THE DETERMINANTIONOF DIRECTORS REMUNERATION IN MALAYSIAN PUBLIC LISTED COMPANIES

By CHONG MENG FONG

Research report submitted in partial fulfillment of the requirements for the degree of Master of Business Administration MAY 2007

DEDICATION

. to my beloved family

ACKNOWLEDGEMENT For each new morning with its light, For rest and shelter of the night, For health and food, For love and friends, For everything Thy goodness sends. Father in heaven, We thank thee.

There are many individuals whom I would like to thank for their underlying support and guidance that made it possible for me to complete this MBA project paper. First of all, my sincere gratitude goes to my beloved family, to my parents for giving me life in the first place and for unconditional support and encouragement to pursue my studies. To my husband for his unremitting love and encouragements, to my two little kids for their obedient and independent that enabled me to complete this work.

I am greatly indebted to my supervisors, Professor Dr. Hasnah Haron and Dr. Sofri Yahya, for their stimulating suggestions, encouragement and providing much-needed assistance in all time of research for and writing of this thesis. Truly, from the bottom of my heart, it is really my honor to have them as my supervisors.

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TABLE OF CONTENTS

DEDICATION ACKNOWLEDGEMENT TABLE OF CONTENTS LIST OF TABLE LIST OF FIGURE ABSTRAK ABSTRACT Chapter 1 INTRODUCTION 1.1 1.2 1.3 1.4 1.5 1.6 1.7 1.8 Chapter 2 Introduction Background Problem Statement Research Objectives Research Question Definition of Key Terms Significance of Study Organization of the Remaining Chapters

i ii iii ix x xi xiii 14 14 14 18 20 20 21 22 23 24 24 iii

LITERATURE REVIEW 2.1 Introduction

2.2 2.3 2.4 2.5

Executive Compensation Agency Theory Directors Remuneration Board Structure 2.5.1 Board size 2.5.2 Board independence 2.5.3 CEO duality

Error! Bookmark not defined. 24 31 34 36 37 39 39 41 43 44

2.6

Ownership structure 2.6.1 Ownership concentration 2.6.2 Managerial ownership 2.6.3 Non-executive director interest

2.7

Control variables 2.7.1 Firm size 2.7.2 Firm performance 2.7.3 Leverage

Error! Bookmark not defined. 46 48 50 Error! Bookmark not

2.7.4 Growth in Earning per Share defined. 2.8 2.9 Theoretical Framework Hypothesis Development 2.9.1 Board size 2.9.2 Board independence 2.9.3 CEO-duality 2.9.4 Ownership concentration

51 52 52 53 54 56

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2.9.5 Managerial ownership 2.5.6 Non-executive director interest 2.10 Chapter 3 Summary

56 57 60 62 62 62 62 63 64 64 64 65 65 66 67

METHODOLOGY 3.1 3.2 Introduction Research Design 3.2.1 Type of Study 3.2.2 Population 3.2.3 Sample Frame 3.2.4 Unit of Analysis 3.2.5 Sample Size 3.2.6 Sampling Method 3.3 Measurements of Variables 3.3.1 Measurement of Independent Variables 3.3.2 Measurement of Dependent Variables

3.3.3 Measurement of Control Variables Error! Bookmark not defined. 3.4 3.5 3.6 Chapter 4 Data Analysis Summary Expected Outcome 68 72 Error! Bookmark not defined. 73 73

RESULTS 4.1 Introduction

4.2 4.3 4.3 4.5

Statistical Analysis

Error! Bookmark not defined. 74 84 86 86 86 88 88 88 88 96 98 98 98 100 100 102 103

Descriptive Statistics of Variables Correlation Analysis Assumptions Testing of the Regression Analysis 4.5.1 Normality of the Error Term Distribution 4.5.2 Linearity of the Relationship 4.5.3 Autocorrelation 4.5.4 Homoscedasticity 4.5.5 Multicollinearity

4.6 4.6 Chapter 5

Hypothesis Testing Regression Analysis Summary of the Findings

DISCUSSION AND CONCLUSIONS 5.1 5.2 5.3 Introduction Recapitulation of the study Discussion of the Findings 5.3.1 Board size and Directors remuneration 5.3.2 Board Independent and Directors remuneration 5.3.3 CEO-duality and Directors remuneration

5.3.4 Ownership concentration and Directors remuneration 104 5.3.5 Managerial Ownership and Directors remuneration 104 5.3.6 Independent Non-executive Director Interest and Directors Remuneration 105

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5.4 5.5 5.6 5.7 REFERENCES APPENDIX A defined. APPENDIX B APPENDIX C APPENDIX D APPENDIX E

Implications of the Study Limitation of Study Suggestions for Future Research Conclusion

108 111 112 113 115

List of Companies Selected for the Study

Error! Bookmark not

Checklist Statistics Pearson Correlation Analysis

Error! Bookmark not defined. Error! Bookmark not defined. Error! Bookmark not defined.

Linear Regression of Directors Remuneration on Board Size Error! Bookmark not defined.

APPENDIX F

Linear Regression of Directors Remuneration on Board Independence Error! Bookmark not defined.

APPENDIX G

Linear Regression of Directors Remuneration on CEO Duality Error! Bookmark not defined.

APPENDIX H

Linear Regression of Directors Remuneration on Ownership Concentration Error! Bookmark not defined.

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APPENDIX I

Linear Regression of Directors Remuneration on Managerial Ownership Error! Bookmark not defined.

APPENDIX J

Linear Regression of Directors Remuneration on Different Level of Managerial Ownership Error! Bookmark not defined.

APPENDIX K Linear Regression of Directors Remuneration on Independent Non-executive Directors Interest APPENDIX L Linear Regression General Model Error! Bookmark not defined. Error! Bookmark not defined.

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LIST OF TABLE

Table No. Table 3.1 Table 4.1 Table 4.2 Table 4.3 Table 4.4

Title of Table Number of sample selected Descriptive Statistics of Variables Frequency distribution of total directors remuneration Frequency distribution for board size Frequency distribution for proportion of independent non-executive directors

Page 45 56 57

58 59 60

Table 4.5 Table 4.6 Table 4.7 Table 4.8

Frequency distribution for CEO duality Frequency distribution for ownership concentration Frequency distribution for managerial ownership Frequency distribution for independent non-executive directors ownership

61

Table 4.9 Table 4.10 Table 4.11 Table 4.12 Table 4.13 Table 4.14

Frequency distribution for firm size Frequency distribution for firm performance Frequency distribution for leverage Correlation Analysis for All Variables Linear Regression of Directors Remuneration Linear Regression of Directors Remuneration With different level of Managerial ownership

62 63 63

Table 4.15

Summary of the Findings

89

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LIST OF FIGURE Figure No. Figure 2.1 Title of Figure Theoretical Framework Page 35

ABSTRAK

Sejak dekad yang lalu, isu tentang ganjaran pengarah telah menarik minat para penganalisis tadbirurus korporat, kerajaan dan orang awam terutamanya selepas beberapa siri krisis kewangan. Teori agensi menyarankan bahawa ganjaran pengarah perlu dihubungkaitkan dengan prestasi untuk menghindari dari konflik agensi. Walau bagaimanpun, kajian empirik telah mendapati perhubungan diantara ganjaran dan prestasi masih lagi lemah.. Oleh kerana kelemahan di dalam struktur tadbirurus korporat, pengarah telah dibayar berlebihan dengan kos dikenakan kepada pemegang saham. Untuk terus meningkatkan keyakinan pelabur dan memastikan pertumbuhan ekonomi yang stabil, usaha untuk membina struktur tadbirurus korporat yang baik adalah penting. Dengan menggunakan sampel 120 buah syarikat yang telah disenarikan di Papan Utama Bursa Malaysia pada 2005, kajian ini dijalankan untuk menentukan ganjaran pengarah yang dibayar oleh syarikat yang disenaraikan di Bursa Saham Malaysia, Sebagai tambahan, kajian ini juga akan melihat keberkesanan struktur tadbirurus koporat dari sudut lembaga pengarah dan ciri pemilikan saham di dalam menentukan ganjaran pengarah di dalam syarikat yang disenaraikan di Bursa Malaysia. Kajian mendapati bahawa apabila komsentrasi pemilikan saham meningkat, ganjaran pengarah akan berkurangan oleh kerana keberkesanan pemantauan oleh pemegang saham luar yang memiliki saham yang banyak. Saiz lembaga pengarah didapati berhubungan positif dengan ganjaran pengarah kerana saiz pengarah yang besar membuatkan mereka kurang berkesan untuk memantau pihak pengurusan. Walau bagaimanapun, kebebasan lembaga pengarah, penduaan ketua pegawai eksekutif,

xi

pemilikan saham oleh pengarah dan pemegang saham oleh ketua pegawai eksekutif tidak didapati mempunyai perhubungan dengan ganjaran pengarah

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ABSTRACT

Over the past decade, the issue of directors remuneration has attracted the attention from corporate governance analysts, goovernment and the general public especially after the serial of financial crisis. Agency theory suggests that directors should be rewarded based on their performance so as to avoid agency conflict. Nevertheless, empirical studies found that the linkage between pay and performance is still very weak. Due to the weaknesses in corporate governance structure, directors had been paid excessively at the expense of shareholders. To continually boost the investors confidence and to ensure a steady economic growth, the move to build up stronger corporate governance structure is essential. Thus, using a sample of 120 companies listed in the Main Board of Bursa Malaysia in 2005, this study is conducted to determine the amount of directors remuneration that is paid out by the Malaysian public listed companies. In addition, this study will examine the effectiveness of the corporate governance structure in terms of board and ownership characteristics in determining the directors remuneration among Malaysian public listed companies This study found that as ownership concentration increases, the amount of directors remuneration will decrease due to the effective monitoring by the external block-holders. Board size was found to be positively associated with directors remuneration because increase board size makes them less effective at monitoring management. However, boards independence, CEO-duality, managerial ownership and independent non-executive directors shareholding are not found to be related to directors remuneration.

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Chapter 1

INTRODUCTION

1.1

Introduction

This chapter introduces the research outline of the study. It begins with highlighting the background of the study and the problem statement followed by research objectives and research question. Definition of key terms of major variables will also be included to assist in understanding. This chapter ends with the significance of the study and will give a brief overview of the remaining chapters in the thesis.

1.2

Background

Over the past decade, executive compensation has been regarded as an internal mechanism to reconcile the agency problem between executives and shareholders. Nevertheless, it has been a subject of debate among corporate governance specialists, compensation experts and institutional investors in the western countries on how to pay their top executives. Much of this debate has been fuelled by concerns that executive compensation is excessive, it is unrelated to firms performance and there is a low level of compensation disclosure. Numerous studies on executive compensation have been conducted in the United States and United Kingdom, where public disclosure of top management compensation has long been the norm. The limited evidence in other countries may be due to the fact that corporate governance reformation is relatively new and that data is unavailable. Academic research into how executives are rewarded has captured the attention of the Malaysian public, particularly after the Asian financial crisis. The massive distortion in

economic system during the Asian financial crisis has alerted Malaysians on the importance of effectiveness of corporate governance mechanisms, and compliance to accounting and auditing standards. There is also an increasing request from the shareholders and investors of companies, especially the public listed companies for an increase in transparency, including even with respect to the directors remuneration. According to MCCG, the amount of directors remuneration should be sufficient to attract and retain the directors needed to run a company successfully and should also be structured so as to link rewards to corporate and individual performance. Generally, the criteria used to set directors remuneration are the size of the company, its profit, sale growth and turnover but the absence of clear guidelines has created a room of manipulation by the directors. Price Waterhouse Coopers (2003) investigation into what top Malaysian directors earn revealed a surprising finding on to the fact that there are evidences to show that some companies listed in Bursa Malaysia, despite making losses, are paying their director excessively. This finding had been supported by subsequent research in year 2006 by KPMG Malaysia who found out that out of 46 companies that increased its total directors remuneration in 2005, 10 had reported losses in that year and also that the increase in total directors remuneration in 2005 is more than doubled that of the previous year. According to the survey on directors remuneration published by Malaysian Business magazine for the period from year 2002 to 2005, Berjaya Group, paid RM33.5 million to its directors in the entire group, even though the group suffered losses as high as RM651.6 million for the financial year 2002. Besides the Berjaya Group, Malayan

