independent members;
A value of 2 when it discloses the existence of a remuneration
committee with less than or equal to one-third independence;
A value of 3 when it discloses the existence of a remuneration
committee with between one-third and less than or equal to
two-third independence;
A value of 4 when it discloses the existence of a remuneration
committee with more than two-third independence.
CEODOM ?indicator variable with a value of 1 if the chairperson of the board
holds the CEO’s position and a value of 0 otherwise;
AUDIT ?indicator variable with a value of 1 when a company is audited by
a “top-tier” audit frm and a value of 0 otherwise;
BLOCK ? cumulative percentage of shares owned in the company by
block-holders that are not directors of the company holding at least
5 per cent of the company’s voting shares;
EXECSHARE ? the cumulative percentage of shares held in the company by
executive directors;
CASH ? the average of the frm’s beginning and ending cash balances for
the study period;
3.3 Measurement of model variables
The variable INDDIR represents the proportion of the board of directors that are
independent from management. This study adopts Carcello and Neale’s (2003, p. 291)
defnition of director independence:
Members can be either affliated directors or independent directors. We defne affliate
directors as current or former offcers or employees of the company or of an affliated entity,
relatives of management, professional advisers to the frm(e.g. consultants, bank offcers, and
legal counsel), offcers of signifcant suppliers or customers of the frm and interlocking
directors.
Director independence was evaluated from disclosures in the company’s annual report.
Details of director relationships with the company are required in the director’s report,
corporate governance statement and related party note to the fnancial statements. It is
considered that a close analysis of these sources provides an objective basis for
determining director independence. The variable REMCOM represents the proportion
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of independent members on the remuneration committee. Where the frm had no
remuneration committee, the variable was set at 0 with an increment of one assigned for
every one-third of total members deemed independent frommanagement. Details of the
existence of a remuneration committee and evaluation of independence of its members
are obtained from disclosures in the company annual report as required by ASX listing
rule 4.10.2. The variable CEODOMrepresents duality of the CEOand board chair roles.
Details of directors occupying the roles of CEO and board chair were obtained from the
directors’ report disclosures in the company annual report. The variable AUDIT is
included in the regression model to control for differences in auditor quality. Audit frm
was identifed from the audit report contained in the relevant annual report. Top-tier
audit frms consisted of KPMG, PriceWaterhouseCoopers, Deloitte Touche Tohmatsu
and Ernst & Young. All other audit frms were classifed as non-top-tier. The control
variable BLOCKwas measured as the cumulative percentage of company equity owned
by block-holders that are not directors of the company. A block-holder was defned as
any shareholder holding at least 5 per cent of the company’s voting shares. Details of
shareholdings were obtained fromsubstantial shareholder disclosures in the company’s
annual report[7]. The control variable EXECSHARE was measured as the cumulative
percentage of company equity owned by executive directors. Details of executive
shareholdings were obtained from the directors’ report contained in the company’s
annual report. Details of frm’s beginning and ending cash balances were obtain from
their 2008 audited fnancial statements.
4. Results and discussion
4.1 Descriptive statistics
Table I categorises the 73 option payers on the basis of the average value of options paid
to each NED.
As shown in Table I, the value of options issued by option payers was considerable.
In fact, after excluding one extreme option payer (that paid on average $115.9 million in
options per NED), the average option payment per NEDwas $357,515, representing 4.65
times the average cash salary paid per NED of $76,903. Over one half of the sample
issued options to their NEDs with an average value of over $100,000 per NED. In total,
21 option payers (28.8 per cent) issued options with an average value per NED of more
than $100,000 and less than $300,000. Five option payers issued options with a value per
NED of more than $300,000 and less than $500,000, six option payers issued options
with a value per NEDof more than $500,000 and less than $1 million, four option payers
Table I.
Average value of
options per NED
Average value of options
per NED
No. of companies
n ?73
Average percentage of total
remuneration paid as options (%)
Less than $100,000 33 37.7
$100,000 to less than $300,000 21 70.0
$300,000 to less than $500,000 5 87.9
$500,000 to less than $1,000,000 6 90.8
$1,000,000 to less than $2,000,000 4 95.5
$2,000,000 or more 4 96.0
Average of the sample 61.2
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issued options valued at more than $1 million but less than $2 million and four issued
options valued at more than $2,000,000 per NED[8].
Analysis of option payer frm size and industry showed that, as suggested by the
literature, remunerating NEDs with stock options appears more likely in smaller
companies and in particular industries. In relation to frmsize, no company ranked in the
top 72 ASXcompanies adopted the practice with 51 option payers (69.9 per cent) having
a market capitalisation that ranked them in bottom half of the ASX Top 400. The
practice of remunerating NEDs with stock options was also found to be more prevalent
in certain industries. In fact of the total 73 companies in the option payer sample 53 (72.6
per cent) belonged to two GISC industry groups (materials 38/52.1 per cent and energy
15/20.5 per cent) [9].
Table II presents the descriptive statistics in respect of the categorical variables of
interest to this study.
Table II shows that companies remunerating their NEDs with options were less
likely to establish a remuneration committee compared to companies that did not
remunerate their NEDs with options. Of the total sample of 73 option payers, only 54.8
per cent (40) had constituted a remuneration committee compared to 79.5 per cent (58) of
non-option payers. When option payers did establish a remuneration committee, it was
also less independent than a comparative remuneration committee established by
non-option payers. For example, 11.0 per cent of option payers had a remuneration
committee comprising more than two-third independent members compared to 28.8 per
cent of non-option payers. In relation to CEO/chair duality, a less marked difference was
observed with 66 (90.4 per cent) of option payers segregating the roles of CEOand board
chair compared to 64 (87.7 per cent) of non-option payers. Table II also shows that option
payers were less likely to engage a top-tier auditor (38 and 52.1 per cent) when compared
to non-option payers (48 and 65.8 per cent).
Table III presents the descriptive statistics in respect of the continuous explanatory
variables.
Table III shows that, on average, the boards of option payers were less independent
than boards of non-option payers. Option payers had on average a board containing 36.4
per cent independent members compared to non-option payer company boards
averaging 42.8 per cent independent members. The average board across the entire
sample comprised 5.4 directors. Within each matched pair, the average difference was
less than 0.1 directors. The average number of independent directors per board across
Table II.
Descriptive statistics
categorical variables
Variable
Independence
level
Option paying
(%)
Non-option
paying (%)
CEODOM (CEO/board chair is segregated) 90.4 87.7
REMCOM (remuneration committee independence) 0 45.2 20.5
1 5.5 5.5
2 13.7 15.1
3 24.7 30.1
4 11.0 28.8
AUDIT (top-tier auditor) 52.1 65.8
Note: For each of the variables n ?73 for each of the option paying and non-option paying categories
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the entire sample was 2.2, with the average option payer board containing 2.0
independent directors compared to 2.4 independent directors on the average non-option
payer board. In relation to the cumulative percentage of shares held by block-holders
both option payers and non-option payers reported an average of 29 per cent of their
shares held by block-holders. Table III also shows that option payers have a much
higher percentage of cumulative shares owned by executive directors (10.1 per cent),
more than double that held by executives of non-option payers (5.0 per cent). Table III
also shows EXECSHAREas the only continuous variable where the difference in means
was statistically signifcant at the 5 per cent level.