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United Industries Bhd, which incurred a net loss of RM996 million, paid out RM6.1 million in total remuneration while Pan Pacific Asia Bhd, with net loss of RM487.3 million, paid RM2.5 million (Nurani & Sakran, 2003). More peculiar was the instance of directors being paid excessively although the company was suffering negative shareholder fund and fell into Practice Note 4 (PN4, thereafter) category. In the case of Mycom, despite the company being in the red for the last couple of years and was still in PN4 status, it increased its directors compensation from RM1.41 million in year 2002 to RM4.03 million in year 2003. Other companies also showing these features in their director remuneration were Faber Group, Aokam Perdana, Pica Corporation, Anson Perdana, Kemayan Corporation and Sriwani Holdings (Kaur, 2004). This situation has not improved over time, Prathaban, Rahim and KPMG (2006) found that 26 companies that reported losses in the year 2005, still paid their directors well. To deter excessive executive compensation, there is an increasing call for the design of incentive compensation scheme that ties executive pay to shareholders wealth. By linking pay to performance, the executive will be accountable to the consequences of his actions and thus acting rationally to maximize firms performance. However, there is no perfect compensation scheme that is able to transfer the profits and risks of the firm to the executives, as shareholders are unlikely to let the executives take huge profit of their firm home. Directors on the other had are unwilling to compensate the shareholders, if their actions had caused the companies to perform badly. It can also be considered fair that the directors not be penalized for poor performance of the companies as there are other external factors beyond the control of the executives that can also effect the firm

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performance for instance the movement of oil price, exchange rate variation and sectorwide fluctuations. In light of the uncertainties and difficulties to design a perfect compensation scheme and is impossible to regulate the structure of executive compensation, the issue of who gets to decide the compensation scheme take the forefront of the scene. The decision-making power of the person who gets to set up the executive compensation package will enjoy an unfettered discretion. Under the corporate system, the power to set the executive compensation is vested in the board of directors. The boards power to determine the executive compensation package is also supported by the Malaysia Code of Corporate Governance which recommends that public listed companies to set up a remuneration committee. Remuneration committees primary function should be to assist the board in evaluating and recommending to remuneration policy and should be consistent with the strategic direction of the company. The committee should also consist of non-executive directors to ensure that directors remuneration is paid fairly.. In conclusion, the above phenomenon have highlighted a troubling issue about directors remuneration in Malaysia i.e. there is an indication that directors remuneration is not based on company performance. According to Hariri, Haron, Aktharuddin and Ismail (2006), the level of directors remuneration disclosure in Malaysia is as low as 28 percent for the year of 2003. As such, in situation where the level of disclosure is among the lowest, there is high possibility of some forms of compensation will go unnoticed and give the impression of lower remuneration among Malaysian companies. This may lead the executive directors to use non-cash forms of compensation to avoid public scrutiny. If

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the above situation was left unresolved, shareholders confident will be affected and ultimately Malaysian economic growth will also be affected.

1.3

Problem Statement

The principle-agent problem arises due to the interest of individual agents (director) conflict with the organization (shareholder). The boards of directors are expected to monitor the firms manager to mitigate agency conflict, however if there are problem with the implementation of the monitoring mechanisms, it can lead to the breakdown of the corporate governance mechanism, no matter how well the structure is. Prior research about the relationship between corporate governance structure and directors compensation had been widely conducted in United States and Europe, and it had been confirmed that the strength of the governance of the firm and ownership structure of the firm have significant influence on the directors remuneration (e.g., Core, Holthausen & Larcker, 1999; Lambert, Lacker & Weigelt, 1993; Yermack, 1996). In Malaysia, concentration of ownership for which the domination of control is by family members or government institution is a very common structure. According to Claessens, Djankov and Lang (1999), one forth of the corporate sectors of Malaysia is controlled by ten families. These companies are being run and dominated by large shareholders who could lead to the insiders maximizing their private benefits at the expense of the general investor for which can be done through attractive remuneration packages. Researches in the area of directors remuneration are important as remuneration is often a major factor in rewarding and motivating the directors to perform their duties

18

efficiently. Furthermore, previous research was more concentrated on the level of CEO remuneration rather than the board of directors as a whole. As the agency cost covers not only the CEO but all the board members, total directors remuneration will be a more appropriate measure in finding the determinant factors of director remuneration. Research that uses Malaysian data is important as institutional, regulation and environmental factors and the uniques characteristics of ownership and corporate

structures are quite different from those overseas. Most empirical studies are conducted in the United States and United Kingdom. The research in the area of corporate governance in Asian countries was initiated only after the Asian financial crisis when there was a reformation of the corporate governance structure. Thus, this study which was based on the data collected from the annual reports of the Malaysian public lisred companies in 2005, that is a few years after the code of cororate governance was implemented, will assist in understanding the influence of corporate governance on the directors remuneration. Previous studies have also shown that firms attributes such as size, performance and leverage of the company have an infleunce on the directors remuneration. Pprior researches in the United States and United Kingdom have revealed inconsistent findings on the topic of directors remuneration. This this study warrants to be undertaken. Thus, this study is conducted to examine whether the characteristics of board of directors, ownership and firm attributes do in fact have an influence on the amount of directors remuneration.

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1.4

Research Objectives

Therefore, this study attempts to accomplish four main objectives as follows: (1) To determine the level of directors remuneration paid by public listed companies in Malaysia; (2) To examine whether there is a relationship between board of directors characteristics (board size, proportion of independent non-executive directors and CEO-duality) and the level of directors remuneration; (3) To examine whether there is a relationship between ownership characteristics (managerial ownership, ownership concentration and the independent nonexecutive directors ownership) and the level of directors remuneration. (4) To examine whether firm attributes (firm size, firm performance and leverage) will affect the level of directors remuneration.

1.5

Research Question

To achieve the above objectives, the study tries to answer the following research question: a) What is the overall level of directors remuneration among the Malaysian public listed company? b) c) What is the relationship between the directors remuneration and the board size? What is the relationship between the directors remuneration and proportion of independent non-executive directors on the board? d) How does CEO duality affect the level of directors remuneration?

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e)

Do managerial ownership and the ownership of independent non-executive directors affect the level of directors remuneration?

f) g) h) i)

How does ownership concentration affect the level of directors remuneration? How does firm size affect the level of directors remuneration? Is the directors remuneration associated with firms performance? How does a firms leverage affect the level of directors remuneration?

1.6

Definition of Key Terms

In order to share common understanding of the concepts and for better understanding of further discussion, the following key terms definition were referred specifically. 1) Level of Directors remuneration The level of directors remuneration refers to the total amount of cash compensation including wages, salaries, allowances, fees, paid annual leave and paid sick leave, profit sharing, bonuses and value of benefits-in-kind such as company car and insurance coverage that is received by both executive and nonexecutive directors of the company. (FRS 119, 2003) 2) Board of directors The board of directors is a formal body that is formed in accordance to the Memorandum and Articles of Association to govern the corporation. The board of directors may not actually participate in the daily operations of the corporation, but the board has authority to set business goals and strategic plans. (Bursa Malaysia Listing Requirement, 2001) 3) Independent non-executive director

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An independent non-executive director is a director who is independent of management and free from any business or other relationship which could interfere with the exercise of independent judgment or the ability to act in the best interests of the corporation. (Bursa Malaysia Listing Requirement, 2001) 4) CEO duality CEO duality is a situation that a person who is the chairman of the board at the same time is the CEO of the company. (Malaysian Code of Corporate Governance, 2001) 5) Ownership concentration It is a situation when a major shareholder (family, government or institutional shareholder) that hold substantial amount of a companys equity share and as such have majority voting power over other shareholder (Dogan & Smyth, 2002).

1.7

Significance of the Study

Theoretically, this study contributes to the agency theory . Agency theory is used to explain the effort to align the interests of the agent with those of the principal for which remuneration packages had been used as tool to counteract the agency conflict. However, this principal-agent problem has remained unresolved due to the conditions of incomplete and asymmetric information which had lead to moral hazard in term of excessive directors remuneration in the expenses of shareholders. This study uses agency theory to explore the determinants of directors remuneration and investigate how director uses the information asymmetry to draw up their remuneration packages.

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This study will make contributions to the regulators, accountants and investors by providing useful information on directors remuneration and its determinants factors. To the regulator, the study will provide reference to Bursa Malaysia on the board structure that is currently practiced by the public listed companies. The information regarding the level of directors remuneration that is disclosed in the annual reports is important for the Malaysian Accounting Standard Board to monitor the companies compliance with the accounting standards. Malaysian Institute of Corporate Governance can also benefit from this study as this study would be able to shed some light on the level of compliance of the companies with the Malaysian Code of Corporate Governance principles and best practices.

1.8

Organization of the Remaining Chapters

This study is structured in five chapters. The first chapter provides an introduction as well as an overview of this study. The second chapter presents the review of literature that outlines previous studies undertaken in relation to directors remuneration, theoretical framework and the hypotheses development. Chapter three will illustrate the data and variable in term of research design, sample collection, measurement of variables, the method of data analysis and expected outcome. Chapter four analyzes the results of finding, focusing on statistical analysis, descriptive statistic, correlation analysis and regression analysis. Lastly, chapter five will present the overall findings and implications of the research will be discussed, limitation of the study as well as suggestion for future research and conclusions.

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Chapter 2

LITERATURE REVIEW

2.1

Introduction

This chapter will present the previous literature that has been undertaken. As such, this chapter will give an overview of literature on directors remuneration, board characteristic, ownership characteristic and the underlying theory. The theoretical framework and the hypothesis development will be presented towards the end of the chapter.

2.2

Agency Theory

In most companies, investors do not manage the companys affairs but entrust the managers to carry out the task. This separation of ownership and control has resulted in a potential conflict of interest (Berle and Means, 1932 as cited in Abdullah, 2004). Although this problem is acute in public listed companies without a controlling shareholder, it permeates all types of business organizations for which a strong blockholder may effectively monitor the management but act in league with executive in the expense of other shareholders. To limit the agency conflict, the shareholders have to monitor the agents and try to ensure that the latter effectively act in their best interest. Although effective corporate governance and high level of compliance system may minimize agency and transaction costs arise as a result of conflicts of interest between principal (shareholder) and agents (director), it entail costs and these efforts drain resources away from productive uses.

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Instead of focusing on agency cost and finding efficient way of monitoring, compensation could be used to counteract the agency conflict. According to Berle and Means (1932) Principal-Agent model, the primary means for the shareholders is to ensure that managers take optimal actions to tie managers pay to performance of their firm; in effect to provide incentives for managers to maximize return to shareholders (as cited in Kakabadse, Kakabadse & Kouzmin, 2003). Recent research in executive compensation has re-confirmed the above relationship. In Elayan et al., 2001, it was found that compensation policy tying directors pay to corporate performance or shareholders wealth provides incentives to exert appropriate efforts on behalf of shareholder. To effectively monitor the agents behavior, agency theory suggests that directors compensation needs to be correlated with the total return to shareholders, typically through ownership of firms stock or options on the firms stock (Kakabadse et al. 2003). By increasing directors stock ownership, individual directors wealth will be tied up with the performance of company. In the context of the agency theory, directors behaviour are less likely to exhibit behaviors that are inconsistent with those of the other owners. As a result, greater directors stock ownership should produce more stable and potentially predictable returns. Agency theory predicts that large shareholding in a firm improves monitoring of managerial behavior and therefore reduces abusive compensation (Shliefer & Vishny, 1986). Baker, Jensen and Murphy (1998) noted that the level of compensation determines where the directors work and the compensation structure determine how hard they work.

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As such, direct share ownership by executive directors is the most powerful link between directors rewards and corporate performance (Jensen & Meckling, 1976). Overall, agency theory predicts that the separation of owners and managers potentially will lead to managers of firms taking actions, which do not maximize shareholders wealth (Jensen et al., 1976). As such, internal monitoring system such as effective corporate governance and compensation system must be in place to ensure that directors implement policies consistent with the maximization of shareholders wealth.

2.3

Corporate Governance

Corporate governance is the process and structure used to direct and manage business and affairs of the company towards enhancing business prosperity and corporate accountability with the ultimate objective of realizing long term shareholders value, whilst taking into account the interest of others stakeholders (Malaysian Code of Corporate Governance, 1999). The principles of corporate governance cover the issue of the directors, directors remuneration, shareholders, accountability and audit. Malaysian Code of Corporate Governance (MCCG, thereafter) laid down the principles to form an effective and balance board. According to MCCG, the effect of board size should be examined on the board effectiveness. Too big the size of the board will constrained active participation and have little sense of accountability. Too small the size of the board, there may be not enough directors to discharge the board responsibilities to lead and control the company. However, there is no specified number of boards recommended.

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MCCG stressed on the issue of board balance to avoid the domination of power by a single individual. As such, it was suggested that company must have at least one third or minimum two independent non-executive directors on the board of directors. The term independent refers to the independence from management and from a significant shareholder. It was intended that independent non-executive directors be appointed to the board of directors so as to bring an independent judgment on the issue of strategy, performance and resources. MCCG suggested a clear division of responsibilities between chairman and chief executive director (CEO, thereafter) to ensure the balance of power and authority so that no one individual has unfettered power of decision. The chairman is primary responsible for the working of the board, the balance of membership in the board and to ensure all directors execute their duties in professional manner. In the other hand, the task of running the business and implementation of strategies adopted by the board shall be executed by the CEO. In the event that there is a combination of these two roles, an explanation must be made public in the companys annual report. In term of directors remuneration, MCCG recommended that the levels of directors remuneration should be sufficient to attract and retain the directors needed to run the company successfully. In this context, the components parts of executive directors remuneration should be structured so as to link rewards to corporate and individual performance. As such, companies are expected to set standard which provide a rational and objective remuneration policy for developing and fixing the remuneration packages of individual directors. In term of directors remuneration disclosure, MCCG recommends that companys annual report should contain the procedure on the make-up

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of remuneration and details of the remuneration of each director so that to promote the principles of fairness and accountability. MCCG suggests public listed company to form a remuneration committee which consisting wholly or mainly of non-executive directors, to recommend to the board of directors on the remuneration of the executive directors in all its forms. The task of the remuneration committee is to develop proposals on remuneration which have to be approved by the full board. The existence of remuneration committee is consistent with agency theory, which stresses on the separation of management from control. Bursa Malaysia requirement on corporate governance was enforced on January 2001 through the issuance of Revamped Listing Requirements. The Revamped Listing Requirements has set out greater obligation for public listed company in financial reporting, disclosure on corporate governance matters under its continuing listing obligations. Under the Revamped Listing Requirement, public listed companies are required comply with the principle stated in the MCCG and to include in their annual report in relation to its level compliance. In term of directors remuneration, Bursa Malaysia listing requirements differ from the Best Practice suggested by MCCG by just requires companies to disclose in bands of RM50,000 their directors remuneration without disclosing the identity of recipients.

2.4

Accounting Standards on Employee Benefits Employee benefits also refer to the Directors compensation.The awareness of

good corporate governance demands high-quality and transparent financial reporting so that the real financial position can be seen and confident established (Devi, 2003). To

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have confidence, investor must believe that a company will apply recognized accounting standard consistently. This led to the establishment of Financial Reporting Act 1997, which established an independent accounting standards body, the Malaysian Accounting Standards Board (MASB). Prior to the establishment of MASB, Malaysia followed the International Accounting Standard. After the formation of MASB in year the 2003, Malaysia has introduced its own accounting standard, known as the MASB. However, globalization had forced Malaysia to standardize its accounting standard to conform to international practice, thus the MASB had been further enhanced by the issuance of the Financial Reporting Standard (FRS, thereafter) in the year 2005. The accounting treatment for employee benefits had gone through a series of revolution before the introduction FRS 119 in the year 2005. Back to the year 1980, the exposure draft on Accounting for Retirement Benefits in Financial Statements of Employers had been issued for public comment and was approved as an accounting standard in the year 1985, which was known as IAS 19. Through the years 1990s, the issue of employment benefits has only been concentrated on the issue of retirement benefits. However, when years go by, the corporate world become more supplicated so as the compensation packages. The introduction of share based payment, share option and warrants had made the existing accounting standard of little relevant. As such, IAS 19 Employee Benefits was enforced in the year 1999 and was superseded by IFRS 2 Share-based Payment in the year 2004. With the formation of MASB, Malaysia had adopted MASB 29 Employee Beneftst in the year 2003 which was superseded by FRS 119 Employee Benefits in the year 2005.

29

The principle underlying the accounting standard on employee benefits is that the cost of providing employee benefits should be recognized in the period in which the benefit is earned by the employee, rather than it is paid or payable. As to deter creative accounting for employment benefits, both MASB 29 and FRS 119 covered all categories of short and long term benefits and request a high level of disclosure not only on provision and obligation but also actuarial assumption of each benefit plan. Both MASB 29 and FRS 119 specified five categories of compensation and benefit as follow: a) Short-term employee benefits, such as wages, salaries and social security contributions, paid annual leave and paid sick leave, profit sharing and bonuses (if payable within twelve months of the end of the period) and non-monetary benefits (such as medical care, housing, cars and free or subsidized goods or services) for current employees; b) Post-employment benefits such as pensions, other retirement benefits, postemployment life insurance and post-employment medical care; c) Other long-term employee benefits, including long-service leave or sabbatical leave, jubilee or other long-service benefits, long-term disability benefits and, if they are payable twelve months or more after the end of the period, profit sharing, bonuses and deferred compensation; d) e) Termination benefits; and Equity compensation benefits. The major provision that differentiate the FRS 119 from MASB 29 is regarding the equity compensation benefits. MASB 29 required company to disclose the equity compensation benefits in term of its nature, term, amount, exercise date, exercise price,

30

conversion rights, voting rights and fair value of the share option scheme by way of notes to account. In this context, company will take up the accounting transactions only when the employee exercises the share option because the companys share capital will increase. However, no transaction has been made to take up the gain made by the employee on the exercise of the share option. As such, FRS 119 go a step further by required company to recognized the equity compensation scheme in the face of the Income Statement as an employment benefit once the share option scheme was granted. By having the benefits accrued from the equity compensation plan charge to the Income Statement, creative accounting of deferring executive compensation paid and payable by disclosing it as an asset of the company rather than expenses, to be deducted from the future profit figure will be taken care of.

2.5

Directors Remuneration

Afair remuneration package of the directors remuneration should be in line with the the responsibility and commitment of the board members. In this study, the empirical

analysis of directors remuneration is mainly based on three different measures, i.e. salary, cash remuneration and total remuneration. Salary measures the fixed monthly compensation, while cash remuneration includes annual bonus, fees, allowances, defined contribution plan and benefits-in-kind such as insurance coverage and company car. Total remuneration is the sum of cash remuneration plus stock options and long term remuneration such as retirement plan. Conyon and Gregg (1994) argue that total remuneration is the most comprehensive measure of directors pay, which had been adopted by Elloumi and

31

Guiyie(2001), Craighead, Magnan and Thorne (2004) and Ghosh et al. (2003). Nevertheless, cash compensation had been more popular measures in previous research which was adopted by Main, Bruce and Buck (1996), Crespi and Grispert (1998), Laing and Weir (1998), Andjelkovic, Boyle and McNoe (2000) and Hassan, Christopher and Evans (2003). According to Core et al. (1999), the amount of compensation that will ultimately be received from long-term compensation plans is uncertain at the time the compensation was awarded. Conyon (1997) and Core et al. (1999) further conclude that inclusion of stock options does not induce the results that based on cash compensation only. In the context of Malaysia, employee share option scheme was disclosed in total without a clear distinction between the portions of share option allocated to the board of directors and the companys employee. Due to the limitation of data and the reliability of cash compensation as a valid remuneration measurement, this study will adopted cash compensation approach to measure directors remuneration which is consistent with the measurement used by Abdullah (2006). Previous research in Western countries shows that there are existence of excessive director remuneration packages among the companies though the corporate governance and disclosure requirements had been long established. According to Kochan (2002), the directors average remuneration in USA was 325 times the average pay of shop floor worker in the year 1997 which increased to 523 times in year 2000 and as high as 600 times in year 2002. The gap between directors remuneration and average pay is continuously increasing, for instances, the CEO of AT&T earns 400 times what the lowest paid employee earns (Wagner & Minard, 1999). This phenomenon was due to the

32

increase in the use of stock option as incentive for top management and board of directors. The granting of stock options has given great opportunity for directors to utilize their insider information to raise share price for their individual benefits. While the Greenbury Committee Report (1995) had recommended for the shift of stock options to more performance based criteria, Malaysia companies still embraced in stock options. Towers Perrin (2003) shown that among Malaysian companies granting options in 2002, average dilution levels were approximately 3.4% of share outstanding, 50% higher than comparable 2001 levels and more than 3 times the level of Hong Kong and Singapore. As such, there is a need for Malaysian companies to adopt vehicles such as performance shares and restricted stock in the globalization challenges. Empirical evidence indicates that CEO compensation is inversely related to the level of control exercised by the remuneration committee. Conyon and Peck (1998) show that the proportion of outsiders on remuneration committee will enhance the strength of link between top management pay and firm performance. However, in the case of Enron Corporation, the remuneration committee was composed entirely by independent director and yet their presence in the committee did not result in critical reduction in CEO compensation (Petra, 2005). A possible rational is that favorable CEO compensation could be hidden in ways that are difficult to captured as some boards has become more creative in designing compensation contracts that do not attract undue attention. In the context of Malaysia, the Standard & Poor Corporate Governance Studies (2004) shows that 82% of Malaysia public listed companies have their remuneration committee but out of this only 7% are wholly independence. Thus, Mak (2006) stated that

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the adoption of corporate governance in Asia is only in form rather than substance, as such the lacking of regulatory and market enforcement has led to false disclosure. Overall, the investors initiative to curb senior directors pay is gaining momentum (Kakabadse et al. 2003). Corporate governance specialist and human

resources practitioner has increasingly capitalize on investor irritation concerning excessive remuneration particularly in poor performing companies. Beside more stringent corporate governance structure and disclosure was introduced, companies must be educated to treat corporate governance not merely for compliance but as strategic vehicle to enhance long term performance and shareholder values.

2.6

Board Characteristics

Previous corporate governance literature identifies four sets of board attribute; namely, composition, characteristics, structure and process. Board composition refers to the size of the board and the mix of different directors demographics in term of education background and working experiences. Board characteristics encompass the director stock ownership, independence and other variables that may influence directors interest and performance. Board structure covers board organization, board committees, board leadership and the information flow in decision making. Lastly, board process refers to decision making activities; the frequency of board meeting, formality of board proceedings, style and culture. To facilitate a good board process, the commitment of each individual director is a key success factor. An efficient board is a board that is able to perform the duty of hiring, compensation, approval of major management initiatives

34

and strategic decision making. Ability among group member of the board to work and to lead is crucial in setting up a powerful board. With the introduction of MCCG, the corporate governance framework has set up a list of good practice for the firm to comply. However, if the initiative for the firm is just for compliance, it wont generate any internal advantage. As such, firms must use the framework as a guideline to improve operational and strategic efficiency so that the rules will no longer be a burden but serve as a tool to improve the competitive advantages. Previous research in Western counties found that corporate governance mechanism has no positive impact on financial performance (Elayan et al., 2000 & Wright, 1996). The main investment criterion is the financial performance and growth potential, corporate governance was less emphasized of except the aspect of information regarding management remuneration. As such, the compliance of FRS 119 should have important impact of increase investor confident. However, the extent of disclosure heavily depends on the board quality and the compensation package that is in place. Muslu (2005) found that board dominated by insiders will be reluctant to disclose non-optimal directors compensation and insider ratio and incentive pay are the predominant explanatory variables for the transparency of compensation disclosure. The research done by Lo (2002) found that the extensiveness of compensation disclosure lead to value-increasing governance improvement; and firm that comply with the disclosure regulation have higher stock return and their performance improved subsequent to the regulation. Thus, we can conclude that the compliance to the disclosure of employee benefit is beneficial to the firm if the firm does not have any practice that contradict to the corporate governance, or exercise excessive pay.