4.2 Statistical analysis – univariate
As recommended by Hosmer and Lemeshow (2000), model development for this study
commences with the univariate analysis of the variables previously outlined. Those
variables shown to be statistically signifcant at the univariate level are then further
examined using a multivariate logistic regression model.
Table IV presents the results of ftting the univariate models.
As can be seen in Table IV, the univariate analysis indicates a statistically signifcant
difference (at the 5 per cent signifcance level) between option payers and non-option
payers with respect to the REMCOM and EXECSHARE variables[10].
4.3 Fitting the multivariable main effects model
Prior to inclusion in the fnal model, the variables REMCOM and EXECSHARE were
investigated for potential correlation as recommended by Hosmer and Lemeshow
(2000). These two variables showed a low negative correlation of ?0.11. When both
variables were included in a multivariate model, the EXECSHAREvariable ceased to be
statistically signifcant. Potential interactions between REMCOM and each of the
matching variables were examined and were found not to be signifcant. The fnal model
therefore consists of one variable shown to have statistical signifcance, the REMCOM
variable.
Further investigation of the characteristics of the REMCOM variable using ?
2
analysis showed that REMCOMat Level 0 (no remuneration committee established) and
at Level 4 (more than two-thirds independent) were the main contributors to the overall
Table III.
Descriptive statistics
– continuous
variables
Variable Group Mean SD
Difference between
means (t-statistic)
INDIR (% independent board directors) Option 36.4 22.0 ?6.5 (?1.91)
Non-Option 42.8 22.3
BLOCK (% cumulative block-holders) Option 29.0 18.8 ?0.3 (?0.09)
Non-option 29.3 21.1
EXECSHARE (% cumulative shares
held by executive directors)
Option 10.1 16.0 5.1 (2.42)*
Non-option 5.0 8.5
CASH (average of the beginning and
ending balance of cash in $ millions)
Option 48.4 111.01 1.7 (0.12)
Non-option 46.7 61.66
Notes: For each of the variables n ? 73 for each of the option paying and non-option paying
categories; *denotes statistical signifcance at the 5% level
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statistical signifcance of the variable. For example, of the 48 companies classifed with
a Level 0 REMCOM, 33 were option payers. Of the 29 companies classifed with a Level
4 REMCOM, only 8 were option payers. Additional ANOVAtests and a non-parametric
Kruskal Wallis tests were performed with respect to the entire sample and demonstrated
similar results. Further robustness tests were performed regarding the sensitivity of the
results to companies who paid options that were small in dollar value. An arbitrary
option value of less than $40,000 per NED was determined to be small, and analysis of
the sample remaining after these frms were removed showed the results of the original
model were robust.
The results of the study therefore suggest that the segregation of the CEOand chair,
the independence of the board and the other control variables included in the model are
not statistically signifcant factors in predicting whether companies remunerate their
NEDs with options. What is important is not only the establishment of a remuneration
committee but also the proportion of independent members appointed to that committee.
Consequently, H1 and H2 are rejected and H3 is accepted at the 5 per cent confdence
level.
4.4 Quantifying the effect
Table IV also shows the odds ratios calculated for each level of the variable REMCOM
with reference to the Level 0 (no remuneration committee exists). The odds ratio for
Level 1 (0.59) suggests that companies with a remuneration committee with no
independent members are 41 per cent less likely to pay options when compared to
companies that do not have a remuneration committee. The odds ratio for Level 2 (0.38)
indicates that companies with a remuneration committee with one-third or less
independent members are 62 per cent less likely to pay options when compared to
companies without a remuneration committee. A similar relationship is observed at
Levels 3 (odds ratio 0.31) and 4 (odds ratio 0.07) with the likelihood of a company
Table IV.
Univariate logistic
regression models
outcomes
Variable Value Coeffcient
Standard
error ?
2a
P
Odds
ratio
95%
confdence
interval
Discordant
pairs
INDIR ?0.016 0.009 3.61 0.058 0.98 (0.97, 1.00) n/a
CEODOM ?0.144 0.270 0.29 0.592 0.75 (0.26, 2.16) (6, 8)
REMCOM – – 11.8 0.019* – – n/a
b
0 – – – – 1 – n/a
b
1 0.544 0.610 0.80 0.372 0.59 (0.13, 2.65) n/a
b
2 0.118 0.403 0.09 0.770 0.38 (0.13, 1.15) n/a
b
3 ?0.103 0.362 0.08 0.776 0.31 (0.11, 0.85) n/a
b
4 ?1.639 0.632 6.72 0.010** 0.07 (0.01, 0.34) n/a
b
AUDITOR ?0.647 0.372 3.18 0.075 0.52 (0.25, 1.09) (21, 11)
BLOCK ?0.001 0.009 0.01 0.929 0.99 (0.98, 1.02)
EXECSHARE 0.037 0.017 4.60 0.013* 1.04 (1.00, 1.07) n/a
b
CASH 0.000 0.002 0.01 0.906 1.00 (1.00, 1.00) n/a
b
Notes: *Signifcance at the 5% level; **signifcance at the 1% level;
a
likelihood ratio
test;
b
discordant pairs were only calculated for binary variables
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remunerating their NEDs with options decreasing, as remuneration committee
independence increases.
5. Summary and conclusions
This study has two main research foci. The frst is to address the paucity of evidence
regarding the prevalence of stock option remuneration of NEDs in ASX-listed
companies. The second is to investigate whether inadequate corporate governance is
associated with NEDremuneration practices discouraged by regulators. Analysis of the
top 400 ASX-listed companies found 73 companies (18.25 per cent) that structured their
NEDremuneration so that more than 10 per cent of their remuneration was represented
by stock options. Comparison of this group to a control group matched on the basis of
size and industry showed that the practice is more common among smaller frms and is
more prevalent in certain industries, particularly materials and energy. Further analysis
of the two groups’ corporate governance environments using multivariate logistical
regression showed that, when compared to non-option payers, option payers were less
likely to establish a remuneration committee, and when they did, it was less likely to be
independent from management.
The results of this study are important, as little empirical evidence exists as to the
prevalence in Australia of the practice of remunerating NEDs with stock options.
The results of this study also show that the existence and independence of the
remuneration committee is an important corporate governance mechanism in
ensuring companies adopt remuneration practise that are seen to be in the best
interest of shareholders. This should give regulators and shareholder groups further
evidence to demand continued corporate governance reforms. However, there are
limitations to this study that must be considered when interpreting the results. The
frst limitation is the use of matched pairs. While this methodology is widely used in
comparable studies, and the 7 per cent variance in average frm size is considered
small, no two frms can ever be assumed to identical. A second potential limitation
is the use of total shareholder return as a proxy for the impact of the Global Financial
Crisis on the incidence of remunerating NEDs with options in the 2008 year. It is
possible that the 2008 year was extraordinary. Another important potential
limitation is our assumption that regulators are correct in discouraging the
remuneration of NEDs with options. This study does not attempt to evaluate
whether issuing stock options to NEDs was actually to the detriment of the
shareholders of those companies. Such an investigation was beyond the scope of this
study and would be an important area of future research.
Notes
1. However, Capezio et al. (2011) report that independent boards are no better than
management-dominated boards in aligning CEO pay with frm performance.
2. However, their study focused on the 2001 year, a time prior to strengthened corporate
governance regulation, and only considered the effect of remuneration committees composed
entirely of independent directors.
3. This methodology is common to many studies in the corporate governance literature. For
example, Agrawal and Cooper (2008), Johnson et al. (2009), Agrawal and Chadha (2005),
Wright (1996) and Beasley (1996) all analysed their samples of companies reporting fraud by
utilising a matching procedure identical to that adopted in this study. Collins et al. (2009)
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investigated the corporate governance characteristics of frms that allowed CEOs to backdate
option grants by matching to a control sample of non-backdating frms on the basis of time,
industry and size.
4. Kaplan and Reishus (1990) recognise that the average proportion of outside directors on a
board tends to vary across industry groupings. They argue this is often because directors are
chosen for their industry expertise.
5. Becher et al. (2005) and Ertugrul and Hedge (2008) also suggest a link between a frm’s growth
opportunities and leverage and the use of director option remuneration. We use frm cash
levels as a proxy for frmlife-cycle profle and argue frms entering the growth stage will have
lower cash levels and higher leverage than frms exiting their growth stage. We fnd no
signifcant difference between cash levels of our sample when compared to the control group.
6. Top-tier audit frms (also known as the “Big 4”) comprise KPMG, PriceWaterhouseCoopers,
Deloitte Touche Tohmatsu and Ernst and Young.
7. Due to inadequate detail in shareholder disclosures, it was not always possible to identify that
directors were not associated with block-holders which poses a potential limitation for the
study’s fndings.
8. Additional robustness testing that excluded all frms that issue options with a value of less
than $40,000 per NED was undertaken and did not affect the study results.
9. Additional testing showed membership of these industry groups was not a statistically
signifcant determinant of the likelihood of a frm remunerated their NEDs with options.
10. Additional robustness testing was performed with respect to frm cash levels and total
shareholder returns. Operating cash fows data were collected as an alternative measure of
cash levels for all matched frms. There was no statistically signifcant difference between the
operating cash fows of the matched pairs in the 2007 fnancial reporting period. Data relating
to total shareholder return were collected for the matched frms for the 2007 and 2008 fnancial
reporting periods as a proxy for the effect of the GFC on equity returns and the potential for
this to infuence the payment of options. No statistically signifcant difference was found
between total shareholder returns of the matched pairs for the 2007 and 2008 period.
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fnancial statements? The role of option compensation and other factors”, Journal of
Financial Economics, Vol. 85 No. 3, pp. 667-708.
Ertugrul, M. and Hedge, S. (2008), “Board composition practices and agency costs of debt”, Journal
of Corporate Finance, Vol. 14 No. 5, pp. 512-531.
European Commission (2009), Roundtable on Directors’ Remuneration, European
Commission, Brussels, Belgium.
Ferrarini, G., Moloney, N. and Ungureanu, M. (2009), “Understanding directors’ pay in europe: a
comparative and empirical analysis”, Working Paper 126/2009, European Corporate
Governance Institute Law, Brussels, Belgium, 9 June.
Fich, E. and Shivdasani, A. (2004), “The impact of stock-option compensation for outside directors
on frm value”, Journal of Business, Vol. 78 No. 6, pp. 2229-2254.
Hart, O. andHolmstrom, B. (1987), “The theoryof contracts”, inBewley, T. (Ed.), Advances inEconomic
Theory, Fifth World Congress, Cambridge University Press, Cambridge, pp. 71-155.
Heron, R.A. and Lie, E. (2007), “Does backdating explain the stock price pattern around executive
stock option grants?”, Journal of Financial Economics, Vol. 83 No. 2, pp. 271-295.
Holmstrom, B. (1979), “Moral hazard and observability”, The Bell Journal of Economics, Vol. 10
No. 1, pp. 74-91.
Hosmer, D. and Lemeshow, S. (2000), Applied Logistic Regression, 2nd ed., John Wiley and Sons,
New York, NY.
Jensen, M., Murphy, K. and Wruck, E. (2004), “Remuneration: where we’ve been, how we got to
here, what are the problems, and how to fx them”, Working Paper 44/2004, European
Corporate Governance Institute.
Johnson, S.A., Ryan, H.E. and Tian, Y.S. (2009), “Managerial incentives and corporate fraud: the
sources of incentives matter”, Review of Finance, Vol. 13 No. 1, pp. 115-145.
Kaplan, S.N. and Reishus, D. (1990), “Independent directorships and corporate performances”,
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Klein, A. (2002), “Audit committee, board of director characteristics, and earnings management”,
Journal of Accounting and Economics, Vol. 33 No. 3, pp. 375-400.
Lie, E. (2005), “On the timing of CEO stock option awards”, Management Science, Vol. 51 No. 5,
pp. 802-812.
Linn, S. and Park, D. (2005), “Outside director compensation policy and the investment
opportunity set”, Journal of Corporate Finance, Vol. 11 No. 4, pp. 680-715.
Matolcsy, Z. and Wright, A. (2011), “CEO compensation structure and frm performance”,
Accounting & Finance, Vol. 51 No. 3, pp. 745-763.
Menon, K. and Deahl Williams, J. (1994), “The use of audit committees for monitoring”, Journal of
Accounting and Public Policy, Vol. 13 No. 2, pp. 121-139.
Miller, G. and Piotroski, J. (2000), “The role of disclosure for high book-to-market frms”, Working
Paper, Harvard University, Cambridge, MA.
Minnick, K. and Zhao, M. (2009), “Backdating and director incentives: money or reputation?”,
Journal of Financial Research, Vol. 32 No. 4, pp. 449-477.
Nagar, V., Nanda, D. and Wysocki, P. (2003), “Discretionary disclosure and stock-based
incentives”, Journal of Accounting and Economics, Vol. 34 No. 1, pp. 283-309.
Newman, H.A. and Mozes, H.A. (1999), “Does the composition of the compensation committee
infuence CEOcompensation practices?”, Financial Management, Vol. 28 No. 3, pp. 41-53.
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Peng, L. and Roell, A. (2006), “Executive pay, earnings manipulation and shareholder litigation”,
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Perkins, S.J. and Hendry, C. (2005), “Ordering top pay: interpreting the signals”, Journal of
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Perry, T. (2000), “Incentive compensation for outside directors and CEO turnover”, Working
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Corresponding author
Michael Seamer can be contacted at: [email protected]
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doc_967983442.pdf
This paper aims to investigate the incidence of remunerating Australian Securities
Exchange (ASX)-listed non-executive directors (NEDs) with options and to determine whether
companies that fail to adhere to NED remuneration recommendations share a common corporate
governance profile. Despite corporate regulators condemning the practice of remunerating NEDs with
stock options, there is a paucity of evidence regarding its prevalence in Australia.
Accounting Research Journal
Remunerating non-executive directors with stock options: who is ignoring the
regulator?
Michael Seamer Adrian Melia
Article information:
To cite this document:
Michael Seamer Adrian Melia , (2015),"Remunerating non-executive directors with stock options: who
is ignoring the regulator?", Accounting Research J ournal, Vol. 28 Iss 3 pp. 251 - 267
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Remunerating non-executive
directors with stock options:
who is ignoring the regulator?