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2.6.1

Board size

With the reformation in corporate governance, firms have been increasingly pressured to appoint directors with different backgrounds and expertise under the assumption that greater diversity should lead to more efficient decision making process. However, the determination of an efficient board size varies according to the differing governance, performance and operation requirements of an organization structure. As such, for a board to be effective, it should not be too big or too small so as to allow for active participation with minimum communication barriers and able to make effective decisions. The empirical evidence to date is mixed and gives little evidence on optimal governance structure. Jensen (1993) found that increase in board size make them less effective at monitoring management because of free-riding problems among directors and increase decision making time. In studying the effect of board size to firm performance, Adams and Mehran (2002) have found a positive relationship between board size and Tobins Q. On the contrast, Baysinger and Butler (1985) and Hermalin and Weisbach (1991) found no meaningful relationship between various characteristics of board and firm performance. In terms of directors remuneration, Yermack (1996) observes that the linkage between directors remuneration and performance sensitivity decreases when the board size increases. This can be explained by Jensen (1993) who found that too big a board is likely to be less effective in supervision of management. It was understood that when a board consists of more members, the total amount of directors remuneration will increase correspondingly. However, in studying the CEO compensation alone, Core et al

36

(1999) found that CEO compensation increase when the board is larger which suggests that when board size is bigger, the likeliness of excessive directors remuneration will occurred. In the context of Malaysia, based on the Corporate Governance Survey Report (2006), the smallest board in Malaysia had three directors and the biggest had fifteen with an average of nine directors a board which is consistent with the finding of Standard & Poor Corporate Governance Studies (2004). However, there was lack of research on the impact of board size in Malaysia context, thus this study is conducted to provide an insight of board size in determine directors remuneration.

2.6.2

Board independence

Board characteristics, particularly on the issue of independence has been studies over the years. The board of director will usually be blamed for failing to protect the interest of shareholders especially after a series of financial scandals. One of the reasons for inability to perform expected role to control the management is the lack of independence of the board of director, and ineffective board monitoring. Jensen (1993) stated that top executives serving on companys boards exploit boards authority and inflict real costs on their companies. A board composed of relatively high ratio of outsiders is more likely to exercise independent judgment on matters pertaining to shareholders interest. The extent of independence is an important issue, a director may be independent only on the surface which creates a grey area director, who are not insider but are relatives of officer of the firms, former employee or employee of a firm with interlocking

37

directorate. The independence of a board member may also eroded over time, the longer is the length of time in the office and the relationship with the CEO becomes closer, the independent director is no longer a watchdog but a supporter for CEO. This weakness is particularly relevant to directors remuneration since remuneration committee, whose function is to approve the remuneration scheme, are usually composed of non-executive directors who are supposed to be independent (Elayan et al., 2001). Consistently, Muslu (2005) found that ineffective board monitoring may result real cost for companies by paying their CEO more for performance beyond CEOs control and record greater abnormal accruals. Empirical studies on the effect of board independence show either mixed or contradictory findings to what has been expected if the agency theory is applied. The research by Adams and Mehran (2002) suggested that the increase in the proportion of independent directors will increase firm performance due to more effective monitoring of managers. However, Firth, Tam and Tang (1999) found that the extent of board independence has little association with compensation level. In Malaysia, the result of Standard & Poor Corporate Governance Studies (2004) has shown that only fourteen percent (14%) of Malaysia companies has between one-half and two-thirds of the board made up of independent directors, while just four percent (4%) of companies has more than two-thirds independent director. Abdullah (2002) found that board independence is negatively associated with directors remuneration. In study the level of accounting standard compliance, Ismail (2006) found that board independence will improve the compliance level of MASB financial disclosure.

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2.6.3

CEO duality

Board structure is an important factor in building a better balanced board. Boards have weak structure if it is dominated by older or busier directors, and where CEO has a strong influence over the board of directors. Board dominated by the CEO is not expected to play the role as effective monitors and supervision of management. Nevertheless, CEO-duality has been a common structure in todays corporation as confirmed by survey done in Europe and US which shows that a quarter of the director on the boards also serve as company executives and majority of board chairs serve as a company CEO (Muslu, 2005). The occurrence of CEO-duality is treated as an unhealthy board because the greater the power of CEO, the less efficient is the role of independent director. According to Williamson (1985), shareholder interests will be safe-guarded only where the chair of the board is not held by the CEO or where CEO has the same interest as the shareholders through appropriately designed incentive compensation plan (as cited in Donaldson & Davis, 1991). The study done by Rechner and Dalton (1991) confirmed that corporation which had independent chair-CEO structures has higher return on equity, return on investment and profit margins. In contrast, Donaldson et al. (1991) found that ROE returns to shareholders are improved by combining the role of the chair and CEO position.

2.7

Ownership Characteristics

Corporate governance problem does not arise merely from separation of managerial control from ownership but only arise if there are multiple ownerships in a single company (Akmova & Schwodiauer, 2004). As such, corporate governance problem will

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not exist in the case of non-managing sole-proprietorship because the agency problem can be solved by monitoring mechanism and incentive schemes to make the management pursue the owners interest with condition benefits of monitoring does not over-weight the costs. According to Jensen et al. (1976), this type of ownership separation is more likely to result in performance of the firm closer to value maximization than ownermanaged enterprise, since owner-managers drive satisfaction from non-pecuniary aspects of their engagement which they trade-off against profits. In corporation which ownership is shared by more than one individual with different preferences, conflict may arise due to the transferability of ownership rights and imperfection of stock market. The conflict of interest will lead to sub-optimal policies in the shareholders wealth maximization process. Nevertheless, separation of ownership has become the most common structure in todays business world due to the vast financing requirement in line with the corporations growth. Therefore, modern

corporations are potentially affected by two type of corporate governance problem. Firstly, it is the problem of securing the control of shareholders over managerial discretion. It arises from the dispersion of shareholder ownership in the form of dispersed outside ownership in publicly held companies. Since the individual shareholders marginal cost of monitoring is bigger than the benefits, dependent on the effort of large shareholders is a dominant approach. As such, to overcome the dilemma, a well functioning stock market with proper corporate control must exist. According to Paul Krugman (1998), the Asian financial crisis was due to the structural weakness in the domestic financial institution supported by unsound macroeconomic policy and moral hazard. Even though various factors had been

40

highlighted, the consensus was the existence of poor corporate governance structure among Asian developing countries. As such, after the financial crisis Malaysia has actively promoted corporate governance to improve the aspect of fairness, transparency, accountability and responsibility in running the organization. Secondly there is the problem of resolving the conflict of interest arising from the various shareholders especially when there is a majority ownership. The conflict of multiple ownership and heterogeneous preferences is due to capital market imperfection, for which substantial shareholders may pursue long-run value maximizing but minority shareholders may prefer short term income, such as currently paid out dividend. By possessing majority voting right, a substantial shareholder may try to use their influence in order to impose policies at their interest but not value-maximizing to other shareholders. High level ownership concentration may deter the forming of efficient market for corporate control. Without such a market, neither the disciplining of managers will be successful nor will the improvement in corporate sector performance.

2.7.1

Ownership concentration

The issue of ownership concentration has been a topic of reasearch since Berle and Means (1932). Further to Berle et al. (1932), La Porta, Lopez-De-Silanes and Shleifer (1999) found that ownership in countries other than United State is more concentrated. When ownership was concentrated, the intensity of supervision will increase because shareholders have better information to monitor manager effort and thus compensation can be tied more closely to actual and observable effort (Dogan & Smith, 2002). Core at al. (1999) found that United State CEO compensation decreases when

41

there is ownership concentration. Consistently, Ramaswamy, Veliyath and Gomes (2000) found that the proportion of ownership is negatively correlated with CEO compensation in India. Similar results were found by Firth et al. (1999) in the context of Hong Kong family controlled firms. Concentration of shareholding is very common ownership patterns in Malaysia. According to Samad (2002), Malaysia corporate sector had been highly concentrate in term of ownership where about half of public listed companies had five shareholders owning approximately 60.4 per cent of the total equity in the corporate sector. Claessens et al. (1999) using the percentage of shares owned by the largest ten shareholders as a benchmark, reported that the state controls 17.8% and families controlled 67.2% of public listed companies in Malaysia. The main reasons of ownership concentration are the significant amount of government ownership and the prevalent of family control in public listed company. Government ownership constitutes a significant part of Malaysias economic structure. The government linked company account for approximately RM260 billion market capitalization of Bursa Malaysia. The survey done by CIMB founds that although government linked company boards complied with the legal form of corporate governance but lack in the performance of the corporate governance in its operation which might be due to the adoption of corporate governance only in form rather than substance. In family controlled firms, corporate management tends to consist of controlling owners, who might try to maximize their own interests, often at the expense of minority shareholders. However, Fama and Jensen (1983) argue that family relationships among

42

owner-managers should reduce agency costs because when ownership and control rests with the same person the need for outside monitoring is reduced. The argument is that a high concentration of family ownership creates a direct control which functions as a built-in check against excessive compensation. Moreover, since any money saved will revert to the family, such companys directors do not emphasizes on compensation but will focus on primary rewards accrued through increasing the value of firm over time. On the other hand, there are also evidences suggested that family obligation can interfere with the efficient operation of family controlled firm. No matter whether the ownership concentration is in the hand of government or family, it should result in greater vigilance and therefore increase pressure on directors to discipline directors compensation. Abdullah (2004) found that high monitoring incentives of outside block-holders increases the value of the firm. Although ownership concentration might mitigate the conflict of interest between manager and owner, a fundamental problem is how to protect minority shareholders from expropriation by controlling shareholders as they might act at their own interest at the expense of minority shareholders.

2.7.2

Managerial ownership

The key aspect of corporate ownership structure is its composition as it will determine who the controlling shareholders are. As such, it is an important element in forming better corporate governance. For the initiative of minimizing the temptation of manipulating accounting based performance measures and the doubt of board ability to monitor firm operations; alternative compensation schemes had been introduced. The

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most common scheme is the ownership of company stock by senior managers by granting company stock options. The managerial ownership program was granted on the premise that the potential agency problem can be mitigated. This is consistent with the findings of Jensen et al. (1976), who found that ownership could align the interest of management to the interest of owners. However, Fama et al. (1983) demonstrated various possibilities that managers who own enough stock to dominate the board of directors could expropriate corporate wealth. The study on the impact of managerial ownership on compensation has been widely conducted. Allen (1981) found that CEO compensation is a decreasing function of CEO ownership of company stock which is consistent with the finding of Holderness and Sheehan (1998) who found that managers who are majority shareholders receive a higher salary. However, Morck et al. (1999) found firm value rises with managerial ownership but the value eroded at higher level of ownership due to the entrenchment effect. In Malaysia, the research by Cleassens et al. (1998) found a positive relationship between managerial ownership and corporate performance. Vethanayagam, Yahya and Haron (2006) found that increase in managerial ownership from 25 percent to 45 percent cause the management to become more entrenched.

2.7.3

Independent Non-executive director ownership

While the executive directors were expected to execute daily functional responsibility to ensure the successful management of the business, the independent nonexecutive directors are perceived as experienced and influential part-timers who are trusted to ensure that standards are maintained. The part-time nature of the role means

44

that when incompetence or malpractice occurs the non-executive will then present. However, we live in a very fast changing society where a reluctance to accept responsibility has become a hallmark of public and business life. As a result, the existence of independent non-executive directors is just compliance to the corporate governance system without bringing substantial benefits to the organization. This was confirmed by the study done in the United States by Yermark (1996) who found a negative relationship between the proportion of outside directors and corporate performance. As such, by increasing the percentage of shares held by independent nonexecutive director, this will ensure they do actually carry out their duties as a watchdog of the organization because their personal wealth was being tied to the shareholders. Hambrick and Jackson (2000) found that the extent of independent non-executive directors interest will make them feel more affiliated to the company, resulting in them being more involved in their oversight and more generous in their time and attention. This was consistent with the empirical finding by Jensen (1993) that outside board members that hold substantial equity interests would have better incentive in monitoring the management. In Malaysia, Abdullah (2006) stated that non-executive directors shareholdings could influence directors remuneration because ownership leads to greater vigilance by the outside directors because their wealth is tied to firms performance.