Michael Seamer and Adrian Melia
Newcastle Business School, Faculty of Business and Law,
The University of Newcastle, Callaghan, Australia
Abstract
Purpose – This paper aims to investigate the incidence of remunerating Australian Securities
Exchange (ASX)-listed non-executive directors (NEDs) with options and to determine whether
companies that fail to adhere to NED remuneration recommendations share a common corporate
governance profle. Despite corporate regulators condemning the practice of remunerating NEDs with
stock options, there is a paucity of evidence regarding its prevalence in Australia.
Design/methodology/approach – Focusing on ASX400 companies during 2008, a series of
hypotheses relating NEDstock option remuneration and corporate governance are tested using logistic
regression.
Findings – The study shows that the prevalence and quantum of NED option payments during 2008
was considerable with 73 of the ASX400 companies, including options in NED remuneration (option
payers). Comparison of the corporate governance characteristics of option payers to that of a matched
control group (non-option payers) highlighted both the existence and independence of the remuneration
committee as critical in ensuring NEDremuneration practices comply with regulator recommendations.
Research limitations/implications – These results provide regulators and stakeholder groups
with additional evidence to continue to call for corporate governance reforms to ensure that corporate
remuneration practices are in the best interest of shareholders.
Originality/value – This study is the frst to highlight the extent to which Australian-listed company
NED remuneration practices fail to comply with regulator recommendations and adds to the limited
research on remuneration committee effectiveness.
Keywords Corporate governance, Non-executive remuneration, Stock options
Paper type Research paper
1. Introduction
Despite a lack of consensus in the literature regarding the economic consequences of
remunerating non-executive directors (NEDs) with options, there is widespread
international regulator opposition to the practice. Ferrarini et al. (2009) refer to the
European Commission (2009, p. 46) Roundtable on Directors’ Remuneration
recommendation against remunerating NEDs with options and observe that most
European member states have similar recommendations in place. They explain that
regulators believe remunerating NEDs with options leads to a:
Confict of interest risks, particularly where non-executive directors are called on to evaluate
accounting practices or to take other decisions with a possible bearing on the company’s
reported earnings, given that such earnings or evaluations could have an impact on their
The current issue and full text archive of this journal is available on Emerald Insight at:
www.emeraldinsight.com/1030-9616.htm
Remunerating
non-executive
directors
251
Received10 December 2013
Revised16 June 2014
Accepted15 August 2014
Accounting Research Journal
Vol. 28 No. 3, 2015
pp. 251-267
©Emerald Group Publishing Limited
1030-9616
DOI 10.1108/ARJ-12-2013-0092
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income. High remuneration for non-executive directors may also jeopardise their
independence.
The Australian Securities Exchange (ASX) (2007, p. 37) also discourages granting
options to NEDs with Guideline 8.2 of the ASX Corporate Governance Principles and
Recommendations prescribing: “Non-executive directors should not receive options or
bonus payments”. These recommendations are also supported by the Australian
Institute of Company Directors (AICD) (2003 p. 4), the principle advocacy group
representing Australian directors:
AICD does not support the granting of options to non-executive directors […] Any
arrangement, that affects the independence or the perception of independence of non-executive
directors, should be discouraged.
Despite the importance of the issue to both regulators and advocacy groups, fewstudies
have attempted to gauge the prevalence and quantum to which NEDs serving on
Australian boards are remunerated with options. This study seeks to address this
paucity of evidence and also determine whether companies that fail to adhere to NED
remuneration recommendations share a common corporate governance profle.
We examine the top 400 ASX-listed companies and fnd 73 companies (18.25 per cent)
remunerated their NEDs with substantial values of stock options (option payers). The
quantum of option remuneration value was higher than expected with some extremes
observed. For example, one frm ranked in the ASX Top 300 issued options worth on
average $115.9 million per NED. For the remainder of the sample, the average value of
options paid per NED totalled $357,515 which was 4.65 times the average cash salary
per NED of $76,903. Comparison of this group to a control group (non-option payers)
matched on the basis of size and industry showed that the practice is more common
among smaller frms and is more prevalent in certain industries. Further analysis of the
two group’s corporate governance environments showed that, when compared to
non-option payers, option payers were less likely to establish a remuneration committee,
and where they did, it was less likely to be independent from management.
2. Literature review and hypothesis development
Two competing theories dominate the literature regarding the appropriate structure of
director remuneration contracts, particularly with regards to the use of stock option
grants. Optimal contracting theory posits that by giving directors compensation that is
sensitive to frmperformance, frmowners can incentivise their agents to work harder to
maximise frm value (Holmstrom, 1979; Hart and Holmstrom, 1987). However,
proponents of managerial power theory, such as Jensen et al. (2004, p. 2), posit that rather
than solving agency problems, issuing options to directors can in fact lead to greater
agency costs. They argue that remuneration contracts that feature stock option grants
have the potential to: “encourage managers to ignore the cost of capital, manage
earnings in a way that destroys value and take action to deceive investors and capital
markets”.
Considerable empirical evidence supports the contention that stock options motivate
directors to engage in opportunistic behaviour aimed at increasing the value of their
holdings. For example, Bizjak et al. (2009), Heron and Lie (2007), Chauvin and Shenoy
(2001), Aboody and Kasznik (2000) and Yermack (1997) all fnd directors manipulate the
timing of stock option grants to their advantage, receiving them either prior to good
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news announcements or after bad newannouncements. Miller and Piotroski (2000) also
fnd managers of poor performing frms are more likely to provide earnings forecasts if
they have higher stock compensation at risk, while Nagar et al. (2003) report both
disclosure frequency and quality are positively related to the proportion of CEO
compensation based on stock price. Studies have also shown a link between director
option holding and fraudulent manipulation of fnancial disclosures. For example, Peng
and Roell (2006) report a positive relationship between the granting of options to
executives and the probability of securities legislation prosecution, while Efendi et al.
(2007) fnd strong links between CEO option holdings and the likelihood of misstated
fnancial statements. Johnson et al. (2009) also show that executives at frms
experiencing management perpetrated fraud have signifcantly larger equity-based
compensation than those at frms free from management perpetrated fraud.
However, the main focus of empirical research has been on stock option grants to
executive directors, particularly the CEO. Fewer studies examine the impact option
grants have on NED motivation to monitor management. Bryan and Klein’s (2004, p. 7)
review of the NED remuneration literature concludes that it “is sparse and divided”. A
similar theoretical divide between optimal contracting and managerial power theorists
exists with respect to issuing NEDs with options. For example, Bhagat et al. (1999) argue
options provide NEDs with greater personal fnancial incentives to ensure management
are maximising frmvalue. Bhagat and Bolton (2008) and Perry (2000) provide empirical
evidence with their fndings of a positive link between independent board members’
option holdings and the likelihood of a CEO being dismissed if the frm is performing
poorly. Ertugrul and Hedge (2008), Linn and Park (2005) and Fich and Shivdasani (2004)
also argue granting options to NEDs provides them with incentives to adequately
monitor management’s risk-taking and investment activities.
Managerial power theorists however argue that issuingNEDs withstockoptions is more
likely to align NED interests with those of managers rather than shareholders. They claim
thisconvergenceof interest resultsinNEDsmimickingexecutiveself-servingbehaviour and
compromises their monitoring of the fnancial reporting process (Boumosleh, 2009).
Boumosleh (2009) provides empirical evidence by reporting a positive relationship between
NEDs option compensation and higher levels of earnings management. Minnick and Zhao
(2009); Collins et al. (2009) and Bebchuk et al. (2010) all fnd that the incidence of frms
covertly backdating option grants increases when NEDs receive option grants on the same
date as executive directors. They argue NEDs are less likely to object to illicit backdating
when they stand to share in the benefts.
2.1 Research questions
The research focus of this study is twofold. Firstly, it attempts to address the paucity of
evidence regarding the prevalence of Australia-listed frms remunerating their NEDs with
stock options. Secondly, it investigates whether corporate governance plays a role in frm
decisions to adopt remuneration practices discouraged by regulators. The literature
acknowledges that as director remuneration can be both a solution to and a cause of agency
confict, corporate governance mechanisms are important in mitigating agency costs
associated with the remuneration process. For example, Jensen et al. (2004, p. 22) argue:
[…] corporate governance and remuneration policies are highly inter-related: bad governance
can easily lead to value-destroying pay practices, and many notorious excesses in pay can be
traced to poor governance.
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Extensive empirical evidence exists linking inadequate corporate governance with
levels of director compensation that are inversely related to frmperformance (Core et al.,
1999).
This study will focus on the following corporate governance mechanisms shown in
the literature to impact on the director remuneration setting process:
• independence of the board of directors;
• CEO/board chair duality; and
• existence and independence of a remuneration committee.
2.1.1 Independence of the board. Studies have consistently shown a strong negative
relationship between the proportion of independent directors on the board and the
over-consumption of benefts by management[1]. For example, Core et al. (1999),
Sridharan (1996) and Brickley and James (1987) all report CEOs of frms with
management-dominated boards receive higher comparative remuneration than CEOs of
frms with independent boards. Minnick and Zhao (2009) and Collins et al. (2009) also
fnd that frms covertly backdating CEO option grants have less independent boards
than frms which did not backdate CEOoptions. Bebchuk et al. (2010) also suggest CEOs
are more likely to receive option grants exercisable at the lowest possible share price
when the board does not have a majority of outside directors.
Given that the literature shows that independent boards are effective in reducing
excess executive remuneration, it is expected that the independence of the board of
directors will have the same positive effect in ensuring NEDs are not remunerated with
stock options. Therefore, this study tests the following hypothesis:
H1. Companies with a higher proportion of non-independent directors on the board
are more likely to remunerate their NEDs with stock options than companies
with a lower proportion of non-independent directors on the board.
2.1.2 CEO/chair duality. Bebchuk and Fried (2006) argue that by controlling the director
selection process and serving on the compensation committee, CEOs can create
“managerial power” that allows them infuence over their remuneration levels.
“Managerial power” is strongest when the CEO also holds the position of board chair.
Jensen et al. (2004, p. 54) note:
The critical job of the Board Chair is to run the process that evaluates, compensates, hires and
fres the CEO and top management team. The CEO cannot perform that job adequately.
Empirical support is provided by Collins et al. (2009) and Bizjak et al. (2009) who report
that frms that covertly backdate CEO option grants have a higher incidence of CEO/
chair duality than frms which do not backdate CEOoption grants. Bebchuk et al. (2007)
also report a strong correlation between CEOdomination of the board and the likelihood
of the CEO receiving options granted at the lowest monthly equity price or receiving
personal bonuses as a result solely of positive industry-wide events. Sridharan (1996)
also fnds a signifcant positive relationship between CEO infuence over the board and
the level of CEO salary and bonuses.
Given that the literature shows frms dominated by the CEOare more likely to adopt
inappropriate remuneration policies, it is expected that the existence of CEO/chair
duality will be associated with NEDs receiving stock option remuneration. This study
tests the following hypothesis:
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H2. Companies that combine the roles of CEO and board chair are more likely to
remunerate their NEDs with stock options than companies that segregate the
roles of CEO and board chair.
2.1.3 Remuneration committee. Perkins and Hendry’s (2005, p. 144) survey of the
remuneration committee literature concludes that the evidence suggests that “the
composition of the company’s compensation committee is important in the closer
alignment of management pay and corporate performance”. For example, Newman and
Mozes (1999) report the relationship between CEO compensation and performance is
biased in the CEO’s favour when insiders sit on the compensation committee, while
Conyon and Peck (1998) report a closer alignment of executive remuneration and
performance when outsiders dominate the remuneration committee. Newman and
Wright (1996) also fnd that CEOs of frms with remuneration committees containing at
least one executive were paid 20 per cent more than CEOs whose remuneration was set
by an independent committee. Klein (2002) reports earnings management is higher in
frms where the CEO also serves on the board’s remuneration committee while
Stathopoulos et al. (2004) report that executive presence on the remuneration committee
has a positive impact on the time to maturity and, hence, the value of executive options.
However, the empirical evidence regarding the effectiveness of remuneration
committees is not unanimous. For example, Conyon and Peck (1998) fnd that the
presence of an independent remuneration committee did not result in lower top
management compensation, as they hypothesised, but in higher pay. Anderson and
Bizjak (2003) also fnd little evidence that lack of independence on the remuneration
committee impacts executive pay levels. In the Australian context, Cybinski and
Windsor (2013) report no link between remuneration committee independence, CEO
remuneration and frm performance[2].
Given that evidence suggests that remuneration committees are effective in reducing
inappropriate executive remuneration, it is expected that the existence and
independence of the remuneration committee will have a positive effect in ensuring
NEDs are not remunerated with stock options. This study tests the following related
hypotheses:
H3a. Companies without a remuneration committee are more likely to remunerate
their NEDs with stock options than companies with a remuneration
committee.
H3b. Companies with less independent remuneration committees are more likely to
remunerate their NEDs with stock options than companies with more
independent remuneration committees.
3. Research method
This study focuses on the largest 400 Australian-listed companies for the 2008 year.
Analysis of the remuneration reports contained in the annual reports of these companies
revealed 79 that remunerated NEDs with stock options. Excluding those companies
where NEDs on average received less than 10 per cent of their total remuneration in
options resulted in a fnal group of 73 frms (option payers). Both ASXlisting regulations
and the Corporations’ Law(2001) require detailed disclosure of director remuneration in
listed company annual reports. Details of options included in NED remuneration were
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obtained from the remuneration report required in the company’s annual report by
Section 300A of the Corporation’s Law (2001). This section requires disclosure of:
[…] the value (worked out as at the time they are granted and in accordance with any
applicable accounting standards) of options that are granted to each director during the year as
part of their remuneration and the percentage of the value of the person’s remuneration for the
fnancial year that consists of options.
Acompany is also required to disclose in its directors’ report whether each director is an
executive director or NED. Given that the value of options disclosed must be determined
in accordance with accounting standards and calculations must be audited by the
company auditor, it is presumed that the disclosed values are relevant and reliable.
To test the hypotheses previously outlined, the corporate governance characteristics
of the sample were compared to a control group of companies that did not pay options as
remuneration to NEDs. To control for variables shown in the literature to infuence both
a company’s remuneration policy and its corporate governance environment, each
company in the sample was matched with a control company that was its closest in
terms of size, industry and fnancial reporting period[3].