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2.8

Firm Attributes

The internal and external environment that the firm operates plays an important role in determining the level of remuneration. In macro-economic context, market growth, demand structure, industry structure, globalization and regulation might affect the level of top management remuneration. These factor though important, it remain a as a poorly understood issue surrounding the directors remuneration. In micro-economic context, the firms characteristics in term of firm size, firm performance and firm debt position play an important role in determine the level of top management remuneration.

2.8.1

Firm size

The common industry norm suggested that the level of remuneration is positively correlated to company size. Larger firms are expected to have a more complicated operation structure, greater growth opportunities and have more extensive hierarchical management structure. The top managers of large size company have more scope to exercise their skills. As such, larger firm do need a higher remuneration package to attract and retain highly qualified man power to manage its operation. Besides, large companies will usually show higher profits, thus an even relatively high compensation may appear as an insignificant expense in the annual report. The growth in firm size can be achieved through the issuance of share to finance acquisition, investments, internal expansion and to finance the employees compensation. Jensen (1986) found that expanding firm size will benefit the manager by enabling them to obtain higher directors remuneration. Due to the wide dispersion of shareholders in

46

large companies, no initiative will be taken by the shareholders in questioning the directors remuneration as the transaction costs might be high. Empirical studies have evidenced the positive relationships between company size and directors remuneration. Conyon et al. (1998) evidenced a positive significant

correlation between firms size and the firms highest paid directors remuneration. This was further confirmed by Firth et al. (1999) who found that the larger the company, the higher the compensation and Andjelkovic et al. (2000) who found that the sole determinant of variations in CEO pay is the firm size. Consistently, Elayan et al. (2001), CEO compensation is positively related to company size. In contrast, Murphy (1985) documents an inverse relationship between company size and pay-performance sensitivities which reflects the agency cost over-weighted by the benefits derived from economies of scale. This was due to the fact that when a firm is too large, the amount of directors pay will look immaterial if compared to the firm revenue, as such, the board might approve a more favorable remuneration package regardless of the firm performance. In local context, Dogan et al. (2002) found strong evidence on the positive relationship between board remuneration and firm size. Firm size had also been widely used in other areas of corporate governance studies, for instances, Tan (2006) in examine the relationship between corporate social responsibilities and corporate governance found insignificant relation between firm size and corporate social responsibilities and Ismail (2006) in examining the level of mandatory compliance with MASB found that firm size will not affect the level of compliance.

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2.8.2

Firm performance

The agency theory suggests that the level of pay is an increasing function of firm performance in terms of stock return or accounting profitability. In practice, the commonly used firm performance measures are stock return and accounting profitability. Stock return is a good measure of firm performance as it represents shareholders wealth. However, in determinant of pay-for-performance, stock returns reflect only the overall business operation but not the efforts of individual director and there are reasons for stock price movement that other than corporate financial performance which directors have little control over the factors. Accounting profit measures though can zoom down to subdivision and product line but can be subject to falsification by management to reflect short term performance. Numerous studies have been conducted in the United States and United Kingdom, it was found that there is a positive association between chief executive officer compensation and recent stock return (e.g. Hallock, 1998; Boshen & Smith, 1995, Jensen et al., 1990). The research by Firth et al. (1999) found that managerial pay is positively related to accounting profitability although the relationship with stock return was insignificant and previous year accounting profitability is associated positively with CEO and executive directors compensation. Main et al. (1996) found a positive link between pay and performance. However, although significant, the relationship was found to be weak mean that there is little incentive for top management to try to improve performance (Liang et al., 1998). To tie the directors pay directly to the shareholders wealth, there is an increasing call for the design of incentive compensation scheme called pay-for-performance, i.e.

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directors will be paid based on firm and personal performance. However, past research on pay-performance link also failed to identify a robust relationship between top management compensation and firm performance. Elayan, Lau and Meyer (2001) found no significant association between CEO compensation with performance measures which is consistent with finding of Jensen and Murphy (1990) who found weak relationships between pay and performance. In Malaysia, Dogan et al. (2002) found that there is a positive relationship between board remuneration and stock market performance but negative for accounting measures. This may be due to the manipulation of accounting profits by Malaysian companies. The research by Hassan et al. (2003) using the data of Malaysian firms during the Asian financial crisis showed that the level of directors remuneration grow at a steady percentage against the deteriorating ROE. This finding suggested that the directors experienced an increase in remuneration at the expense of shareholders return. Abdullah (2006) found that firms growth and size are more important factor in determine top management compensation than performance. Apart from that, Towers Perrins research of pay-for-performance link among Asias largest companies in year 2003 revealed that among Asian countries, Hong Kong directors are the best paid across Asia with average pay of USD310,000 which was double of Malaysian director with average pay of USD115,000. However, Malaysian directors experienced the highest pay increase of 11.5% as compared to 7% in Singapore and 1.95% in Hong Kong. The research indicates a weak link between directors remuneration and company performance. The result of this study has further confirm the

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research undertaken by Malaysian Business magazine that significant pay increases occur despites declining profits or even suffering losses.

2.8.3

Leverage

A companys financial leverage determines the company finance structure. A firm financial leverage will determine available free cash flow. Thus, when the leverage level increases this will add pressure to the management to efficiently manage the cash flow. A company is said to be highly leveraged if the extent of debt financing is more significant than equity financing. Although the leverage level determines the available free cash flow after financing all profitable projects, it is constrained by the obligation to utilize for high return investment or employ in operating expenses and debt repayment. As such, to ensure the managers utilize the cash efficiently, a firm may increase their leverage. By reducing the available free cash flow, the possibility of allocating these cash flows to low-return diversification, sumptuary expenses, raising managers salary and others suboptimal investments decision will be reduced. This was confirmed by Jensen (1993) who found that the board obligation to fulfill an enforceable contract decrease the possibility of opportunistic behavior and reduce the amount of cash flow that they can freely allocated. When the shareholders control is supplemented with higher level of creditors ability to monitor the debt contract, the leverage level will become higher. In return, the discretionary power of the board members will be reduced. However, the research by Crespi and Gisprt (1998) using the data of Spanish companies, was not able to derive a

50

clear tendency about the impact of leverage in the board remuneration-performance relationship. In Malaysia, in the study of level of compliance with MASB, Ismail (2006) found that leverage does not affect the level of compliance with MASB. Apart from that, leverage had seldom been studied especially in Malaysia context. Due to lack of empirical evidence, this study will explore further the effect of leverage on directors remuneration.

2.9

Theoretical Framework

The design of top management compensation contract has been an important topic of investigation in the principal agent literature. The objective of excessive research in this area is to formulate an optimal compensation scheme that motivates the agents to maximize firm performance, taking into account corporate governance structure. The corporate governance conditions depend on the rule and regulation in the country of origin. Furthermore, the external environment in which the firms operate such as industry performance, firm size and business risk may also influence the director-shareholder relationship. Previous studies on the determinants of top management remuneration have produced mixed evidence and little research had been done in Malaysia context. As such, this study will try to examine the determination factors of directors remuneration in Malaysia. The theoretical framework of the study described in schematic diagram is shown in Figure 2.1.

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Board Characteristic - Board size - Board independence - CEO duality Ownership Characteristic - Ownership concentration - Managerial ownership - Independent non-executive directors ownership

Directors Remuneration

Firm Attribute - Firm size - Firm performance - Leverage

Figure 2.1:

Theoretical Framework

2.10

Hypothesis Development

The hypothesis development in this study is based on the agency theory framework. Based on the theoretical framework shown above, nine hypotheses and will be tested in this study.

2.10.1 Board size There is no any regulation that spelled out specifically the number of director required to form an effective board. As such, the size of companies board will normally depend on the firm size and operational efficiency. Jensen (1993) and Yermack (1996) find that boards are less effective if they grow in size. This may be due to communication

52

barrier when there are too many people involved in the decision making process. Smaller board is expected to be able to better control over its operation. Ghosh et al. (2003) found that larger boards are associated with higher CEO compensation. Consistently, Core et al. (1999) found that CEOs compensation increases as board size increase. As such, smaller boards seem more likely to constrain directors pay. The size of the board of directors is expected to be associated with less effective board monitoring, based on the argument that when boards become larger, the decision making power become diluted while the CEO will dominate the board, and are less able to control employee compensation effectively. Therefore, based on the discussion above, the hypothesis of this study will be: Hypothesis 1: Board size is positively related to the level directors remuneration.

2.10.2 Board independence The composition of the board of director is an important element to protect the interest of the shareholders. The link between board independence and directors remuneration is predicted to exist as the independent non-executive director may exercise their power to monitor and discipline the manager. Ryan and Wiggins (2004) found that an independence board is generally associated with good corporate governance and thus the compensation packages will be more closely align with shareholders wealth maximization. However, Crystal (1991) argued that in a system where outside directors serve essentially at the pleasure of the CEO, it is difficult for them to oppose the decision of the CEO particularly in his compensation (as cited in Ghosh & Sirmans, 2003). However, Conyon et al. (1998) and

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Firth et al. (1999) did not found the link between board independence and directors compensation to be existed. Consistently, Petra (2005) found no clear benefit to firm performance given by independent director; and the present of independent director on remuneration committee did not result in critical evaluation of CEO performance and reduced CEO remuneration. Due to the different of regulation and corporate governance structure, in the context of Malaysia, Abdullah (2006) found that board independent is negatively associated with directors remuneration. Traditionally, independent non-executive directors were appointed for the strategic insights based on their political background or experiences or even just for compliance purpose. However, now they are expected to be the watchdog of the boards activities by focusing on the realization and promotion of corporate governance especially in areas where the interests of management and the shareholders diverge, such as directors remuneration, corporate control, accountability and audit. Due to the change on the perception of independent non-executive directors function, therefore, this study hypothesized that: Hypothesis 2: The proportion of independent non-executive directors negatively related to the level of directors remuneration.

2.10.3 CEO-duality The board is perceived as independent if the chairman and the Chief executive Officer (CEO) post are held by different persons. CEO-duality enables the CEO to gain full control in dominating the decision making of the company. By holding two main positions in an organization, the CEO may have the conflicts of personal interest to

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shareholders interest and have strong influence over the board of directors in shape his own compensation. This result in ineffective monitoring and therefore are likely to exercise his discretionary power at the expense of the shareholders. Daily and Dalton (1993) state that duality is often a sign of strong CEO power, which combined with a lack monitoring of board decision, may have negative consequences for corporate performance. Core e al. (1999) found that CEO compensation increase when the CEO also is board chair. Consistently, Kakabadse et al. (2004) found that shareholders bear the cost of excessive pay when a director has notable power. Similarly, Elloumi et al. (2001) found that the greater the power of CEO, the higher is the level of total compensation. More recent study by Muslu (2005) also found that incentive compensation is greater in companies with board chairs serving as CEOs. However, due to different regulation and corporate structure, Abdullah (2004) found that CEO-duality do not have significant impact on directors remuneration. To enhance board independence, a firm not only need to ensure substantial number of independent non-executive directors was appointed but also having the board chairperson is someone other than the CEO. This is to ensure that the role of supervisor and manager should not be combined. If the situation of CEO-duality occurred, it will be difficult for the chairman to represents the interest of the shareholders due to his own economic benefits. Therefore, it is hypothesized that: Hypothesis 3: Firm with CEO-duality is more likely to have higher directors remuneration.

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2.10.4 Ownership concentration The extent to which the firms shares are owned in large quantity either by institutional investors or a family have direct impact on the directors remuneration because the large shareholders will have better information and more incentive to monitor the management. Moreover, by holding majority voting rights, the large shareholders may be able to vote against excessive directors remuneration. Crespi et al. (1998) found that for more concentrated firms, board remuneration will depend on the shareholders wealth. Since excessive directors remuneration will ultimately affect firm value, the extent of ownership concentration will lead to a fair remuneration package. Dogan et al. (2002) found that ownership concentration has a negative significant effect on remuneration. Ghosh et al. (2003) found that outside blockowners are effective monitors of CEOs performance. Consistently, Core et al. (1999) found that CEO compensation is lower when there is an external block-holder who owns at least 5% of the shares. The level of the ownership concentration represents the intensity of shareholder supervision. As such, the more concentrated is the ownership, and the easier will be the monitoring effort as the voting right is concentrated. Therefore, the following hypothesis is tested: Hypothesis 4: Ownership concentration is negatively related to directors remuneration.