The relative size of an organisation has been shown to infuence both an entity’s
corporate governance environment and its remuneration policies. Menon and Deahl
Williams (1994) assert that larger frms have incentives to monitor the greater
complexities associated with size and can better carry the signifcant costs of
establishing and operating corporate governance mechanisms such as remuneration
committees. Bryan and Klein (2004) also fnd larger frms are less likely to issue options
to non-management directors while Lie (2005) fnds that smaller frms are more likely
than larger frms to covertly backdate CEO options. Cybinski and Windsor (2013) also
indicate frm size as an infuential factor in aligning Australian CEO remuneration
levels with frm performance. This study uses the company’s market capitalisation at
the end of the 2008 year as a measure of size. Market capitalisation data were collected
from the annual market capitalisation rankings of all Australian-listed companies as
published by ASX.
The industry in which a company operates has also been identifed as a factor that
affects both a frm’s corporate governance and remuneration policy[4]. For example,
Stathopoulos et al. (2004) fnd that stock options are more likely to be granted to NEDs
of “New Economy” (e-commerce and dot.com) frms compared to “Old Economy”
traditional retail frms who tend to remunerate in cash. Bryan and Klein (2004) also fnd
marked variations in the use of stock option grants for NEDs across US industries
varying from one-third or less for energy and utility frms to over 70 per cent for
manufacturing, mining and service frms. Collins et al. (2009) also report frms with
greater return volatility and frms in high technology industries exhibit greater evidence
of allowing CEO option grants to be backdated. Control companies for this study were
selected on the basis of the four-digit S & P Global Industry codes, as adopted by ASX.
In addition to matching the control group on the basis of industry and size, it is
imperative that further comparison is performed with respect to the same time period.
The matching process resulted in a fnal sample size of 146 companies (73 option payers
paired with 73 non-option payers). Overall matched pairs showed a relatively low
variance in market capitalisation of 7 per cent, with option paying frms being, on
average, 7 per cent larger than non-option paying frms. Beasley (1996) argued the 20 per
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cent variance in size between his sample of frms reporting corporate fraud and a
matched control group was tolerable.
3.1 Control variables
The literature suggests other factors that may infuence company remuneration
practices. These are listed belowand are used as control variables in the research model:
• block-holder equity ownership;
• executive director equity ownership;
• auditor quality; and
• frm cash reserves[5].
Matolcsy and Wright’s (2011) study of CEOremuneration practices in Australia reports
that both executive share ownership and the presence of outside block-holders are
signifcant determinants of compensation structure. They fnd that frms where the CEO
owns more shares are more likely to offer equity-based compensation, whereas frms
with greater outside block-holders are more likely to remunerate using cash. Ertugrul
and Hedge (2008) also argue that executive director shareholdings infuence a frm’s risk
profle. The empirical evidence also suggests that frms audited by “top-tier” auditors[6]
are more likely than frms audited by non-top-tier auditors to adopt appropriate
remuneration structures. For example, Carson (2002) reports Australian-listed
companies are more likely to establish a remuneration committee when they are audited
by a top-tier auditor while Collins et al. (2009) fnd frms audited by top-tier auditors
exhibit a lower incidence of covertly backdating CEOoption grants. Firmcash levels are
included to control for liquidity differences that may drive the decision to remunerate
NEDs with options.
3.2 Research methodology
Logistic regression analysis is used to compare the characteristics of option payers with
the non-option payer control group. The hypotheses previously outlined will be tested,
frstly, using a series of univariate regressions, followed by multivariate regression. The
equations for the univariate regressions are as follows:
OPTION
i
? ? ? ?
1
INDDIR
i
? ?
i
(1)
OPTION
i
? ? ? ?
2
REMCOM
i
? ?
i
(2)
OPTION
i
? ? ? ?
3
CEODOM
i
? ?
i
(3)
OPTION
i
? ? ? ?
4
AUDIT
i
? ?
i
(4)
OPTION
i
? ? ? ?
5
BLOCK
i
? ?
i
(5)
OPTION
i
? ? ? ?
6
EXECSHARE
i
? ?
i
(6)
OPTION
i
? ? ? ?
7
CASH
i
? ?
i
(7)
Variables found to be signifcant at the univariate level are then tested using the
following multivariate regression defned as follows:
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OPTION
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CEODOM
i
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AUDIT
i
? ?
5
BLOCK
i
? ?
6
EXECSHARE
i
? ?
7
CASH
i
? ?
i
Where
i ?Company 1 through 146;
OPTION ? dependent dichotomous variable with the value of 1 when a
company paid its NEDs on average more than 10 per cent of their
remuneration in options and a value of 0 otherwise;
INDDIR ?the percentage of board members who are independent;and
REMCOM ?a value of zero when a company has no remuneration committee:
A value of 1 when it discloses the existence of a remuneration
committee with no independent members;
A value of 2 when it discloses the existence of a remuneration
committee with less than or equal to one-third independence;
A value of 3 when it discloses the existence of a remuneration
committee with between one-third and less than or equal to
two-third independence;
A value of 4 when it discloses the existence of a remuneration
committee with more than two-third independence.
CEODOM ?indicator variable with a value of 1 if the chairperson of the board
holds the CEO’s position and a value of 0 otherwise;
AUDIT ?indicator variable with a value of 1 when a company is audited by
a “top-tier” audit frm and a value of 0 otherwise;
BLOCK ? cumulative percentage of shares owned in the company by
block-holders that are not directors of the company holding at least
5 per cent of the company’s voting shares;
EXECSHARE ? the cumulative percentage of shares held in the company by
executive directors;
CASH ? the average of the frm’s beginning and ending cash balances for
the study period;
3.3 Measurement of model variables
The variable INDDIR represents the proportion of the board of directors that are
independent from management. This study adopts Carcello and Neale’s (2003, p. 291)
defnition of director independence:
Members can be either affliated directors or independent directors. We defne affliate
directors as current or former offcers or employees of the company or of an affliated entity,
relatives of management, professional advisers to the frm(e.g. consultants, bank offcers, and
legal counsel), offcers of signifcant suppliers or customers of the frm and interlocking
directors.
Director independence was evaluated from disclosures in the company’s annual report.
Details of director relationships with the company are required in the director’s report,
corporate governance statement and related party note to the fnancial statements. It is
considered that a close analysis of these sources provides an objective basis for
determining director independence. The variable REMCOM represents the proportion
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of independent members on the remuneration committee. Where the frm had no
remuneration committee, the variable was set at 0 with an increment of one assigned for
every one-third of total members deemed independent frommanagement. Details of the
existence of a remuneration committee and evaluation of independence of its members
are obtained from disclosures in the company annual report as required by ASX listing
rule 4.10.2. The variable CEODOMrepresents duality of the CEOand board chair roles.
Details of directors occupying the roles of CEO and board chair were obtained from the
directors’ report disclosures in the company annual report. The variable AUDIT is
included in the regression model to control for differences in auditor quality. Audit frm
was identifed from the audit report contained in the relevant annual report. Top-tier
audit frms consisted of KPMG, PriceWaterhouseCoopers, Deloitte Touche Tohmatsu
and Ernst & Young. All other audit frms were classifed as non-top-tier. The control
variable BLOCKwas measured as the cumulative percentage of company equity owned
by block-holders that are not directors of the company. A block-holder was defned as
any shareholder holding at least 5 per cent of the company’s voting shares. Details of
shareholdings were obtained fromsubstantial shareholder disclosures in the company’s
annual report[7]. The control variable EXECSHARE was measured as the cumulative
percentage of company equity owned by executive directors. Details of executive
shareholdings were obtained from the directors’ report contained in the company’s
annual report. Details of frm’s beginning and ending cash balances were obtain from
their 2008 audited fnancial statements.
4. Results and discussion
4.1 Descriptive statistics
Table I categorises the 73 option payers on the basis of the average value of options paid
to each NED.
As shown in Table I, the value of options issued by option payers was considerable.
In fact, after excluding one extreme option payer (that paid on average $115.9 million in
options per NED), the average option payment per NEDwas $357,515, representing 4.65
times the average cash salary paid per NED of $76,903. Over one half of the sample
issued options to their NEDs with an average value of over $100,000 per NED. In total,
21 option payers (28.8 per cent) issued options with an average value per NED of more
than $100,000 and less than $300,000. Five option payers issued options with a value per
NED of more than $300,000 and less than $500,000, six option payers issued options
with a value per NEDof more than $500,000 and less than $1 million, four option payers
Table I.
Average value of
options per NED
Average value of options
per NED
No. of companies
n ?73
Average percentage of total
remuneration paid as options (%)
Less than $100,000 33 37.7
$100,000 to less than $300,000 21 70.0
$300,000 to less than $500,000 5 87.9
$500,000 to less than $1,000,000 6 90.8
$1,000,000 to less than $2,000,000 4 95.5
$2,000,000 or more 4 96.0
Average of the sample 61.2
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issued options valued at more than $1 million but less than $2 million and four issued
options valued at more than $2,000,000 per NED[8].
Analysis of option payer frm size and industry showed that, as suggested by the
literature, remunerating NEDs with stock options appears more likely in smaller
companies and in particular industries. In relation to frmsize, no company ranked in the
top 72 ASXcompanies adopted the practice with 51 option payers (69.9 per cent) having
a market capitalisation that ranked them in bottom half of the ASX Top 400. The
practice of remunerating NEDs with stock options was also found to be more prevalent
in certain industries. In fact of the total 73 companies in the option payer sample 53 (72.6
per cent) belonged to two GISC industry groups (materials 38/52.1 per cent and energy
15/20.5 per cent) [9].
Table II presents the descriptive statistics in respect of the categorical variables of
interest to this study.
Table II shows that companies remunerating their NEDs with options were less
likely to establish a remuneration committee compared to companies that did not
remunerate their NEDs with options. Of the total sample of 73 option payers, only 54.8
per cent (40) had constituted a remuneration committee compared to 79.5 per cent (58) of
non-option payers. When option payers did establish a remuneration committee, it was
also less independent than a comparative remuneration committee established by
non-option payers. For example, 11.0 per cent of option payers had a remuneration
committee comprising more than two-third independent members compared to 28.8 per
cent of non-option payers. In relation to CEO/chair duality, a less marked difference was
observed with 66 (90.4 per cent) of option payers segregating the roles of CEOand board
chair compared to 64 (87.7 per cent) of non-option payers. Table II also shows that option
payers were less likely to engage a top-tier auditor (38 and 52.1 per cent) when compared
to non-option payers (48 and 65.8 per cent).
Table III presents the descriptive statistics in respect of the continuous explanatory
variables.
Table III shows that, on average, the boards of option payers were less independent
than boards of non-option payers. Option payers had on average a board containing 36.4
per cent independent members compared to non-option payer company boards
averaging 42.8 per cent independent members. The average board across the entire
sample comprised 5.4 directors. Within each matched pair, the average difference was
less than 0.1 directors. The average number of independent directors per board across
Table II.
Descriptive statistics
categorical variables
Variable
Independence
level
Option paying
(%)
Non-option
paying (%)
CEODOM (CEO/board chair is segregated) 90.4 87.7
REMCOM (remuneration committee independence) 0 45.2 20.5
1 5.5 5.5
2 13.7 15.1
3 24.7 30.1
4 11.0 28.8
AUDIT (top-tier auditor) 52.1 65.8
Note: For each of the variables n ?73 for each of the option paying and non-option paying categories
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the entire sample was 2.2, with the average option payer board containing 2.0
independent directors compared to 2.4 independent directors on the average non-option
payer board. In relation to the cumulative percentage of shares held by block-holders
both option payers and non-option payers reported an average of 29 per cent of their
shares held by block-holders. Table III also shows that option payers have a much
higher percentage of cumulative shares owned by executive directors (10.1 per cent),
more than double that held by executives of non-option payers (5.0 per cent). Table III
also shows EXECSHAREas the only continuous variable where the difference in means
was statistically signifcant at the 5 per cent level.
4.2 Statistical analysis – univariate
As recommended by Hosmer and Lemeshow (2000), model development for this study
commences with the univariate analysis of the variables previously outlined. Those
variables shown to be statistically signifcant at the univariate level are then further
examined using a multivariate logistic regression model.
Table IV presents the results of ftting the univariate models.
As can be seen in Table IV, the univariate analysis indicates a statistically signifcant
difference (at the 5 per cent signifcance level) between option payers and non-option
payers with respect to the REMCOM and EXECSHARE variables[10].
4.3 Fitting the multivariable main effects model
Prior to inclusion in the fnal model, the variables REMCOM and EXECSHARE were
investigated for potential correlation as recommended by Hosmer and Lemeshow
(2000). These two variables showed a low negative correlation of ?0.11. When both
variables were included in a multivariate model, the EXECSHAREvariable ceased to be
statistically signifcant. Potential interactions between REMCOM and each of the
matching variables were examined and were found not to be signifcant. The fnal model
therefore consists of one variable shown to have statistical signifcance, the REMCOM
variable.
Further investigation of the characteristics of the REMCOM variable using ?
2
analysis showed that REMCOMat Level 0 (no remuneration committee established) and
at Level 4 (more than two-thirds independent) were the main contributors to the overall
Table III.
Descriptive statistics
– continuous
variables
Variable Group Mean SD
Difference between
means (t-statistic)
INDIR (% independent board directors) Option 36.4 22.0 ?6.5 (?1.91)
Non-Option 42.8 22.3
BLOCK (% cumulative block-holders) Option 29.0 18.8 ?0.3 (?0.09)
Non-option 29.3 21.1
EXECSHARE (% cumulative shares
held by executive directors)
Option 10.1 16.0 5.1 (2.42)*
Non-option 5.0 8.5
CASH (average of the beginning and
ending balance of cash in $ millions)
Option 48.4 111.01 1.7 (0.12)
Non-option 46.7 61.66
Notes: For each of the variables n ? 73 for each of the option paying and non-option paying
categories; *denotes statistical signifcance at the 5% level
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statistical signifcance of the variable. For example, of the 48 companies classifed with
a Level 0 REMCOM, 33 were option payers. Of the 29 companies classifed with a Level
4 REMCOM, only 8 were option payers. Additional ANOVAtests and a non-parametric
Kruskal Wallis tests were performed with respect to the entire sample and demonstrated
similar results. Further robustness tests were performed regarding the sensitivity of the
results to companies who paid options that were small in dollar value. An arbitrary
option value of less than $40,000 per NED was determined to be small, and analysis of
the sample remaining after these frms were removed showed the results of the original
model were robust.