2.10.5 Managerial ownership Managerial ownership is a factor in reducing agency problems in the firm because it aligns the interest of the managers and the shareholder. The positive relationship

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between managerial ownership and firm values reflects the convergence of interest effect; as managerial ownership increase, manager are likely to coincide more closely with those outside shareholders interest (Vethanayagam et al., 2006). Bournosleh (2002) found that stock option grants to CEO are positively associated with an increase in distribution of excess cash in the form of dividend. Thus his finding is consistent with Jensen et al. (1976) who found that ownership could align the interest of management to the interest of owners. Firth et al. (1999) found that the directors share ownership is associated with lower compensation. Consistently, Core et al. (1999) found that CEO compensation is a decreasing function of the CEOs ownership stake. The higher the ownership level by the management, the more likely that the management will act efficiently to enhance the firm value. By holding large amount of shares, the director will expect capital appreciation and not solely cash remuneration. Therefore, based on the literature, it is hypothesized that: Hypothesis 5: Managerial ownership is negatively related to directors remuneration.

2.10.6 Independent non-executive directors ownership The primary objective for appointment of independent non-executive directors on the board of director is to check the impartiality of the decision made by executive director. Their existence is essential in creating a board that will function as an effective monitor of management. Nevertheless, the effectiveness of this monitoring role depend not only the proportion of independent non-executive director on the board but also their shareholding. As such, the increase in non management investors may enhance the firm

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performance and hence share value. Shivdasani (1993) found that firms with less ownership by outside directors are more prone to hostile takeovers. Cyert, Kang, Kumar and Shah (1997) found that the control exercise by remuneration committee was increased with the presence of stock ownership held by outside independent directors. Bournosleh (2002) found that stock options for outside directors are associated with greater monitoring of management. Abdullah (2006) found negative influence of the extent of shareholding by non-executive directors to directors remuneration. The higher the level of independent non-executive director share ownership, the higher will be the initiative to monitor the performance of the board of director because of the financial interests. Thus, consistent with the prediction that interest by outside directors increase monitoring and participation incentives, therefore, it is hypothesis that: Hypothesis 6: Firm with higher independent non-executive director ownership is more likely to have lower directors remuneration.

2.10.7 Firm size Previous study has shown consistent finding that top management remuneration is positively correlated with firm size, for example Firth et al. (1999) and Conyon et al. (1998). The rationale is that a larger firm will have a more complicated operation structure and environment. The more uncertain and ambiguous the environment faced by a firm, the more likely the top management will be paid higher in response for their dealing with complexity. As the operation complexity increase, the firm will need more

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skillful and professional employee to run the operation. As such, it needs to offer a higher remuneration package to attract and retain qualified manager. On the other hand, Bebchuk and Grinstein (2005) suggest that managers might be able to expand the size of the firm by issuing new shares and by avoiding distribution of dividend. Expanding firm size will benefit the manager because the larger the firm, the more predictable are its future prospects and the more access it has to the capital market. Thus, there will be more available cash flow to finance the company operation besides serving the board private interest through more attractive directors remuneration package. Therefore, based on the above discussion, it is hypothesis that: Hypothesis 7: The larger the firm size, the higher will be the directors remuneration.

2.10.8 Firm performance A firm with sound financial records, showing high earning and investment expectation will be more willing to pay higher remuneration to the employees because this is a mean of motivation to the employee for the effort that they put in. As such, when firm achieved a good financial result, various incentives will be granted to the employee including the board of directors. A number of studies on the directors compensation had found a significant positive relationship between directors pay and performance for both accounting and share price measures. Main et al (1995) using accounting measures, Main et al. (1996) using stock market return found a positive link between performance and directors pay. This study expects a positive relationship between directors remuneration and firm performance. Due to the reformation of corporate governance and increase in

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investor education after the Asian financial crisis, firm has been forced to tie directors remuneration more strictly to financial performance or the value of the companys common stock. Based on the above argument, therefore, it is hypothesis that: Hypothesis 8: Firm that achieved better financial performance will pay higher directors remuneration.

2.10.9 Leverage Corporate debt can be considered as a mechanism to align management and shareholders interests (Elloumi et al., 2001). This is because the level of leverage determined a firm available cash flow and its ability to meet contractual obligation, and therefore if the leverage is high, the directors remuneration will be reduced. Jensen (1993) found that the board obligation to fulfill an enforceable contract decrease the possibility of opportunistic behavior and reduce the amount of cash flow they can freely allocated. This study supports the fact that highly leverage firms is likely to have its capital tie-up for the servicing of long term debt, thus, reduce its available cash flow for investment, dividend distribution and also the company daily operation expenditures. As the level of cash flow decrease, firm will normally adopt the cost cutting strategy to reserve fund for maintaining the companys core operation. Based on the above rationale, therefore, it is hypothesis that: Hypothesis 9: Firm with higher leverage will pay lower directors remuneration.

2.11

Summary

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The above literature presents the detail of past research on board and ownership characteristic and firm attribute with directors remuneration. It can be seen that there is a significant relationship between these variables. However, there is a lack of study in Malaysia context that able to draw the direct relationship between the corporate governance to the level of directors remuneration. As past research use board structure as control variables, and were always link to firms performance as dependent variables. Therefore, the objective of this study is to find how the board structure, ownership structure and firm attributes influence the level of directors remuneration.

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Chapter 3

METHODOLOGY

3.1

Introduction

The present study seeks to investigate the extent to which the board characteristics, ownership characteristics and firm attribute affect the level of directors remuneration in the context of Malaysian public listed companies. Thus, this chapter will elaborate on the methodological details of the study. It comprises the research design, instruments, measurements, data collection and data analysis details.

3.2

Research Design

This section discusses the type of study, population, sample frame, sampling method, unit of analysis and sample size.

3.2.1

Type of Study

The present study is a descriptive study, which is a type of research designed to describe the characteristics of a population or a phenomenon (Zikmund, 2003). It is a correlation study as the reason being that this study delineated the relationship between board characteristics, ownership characteristics and firm attribute towards the level of directors remuneration respectively. This study is in non-contrived setting as it uses accounting data about directors remuneration and governance data from the annual report.

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3.2.2

Population

The population of the present study will be all the public listed companies which are listed in the Main Board of Bursa Malaysia for the period between 1st January to 31st December 2005. There were 646 companies listed on the Main Board of Bursa Malaysia in year 2005. The financial companies had been excluded from the present study due to the different regulatory framework and governance environments in Malaysia. This is consistent with the study of Firth et al. (1999) who excluded banking corporation from the sample because the financial statements differ markedly from other firms and their inclusion makes cross-sectional models difficult to interpret. Other studies on top management remuneration that eliminated financial companies from their population include Elloumi et al. (2001), Dogan et al. (2002) and Abdullah (2004). According to Dogan et al. (2002), limiting the sample to manufacturing and service industries makes the sample more uniform and reduces potential biases that would be due to a mix of relatively incompatible sectors. As such, beside financial company, firm in the hotel, infrastructure and mining industries have been excluded since there are only a handful of companies listed on the Main Board of Bursa Malaysia for those sectors. There were nine funds and trusts listed on the Main Board of Bursa Malaysia which are managed by a group of managers, and subject to different reporting requirements, were also excluded. After exclusion of the above, the seven sectors that are included in this study are consumer products, industrial products, trading and services,

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plantations, properties, construction and technology, with total population of 598 companies listed on the Main Board of Bursa Malaysia in year 2005.

3.2.3

Sample Frame

This study uses secondary data, i.e. the annual report of public listed companies for the year of 2005; which can be downloaded from www.klse.com.my. Year 2005 was selected because it is the most recent financial ending year which financial report submitted to Bursa Malaysia at the time this study was undertaken. The seven sectors that included in this study are consumer products, industrial products, trading and services, plantations, properties, construction and technology.

3.2.4

Unit of Analysis

The unit of analysis will be the public listed companies on the Main Board of Bursa Malaysia. Each companys data on board characteristics, ownership characteristics and firm attribute will be treated as individual data sources.

3.2.5

Sample Size

Sekaran (2003) states that as a rule of thumb, sample sizes between 30 and 500 could be effective depending on the type of sampling design used and the research question investigated. As such, based on the population of 598 listed companies in the year of 2005, a sample of 120 public listed companies on the Main Board of Bursa Malaysia will be selected (refer Appendix I). To reduce selection bias, the proportional

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stratified sampling method is used in this study to determine the sample size of each sector.

3.2.6

Sampling Method

Sample will be constructed by first identifying all firms listed on the Main Board of Bursa Malaysia for the year 2005. Then, sample will be selected from each sector of industry from the total population by using proportional stratified sampling method. The sample selection is non-random as it may be restricted by the availability of Annual Report. Companies will be excluded from initial sample if they do not have sufficient directors remuneration data or other necessary data is unavailable. A final sample of 120 firms with complete data is used to test the research hypothesis.

Table 3.1

Number of sample of study Total no. listed 88 162 144 41 103 43 17 598 No. sample selected 18 32 28 9 20 9 4 120

Industry Consumer Products Industrial Products Trading and Services Plantations Properties Construction Technology Total

3.3

Measurements of Variables

This section identifies the method used to measure the independent variables and dependent variables.

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3.3.1 1.

Measurement of Independent Variables

Board size refers to the number of executive and non-executive directors serving on the board. Thus, it is measured as the total number of directors on the board of directors.

2.

Board independence is measured as the percentage of independent non-executive director on the board of directors. Independent non-executive director refers to those directors who are independent and do not serve as an executive during the relevant period. This study will gather data from the annual report by dividing the number of independent non-executive directors on a board of directors by the total number of the board members.

3.

CEO duality will be measured via binary variable. CEO is board chair is an indicator variable equal to one if the CEO also chairman of the board, and zero otherwise.

4.

Ownership concentration is the degree in which the company share owned by large shareholder, which is measured as the percentage of shares owned by the largest shareholder. This measurement is consistent with the approach adopted by Crespi et al. (1998) and Dogan et al. (2002).

5.

Managerial ownership is the percentage of outstanding shares owned by all the executive directors on the board, excluding indirect interest. It is measured as the cumulative number of shares owned by executive directors divided by total outstanding shares.

6.

Independent non-executive director ownership is the percentage of share ownership by independent non-executive director on the board, excluding indirect

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interest. It is measured as the cumulative number of shares owned by independent non-executive director divided by total outstanding shares. 7. Firm size is measured as the natural logarithm of the companys total assets. Total assets are extracted directly from the balance sheet published in the companys annual report. 8. Performance indicator that to be used in this study is return on assets (ROA). ROA is measured by the ratio of net income to total assets. This accounting measure performance is a valid measure of overall company performance. According to Elayan et al. (2001), ROA provides information to the board about the value added to the company by the directors, which in turn affects their compensation. 9. Leverage is measured as the total long term liabilities that bear cost of borrowing divided by the book value of shareholders fund which is extracted from the balance sheet published in the companys annual report.

3.3.2

Measurement of Dependent Variables

The dependent variable is the directors remuneration will be measured by using natural logarithm of total cash remuneration. The proxy for total cash remuneration used in this research includes salaries, wages, annual bonus, fees, allowances, defined contribution plan and benefits-in-kind such as insurance coverage and company car. Share options granted are not included due to unavailability of data because according to Malaysian reporting framework, details of executive share option granted to the board member are not compulsory for disclosure in the annual report. As a result, the value of share options

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cannot be estimated with any degree of confident. This is consistent with the measurement approach adopted by Hassan et al. (2003) and Abdullah (2006) in examining directors remuneration in the context of Malaysia. Furthermore, the total cash compensation measurement was generally accepted and had been adopted in the study by Elloumi and Guiyie(2001), Craighead, Magnan and Thorne (2004) and Ghosh et al. (2003).