The results of the study therefore suggest that the segregation of the CEOand chair,
the independence of the board and the other control variables included in the model are
not statistically signifcant factors in predicting whether companies remunerate their
NEDs with options. What is important is not only the establishment of a remuneration
committee but also the proportion of independent members appointed to that committee.
Consequently, H1 and H2 are rejected and H3 is accepted at the 5 per cent confdence
level.
4.4 Quantifying the effect
Table IV also shows the odds ratios calculated for each level of the variable REMCOM
with reference to the Level 0 (no remuneration committee exists). The odds ratio for
Level 1 (0.59) suggests that companies with a remuneration committee with no
independent members are 41 per cent less likely to pay options when compared to
companies that do not have a remuneration committee. The odds ratio for Level 2 (0.38)
indicates that companies with a remuneration committee with one-third or less
independent members are 62 per cent less likely to pay options when compared to
companies without a remuneration committee. A similar relationship is observed at
Levels 3 (odds ratio 0.31) and 4 (odds ratio 0.07) with the likelihood of a company
Table IV.
Univariate logistic
regression models
outcomes
Variable Value Coeffcient
Standard
error ?
2a
P
Odds
ratio
95%
confdence
interval
Discordant
pairs
INDIR ?0.016 0.009 3.61 0.058 0.98 (0.97, 1.00) n/a
CEODOM ?0.144 0.270 0.29 0.592 0.75 (0.26, 2.16) (6, 8)
REMCOM – – 11.8 0.019* – – n/a
b
0 – – – – 1 – n/a
b
1 0.544 0.610 0.80 0.372 0.59 (0.13, 2.65) n/a
b
2 0.118 0.403 0.09 0.770 0.38 (0.13, 1.15) n/a
b
3 ?0.103 0.362 0.08 0.776 0.31 (0.11, 0.85) n/a
b
4 ?1.639 0.632 6.72 0.010** 0.07 (0.01, 0.34) n/a
b
AUDITOR ?0.647 0.372 3.18 0.075 0.52 (0.25, 1.09) (21, 11)
BLOCK ?0.001 0.009 0.01 0.929 0.99 (0.98, 1.02)
EXECSHARE 0.037 0.017 4.60 0.013* 1.04 (1.00, 1.07) n/a
b
CASH 0.000 0.002 0.01 0.906 1.00 (1.00, 1.00) n/a
b
Notes: *Signifcance at the 5% level; **signifcance at the 1% level;
a
likelihood ratio
test;
b
discordant pairs were only calculated for binary variables
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remunerating their NEDs with options decreasing, as remuneration committee
independence increases.
5. Summary and conclusions
This study has two main research foci. The frst is to address the paucity of evidence
regarding the prevalence of stock option remuneration of NEDs in ASX-listed
companies. The second is to investigate whether inadequate corporate governance is
associated with NEDremuneration practices discouraged by regulators. Analysis of the
top 400 ASX-listed companies found 73 companies (18.25 per cent) that structured their
NEDremuneration so that more than 10 per cent of their remuneration was represented
by stock options. Comparison of this group to a control group matched on the basis of
size and industry showed that the practice is more common among smaller frms and is
more prevalent in certain industries, particularly materials and energy. Further analysis
of the two groups’ corporate governance environments using multivariate logistical
regression showed that, when compared to non-option payers, option payers were less
likely to establish a remuneration committee, and when they did, it was less likely to be
independent from management.
The results of this study are important, as little empirical evidence exists as to the
prevalence in Australia of the practice of remunerating NEDs with stock options.
The results of this study also show that the existence and independence of the
remuneration committee is an important corporate governance mechanism in
ensuring companies adopt remuneration practise that are seen to be in the best
interest of shareholders. This should give regulators and shareholder groups further
evidence to demand continued corporate governance reforms. However, there are
limitations to this study that must be considered when interpreting the results. The
frst limitation is the use of matched pairs. While this methodology is widely used in
comparable studies, and the 7 per cent variance in average frm size is considered
small, no two frms can ever be assumed to identical. A second potential limitation
is the use of total shareholder return as a proxy for the impact of the Global Financial
Crisis on the incidence of remunerating NEDs with options in the 2008 year. It is
possible that the 2008 year was extraordinary. Another important potential
limitation is our assumption that regulators are correct in discouraging the
remuneration of NEDs with options. This study does not attempt to evaluate
whether issuing stock options to NEDs was actually to the detriment of the
shareholders of those companies. Such an investigation was beyond the scope of this
study and would be an important area of future research.
Notes
1. However, Capezio et al. (2011) report that independent boards are no better than
management-dominated boards in aligning CEO pay with frm performance.
2. However, their study focused on the 2001 year, a time prior to strengthened corporate
governance regulation, and only considered the effect of remuneration committees composed
entirely of independent directors.
3. This methodology is common to many studies in the corporate governance literature. For
example, Agrawal and Cooper (2008), Johnson et al. (2009), Agrawal and Chadha (2005),
Wright (1996) and Beasley (1996) all analysed their samples of companies reporting fraud by
utilising a matching procedure identical to that adopted in this study. Collins et al. (2009)
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investigated the corporate governance characteristics of frms that allowed CEOs to backdate
option grants by matching to a control sample of non-backdating frms on the basis of time,
industry and size.
4. Kaplan and Reishus (1990) recognise that the average proportion of outside directors on a
board tends to vary across industry groupings. They argue this is often because directors are
chosen for their industry expertise.
5. Becher et al. (2005) and Ertugrul and Hedge (2008) also suggest a link between a frm’s growth
opportunities and leverage and the use of director option remuneration. We use frm cash
levels as a proxy for frmlife-cycle profle and argue frms entering the growth stage will have
lower cash levels and higher leverage than frms exiting their growth stage. We fnd no
signifcant difference between cash levels of our sample when compared to the control group.
6. Top-tier audit frms (also known as the “Big 4”) comprise KPMG, PriceWaterhouseCoopers,
Deloitte Touche Tohmatsu and Ernst and Young.
7. Due to inadequate detail in shareholder disclosures, it was not always possible to identify that
directors were not associated with block-holders which poses a potential limitation for the
study’s fndings.
8. Additional robustness testing that excluded all frms that issue options with a value of less
than $40,000 per NED was undertaken and did not affect the study results.
9. Additional testing showed membership of these industry groups was not a statistically
signifcant determinant of the likelihood of a frm remunerated their NEDs with options.
10. Additional robustness testing was performed with respect to frm cash levels and total
shareholder returns. Operating cash fows data were collected as an alternative measure of
cash levels for all matched frms. There was no statistically signifcant difference between the
operating cash fows of the matched pairs in the 2007 fnancial reporting period. Data relating
to total shareholder return were collected for the matched frms for the 2007 and 2008 fnancial
reporting periods as a proxy for the effect of the GFC on equity returns and the potential for
this to infuence the payment of options. No statistically signifcant difference was found
between total shareholder returns of the matched pairs for the 2007 and 2008 period.
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Corresponding author
Michael Seamer can be contacted at: [email protected]
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