3.4

Data Analysis

The data collected is to be analyzed to achieve the research objectives. The software application to be used is SPSS (Statistical Package of Social Science) version 12. The following section describes the technique used to analyze data. Various techniques will be used to study the relationship between board characteristics, ownership characteristics, firm attribute and level of directors remuneration such as descriptive statistics, correlation analysis and multiple regressions. Descriptive statistics was used to study the board characteristics, ownership characteristics, firm attribute and the level of directors remuneration. Each variables under board characteristics, ownership characteristics and firm attribute, i.e. board size, board independence, CEO-duality, ownership concentration, managerial ownership, independent non-executive director ownership, firm size, firm performance and leverage were analyzed using descriptive statistics, such as frequencies and percentages. This is the fundamental information necessary for us to have a general picture of the population represented by the samples. To examine the association between independent and dependent variables, Person correlation analysis is employed.

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The nine hypotheses stated in Chapter 2 will also be tested using multiple regression analysis. The multiple regression analyses will be used to evaluate the significant interaction between the nine variables towards the determinant of directors remuneration. The multiple regression models that to be used is as follow:

REM = 0 + 1 BSIZE - 2 BDIND + 3 DUAL - 4 OWNCON - 5 MGROWN - 6 INEDINT+ 7 FSIZE + 8 FPERF - 9 LEV + Where;REM BSIZE BDIND DUAL OWNCON MGROWN INEDINT FSIZE FPERF LEV = = = = = = = = = = = = = Directors remuneration Board size Proportion of independent non-executive directors CEO duality Ownership concentration Executive directors ownership Independent Non-executive directors ownership Firm size Firm performance Leverage intercept the estimate from the regression model the stochastic error term (1)

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Prior to the conduct of regression analysis, four assumptions underlying multiple regression analysis (normality of the error term distribution, linearity of the relationship, independence of error term, and constant variance of the error term) were tested (Hair et al., 1998). Several diagnostics that were used to test the assumptions were explained as follows:

1)

Normality of the Error Term Distribution The histogram of residuals and normal probability plot (p-p plot) were used to test the normality of the error term assumption (Hair et al., 1998). The histogram of residuals that showed a bell-shaped represented a normal distribution (Hair et al., 1998). Meanwhile, the residuals in the p-p plot that fell closely along the diagonal line indicated the normality of the data (Hair et al., 1998).

2)

Linearity of the Relationship To validate the assumption of linearity, partial regression plot was used to examine the relationship of a single independent variable to the dependent variable (Hair et al., 1998). The randomized pattern of the scatter plot indicated the linearity assumption was met (Hair et al., 1998).

3)

Autocorrelation (Independent of Error Term) To assess the independence of error term assumption, Durbin-Watson statistics was employed. The value of Durbin-Watson which fell between 1.50 and 2.50 indicated no autocorrelation problem (Coakes & Steed, 2003).

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4)

Homoscedasticity (Constant Variance of the Error Term) To validate the homoscedasticity assumption, scatter plot between studentized residuals against predicted criterion values was used (Hair et al., 1998). If there was no pattern of increasing or decreasing residuals, it indicated homoscedasticity in the multivariate case (Hair et al., 1998).

5)

Multicollinearity Multicollinearity was examined by collinearity statistics. For each of the variables, tolerance value of more than 0.10 and variance inflation factor (VIF) value of less than 10 indicated no serious collinearity problem (Hair et al., 1998).

Apart from that, diagnosis of outliers was examined (Hair et al., 1998). Outliers were examined through Casewise diagnostics. Any outlier cases would be removed from multiple regression analysis (Hair et al., 1998). After the assumptions had been tested, the regression analysis was run to analyze the relationship between the independent and dependent variables. The Beta value will indicate the relationship between the independent and dependent variables. The positive (+) or negative (-) sign of beta revealed the direction of the relationship. Significance of the relationship was measured by the p-value. R square (R2) measured the total variance explained in the dependent variable by all independent variables (Hair et al., 1998). If there was significant increase in R2, it indicated that the

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variance of the dependent variable can be explained by the specified independent variables.

3.5

Summary

This research is based on secondary data sources and the process of collecting data may be constrained by the sample size and availability of data. However, it will gain much benefit of understanding the subject under research and contribute to both the academic and practitioner.

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Chapter 4

RESULTS

4.1

Introduction

This chapter analyzes the finding of the study. In order to test whether the result of analysis will support the proposed hypothesis, several statistical tools had been employed. First of all, the frequencies, mean and standard deviation were generated to obtain a description of the variables which reflect the Malaysian listed companies background. Then, the correlations among the variables were tested to find the

interrelationship of the independent variables and control variables. Finally, using the regression model structuring and test, the hypotheses from the proposed model were tested by running the regression analysis.

4.2

Overview of Directors Remuneration Disclosure

Directors remuneration had been a mandatory disclosure item in accordance to the FRS 119 and Malaysian Code of Corporate Governance. The purpose of disclosure is to increase transparency and reduce the conflict of interest between the owner and manager. As such, the directors remuneration disclosures can be found from the annual reports mainly from the page of income statement, notes to financial statement and corporate governance statement. However, the extents of disclosure are much depends on the willingness of the company to disclose the information which was considered sensitive. Coulton et al. (2001) stated that managers are sensitive about disclosing compensation details or at least try to put the best possible spin on the details. As such, most of the

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companies under this study still disclose the minimum information as required by the regulatory. The international practices, as in the case of US and UK are to disclose the exact remuneration received by each executive and non-executive director. However, this study found that none of the Malaysian public listed company had disclosed this information despite Malaysian Code of Corporate Governance recommendation that companys annual report should contain details of the remuneration of each director. In other hand, in compliance to the Bursa Malaysia Listing Requirement, Malaysian public listed company only disclose remuneration in bands without disclosing the identity of recipients. For the 120 Malaysian public listed companies under study, 94 percent of the firms split the disclosure of total directors remuneration into executive and nonexecutive directors. The same group of firms also discloses information on the type of remuneration such as salary, fee, and cash value of benefit-in-kind of its executive and non-executive directors in total and in bands. As the standard only required company to disclose the employee share option scheme as a whole, none of the company makes a further step to disclose the value of stock option, including warrant that allocated to each director to conform to the international practice.

4.3

Descriptive Statistics of Variables

This study focused on 120 public listed companies selected from 7 different industries listed on the Main Board of Bursa Malaysia. The descriptive statistics for the dependent variable and independent variables are shown in Table 4.1.

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This study found that the mean for directors remuneration is at RM2.88 million. Abdullah (2002) found that the mean of directors remuneration for year 2000 is at RM1.05 million and increase to RM1.09 million in year 2001. As compared to Abdullah (2002) results, it shows that in five years time, directors remuneration had increase by more than 100 percent. This might be due to economy recovery; companies now enjoy better performance and growth. Refer to table 4.1, the range of total directors remuneration is from RM68 thousand to RM26.2 million with standard deviation of RM3.04 million. The descriptive statistics of corporate structure show that the board size range from the minimum of 3 directors to the maximum of 15 directors. On average, a board had 9 directors. This finding is consistent with the finding of Standard & Poors Corporate Governance Studies (2004) and the Corporate Governance Survey Report (2006). The proportion of independent non-executive directors to the board size varies from 13 percent to 78 percent with the mean of board independent at 41 percent, which is consistent with the finding of the Corporate Governance Survey (2006). Past research shows that board independence in Hong Kong was at 77 percent (Chen, 2002), 62 percent for Australia (Coulton et. al, 2001) and New Zealand at 71 percent (Elayan et. al, 2001). These statistics show that board independence of Malaysian companies is still far behind global trend for more independent boards. The initiative by the regulator for the appointment of independent non-executive directors is to increase transparency and accountability in financial statement. However, the statistical results of this study reveal the fact that insider management still dominant the board and the appointment of

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independent non-executive directors is just for the sake of fulfilling the listing requirement. The mean for ownership concentration is 35 percent with standard deviation of 16 percent. The range of concentration is between 5 to 72 percent. This number reveals a high percentage of ownership concentration among Malaysian public listed company, mainly due to significant amounts of government and family control in these public listed companies. However, the ownership concentration level that found by this study is lower as compared to the finding of Dogan et al. (2002) who found that the ownership concentration in Malaysia is as high as 41.27 percent. The possible reason for the decrease of ownership concentration might be due to the changes of ownership structure over the pass few years. The number of fund manager had increase over time and involvement of fund manager had been more active than previously. The extensive investment by the fund manager has changed the ownership structure from closely held by a group of shareholders to more widely hold by the public. The descriptive statistics of ownership structure show the percentage of managerial ownership ranged from zero to 60.79 percent. The mean value of the proportion shares held by managerial ownership is 12.71 percent. This study shows a much lower managerial ownership as compared to past research in the Western countries because of the exclusion of indirect shareholding through nominee and private limited company by the executive directors due to limitation of information disclosed. As such, the level of managerial ownership reduced corresponded to the high ownership concentration by state government and family.

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Although it is widely accepted that the shareholding of independent nonexecutive director may increase their commitment toward the organization, the descriptive statistic show that this control measure still not yet been established among Malaysian public listed companies. From table 4.1, the independent non-executive director ownership is as low as zero to 6 percent with the mean value at 0.32 percent reveals that independent non-executive director as a minority interest is powerless to oppose the board decision. From table 4.1, the mean of firm size from 120 samples of Malaysian listed companies is RM1,538 million. The smallest Malaysian public listed company have its total asset of RM20 million and the largest at RM33,410 million. The mean for firms performance is 3.49 percent. In the year 2005, companies that suffered losses have their ROA as low as -227.18 percent while companies that performs well have their ROA up to 41.06 percent. The mean for leverage from the selected samples is 0.86. This number reveals that average 86 percent of the companys assets were financed through fund raised from the interest bearing borrowing. The highest level of leverage is at 23.26. The high level of leverage among Malaysian public listed company in the year under study may be due to high borrowing to finance rapid growth in response to economy recovery. To further investigate the characteristic of the sample companies, frequency distribution was obtained and the result was displayed from table 4.2 to table 4.11 for each individual variables.

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Table 4.1

Descriptive Statistics of Variables

N 120 120 120 120 120 120 120 120 120 120 Minimum 3 13 4.71 .00 0 20,484 -227.18 .00 68 Maximum 15 78 72.46 60.79 6 33,410,200 41.06 23.26 26,245 Mean 8.21 40.73 34.9489 12.7093 .32 1,538,509.57 3.4889 .8603 2,875.79 Std. Deviation 2.122 10.027 16.36201 17.07336 .954 4,098,396.029 24.30181 2.34509 3,037.576

Board Size Board Independence Ownership concentration Managerial ownership Independent Non-executive Director Ownership Firm size Firm performance Leverage Directors remuneration Valid N (listwise)

Table 4.2 shows that majority of Malaysian public listed companies paid its directors in the range of RM1.0 to RM3.0m for which 25 percent of the directors was being paid RM1.0m to RM2.0m while 28.3 percent of the directors was being paid in the range between RM2.0m to RM3.0m. Only 15.8 percent of firm paid its directors below RM1.0m while on the highest end 11.8 percent of firms paid more than RM5.0m of directors remuneration. Among company in the sample that paid out highest directors remuneration were PPB Group Berhad, YTL Corporation Berhad Wah Seong Corporation Berhad, Star Publication (M) Berhad and SP Setia Berhad with their directors remuneration range from RM9.0m to RM26.2m.

Table 4.2

Frequency distribution of total directors remuneration No. of firms 19 30 34 13 10 14 120 % of sample 15.8 25.0 28.3 10.8 8.3 11.8 100

Directors remuneration Less than RM1m RM1.0m to RM2.0m RM2.0m to RM3.0m RM3.0m to RM4.0m RM4.0m to RM5.0m More than RM5.0m Total

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According to MCCG, board size should not be too big or too small so as to allow for active participation with minimum communication barriers and able to make effective decisions. The result of this study found that the total number of directors in the Malaysia public listed companies range from 3 to 15. Table 4.3 shows that 82.5 percent of companies have their board size range between 5 to 10 directors. Only 10.8 percent of companies having a large board size of more than 10 directors and 6.7 percent of companies having small board size of less than 5 members. This frequency distribution shows a consistent result with the finding of Standard & Poors Corporate Governance Studies (2004) who found that the smallest board in Malaysia had three directors and the biggest had fifteen with an average of nine directors a board.

Table 4.3 Board size Less than 5 5 - 10 More than 10 Total

Frequency distribution for board size No. of firms 8 99 13 120 % of sample 6.7 82.5 10.8 100

Table 4.4 shows the number of companies segregated according to the proportion of independent non-executive directors on the board of directors as a measure of board independence. From the 120 samples selected, 90 companies have independent nonexecutive directors of less than 45 percent and only 10.8 percent of companies have their proportion of independent non-executive directors of more than 55 percent. According to the Bursa Malaysia Listing Requirement of, at least one third (1/3) of the board members should be independent non-executive directors or must have at least two independent non-executive directors on their boards. As such, for the reason of compliance, 36.7

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percent of the companies have less than 35 percent independent non-executive directors on their board of directors.

Table 4.4

Frequency distribution for proportion of independent non-executive directors

INED Less than 35% 35% - 45% 45% - 55% More than 55% Total

No. of firms 44 46 17 13 120

% of sample 36.7 38.3 14.2 10.8 100

Referring to table 4.5, the separation of the CEO and chairman roles is increasingly seen in Malaysia corporate world with be seen with only 26.7 percent of Malaysia companies having the CEO and the board chairman positions held by the same individual. Prima facie, this reflects a good corporate governance structure among Malaysian public listed companies. However, the true chair independence is hard to excess as no disclosure of relationship between the individual that holding the two positions. Furthermore, if clearly examined the chairman profile, they are normally someone with political background who at the same time holding the chairman position in few boards. As such, the commitment toward one organization will be limited which may end up as a symbolic chairman while the real power rested in the hand of CEO, who indirectly ruled the board.

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Table 4.5 CEO duality No Yes Total

Frequency distribution for CEO duality No. of firms 88 32 120 % of sample 73.3 26.7 100

Dogan et al. (2002) stated that a corporation has a controlling shareholder if the shareholders direct and indirect voting rights in a firm exceed 20 percent. Table 4.6 shows that only 19.2 percent of companies have lower than 20 percent of ownership concentration and the balance of 80.8 percent of companies have high level of concentration range from 21 percent to 70 percent. This result is consistent with the finding of Dogan et al. (2002) that Malaysias ownership is highly concentrated.

Table 4.6

Frequency distribution for ownership concentration No. of firms 23 42 22 33 120 % of sample 19.2 35.0 18.3 27.5 100

Ownership concentration Less than 20% 20% - 35% 35% - 50% More than 50% Total

Table 4.7 reports the percentage of companies partitioned according to the level of managerial ownership. Result shows that 53.3 percent of companies have managerial ownership of less than 5 percent, 22.5 percent of companies have the managerial ownership ranging from 5 percent to 25 percent, 16.7 percent of companies have the managerial ownership ranging from 25 percent to 45 percent and 7.5 percent of companies have the managerial ownership of more than 45 percent. Generally, the result

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shows that majority of Malaysian public listed companies have managerial ownership of less than 25 percent.

Table 4.7

Frequency distribution for managerial ownership No. of firms 64 27 20 9 120 % of sample 53.3 22.5 16.7 7.5 100

Managerial Ownership Less than 5% 5% - 25% 25% - 45% More than 45% Total

According to table 4.8, only 2.5 percent of companies have their independent nonexecutive director ownership of more than 4 percent. In the lower end, 94.2 percent of companies have their independent non-executive directors ownership as low as 2 percent or even dont have any single shareholding. The result reveals that the independent nonexecutive directors might have been appointed only for compliance purpose as they do not have economy interest that drive their effort as a watch dog of the board of directors.

Table 4.8 INED Interest Less than 2% 2% - 4% More than 4% Total

Frequency distribution for independent non-executive directors interest No. of firms 113 4 3 120 % of sample 94.2 3.3 2.5 100

Table 4.9 shows the firm size of the sample companies which was measured by the total assets. The result shows that 53.3 percent of companies having total assets below RM500 million and the balance of 46.7 percent of companies have total assets above RM500 million to the highest of RM33 billion.

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Table 4.9

Frequency distribution for firm size No. of firms 33 31 22 6 28 120 % of sample 27.5 25.8 18.3 5.0 23.4 100

Total Assets Less than RM250m RM250m RM500m RM500m RM750m RM750m RM1b More than RM1b Total

Firm performance was measured by return on asset (ROA). ROA is an indicator of company profitability relative to its assets, thus it show the efficiency of management in using their assets to generate income. Refer to table 4.10, 65 percent of the companies achieved ROA of 1 to 10 percent, 17.5 percent of companies ROA are in the range of 10 to 20 percent. Only 2.5 percent of companies manage to achieve ROA of more than 30 percent, while 13.3 percent of companies suffered a negative ROA.

Table 4.10

Frequency distribution for firm performance No. of firms 16 78 21 2 3 120 % of sample 13.3 65.0 17.5 1.7 2.5 100

ROA Less than 1% 1% - 10% 10% - 20% 20% - 30% More than 30% Total

Based on table 4.11, 60.8 percent of the companies have leverage ratio below 0.5 which means that most of the companies having their operations financed internally via shareholders fund. Only 12.6 percent of companies rely heavily on external borrowing which was shown by the high leverage ratio above 1.5.

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Table 4.11 Leverage Less than 0.5 0.5 1.0 1.0 1.5 More than 1.5 Total

Frequency distribution for leverage No. of firms 73 25 7 15 120 % of sample 60.8 20.8 5.8 12.6 100

4.4

Correlation Analysis

From Table 4.12, it shows that at 1 percent significant level, board size is positively correlated with firm size. This is consistent with previous studies found that when the firm size increases, the number of directors on the board will also increase. Board size is also positively correlated with directors remuneration at 1 percent significant level. This is consistent with the finding of Core et al. (1999) that CEO compensation increases when board is larger. At 5 percent significant level, positive correlations was found between board size and firm performance. These positive correlations indicate that more directors will be needed to oversee the company operation when the company grows larger and when the company achieves higher profitability. Board size was found to be negatively correlated with board independence, managerial ownership and the leverage at 5 percent significant level. Firstly, the negative correlation between board independent and board size indicates that if board size is increase, the proportion of executive director will increase in a higher percentage than the proportion of independent non-executive directors, mainly due to the fact that the appointment of non-executive director is just for compliance purpose. Secondly, the negative correlation between managerial ownership and board size reveals the fact that in a larger board, the percentage of shareholding by the executive directors will reduce due

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to the wide spread of shareholding in the larger board. Thirdly, board size is negatively correlated with leverage indicates that when board size increase, more internal funds will be used to finance companys operation. Board independence and leverage was found to be positively correlated at 5 percent significant level, mainly explain the fact that when the proportion of executive director of a company increases, a company will depend more on internal fund to finance the companys operation. This situation exists mainly due to the fact that when the board was dominated by family member or the director of a institutional block-holder, funds will normally be channeled internally through the founder or the holding company. At 1 percent significant level, negative correlation was found between ownership concentration and managerial ownership. This result reveals the fact that when the shareholding was concentrated in the hand of family or external block-holder, fewer shares will be hold by board members. Firm size was found to be positively correlated with directors remuneration at 1 percent significant level with the magnitude of coefficient of 0.267, which is consistent with the findings of the studies by Dogan et al. (2002) who found that firm size is positively correlated with directors remuneration with the magnitude of coefficient of 0.28. This is also consistent with the study by Laing et al. (1999) in the context of United Kingdom who found the magnitude of coefficient ranging from 0.23 to 0.27. The consistency of finding support the view that when firm size growth larger, the structure become more complicated and thus need to employ more qualified manager with higher remuneration level.

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At 1 percent significant level, leverage is negatively correlated with firm performance which means that when a company is suffering losses, internal fund will reduce and hence to continue its daily operation, the company has to depend on external borrowing. Details of Correlation analysis is shown in APPENDIX D.

4.5

Assumptions Testing of the Regression Analysis

As mention in Chapter 3, the tests on the five assumptions of the regression analysis were performed to ensure the models of this study are valid.

4.5.1

Normality of the Error Term Distribution

Refer to APPENDIX E and APPENDIX F, the distribution of the histograms is bell-shaped and the P-P plots show the residual data falls along the diagonal line without systematic departure from the diagonal line. This indicates that the normality assumption is met.

4.5.2

Linearity of the Relationship

All partial regression plots from APPENDIX E and APPENDIX F show the relationship between board sizes, board independent, CEO-duality, ownership concentration, managerial ownership (including different levels of managerial ownership) and independent non-executive directors ownership, firm size, firm performance and leverage towards directors remuneration is well defined.

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Table 4.12

Correlation Analysis for All Independent Variables and Control Variables

Board size 1 -.197(*) .102 -.175(*) .145 .206(*) -.197(*) .247(**) .290(*) Board independence Ownership concentration Managerial Ownership INED Ownership Firm performance Leverage Firm size Directors Remuneration

Board size Board Independence Ownership Concentration Managerial Ownership INED Ownership Firm performance Leverage Firm size Directors Remuneration

1 -.024 -.064 .012 -.122 .181(*) .052 .039 1 -.230(**) -.060 .087 -.131 .083 -.068 1 .099 .045 .003 -.046 -.080 1 .057 -.049 -.095 -.042 1 -.810(**) .018 .087 1 .036 -.018 1 .267(**) 1

* Correlation is significant at the 0.05 level (2-tailed). ** Correlation is significant at the 0.01 level (2-tailed).

4.5.3

Autocorrelation (Independent of Error Term)

There is no autocorrelation problem if the statistics of the Durbin Watson values was within the limit of 1.5 to 2.5. Refer to APPENDIX E and APPENDIX F the values of Durbin Watson are approximately at 2.3 which showing that autocorrelation assumption is not violated.

4.5.4

Homoscedasticity (Constant Variance of the Error Term)

From APPENDIX E and APPENDIX F, the scatter plots show the magnitude of the residuals do not increase with the increasing predicted values, indicating no evidence of non-uniform variance. Hence, the homoscedasticity assumption is fulfilled.

4.5.5

Multicollinearity

The tolerance value of more than 0.10 and variance inflation factor (VIF) value of less than 10 indicated no serious collinearity problem. APPENDIX E and APPENDIX F shows that all the variables tolerance value are more than 0.10 with the smallest tolerance value at 0.304 and none of the VIF is above 10, with the highest VIF at 3.292. It shows that serious multicollinearity among the independent variables and control variables does not exist.

4.6

Hypothesis Testing Regression Analysis

The relationship between dependent variable and independent variables were tested by using regression analysis. The multiple regression models that tested in this study were as follow:

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REM = 0 + 1 BSIZE - 2 BDIND + 3 DUAL - 4 OWNCON - 5 MGROWN 6 INEDINT+ 7 FSIZE + 8 FPERF - 9 LEV + Where;REM BSIZE BDIND DUAL OWNCON MGROWN INEDINT FSIZE FPERF LEV = = = = = = = = = = = = = Directors remuneration Board size Proportion of independent non-executive directors CEO duality Ownership concentration Executive directors ownership Independent Non-executive directors ownership Firm size Firm performance Leverage intercept the estimate from the regression model the stochastic error term (1)

Table 4.13 exhibits the statistical summary result from the linear regression analysis. The model is significant according to the F statistic of 6.287 with the R square of 0.289. This means that 28.9 percent of the variables that contribute to the

determination of directors remuneration can be explained by the above model. The low of R square value is a common norm among social sciences research and is consistent with previous research. For instances, in studying executive compensation in New

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Zealand, Elayan et al. (2001) statistical result show a range of R square range from 0.14 to 0.55 for his different models. The detailed statistical analysis is shown in APPENDIX E. Casewise diagnostics is used to identify the outlier for which total 2 outliers were found and eliminated from the sample.

Hypothesis 1: Board size is positively related to the level directors remuneration. Based on the SPSS output, board size was found to be significant at 1 percent significant level with the t value of 3.300. It shows that there is positive relationship between the level of directors remuneration and the board size. In other words, the bigger the size of board of directors, the weaker is the control measures that exist in overseeing the quantum of directors remuneration. Hence, the hypothesis is supported.

Hypothesis 2: The proportion of independent non-executive directors negatively related to the level of directors remuneration. Board independent was found to be positively significant at 10 percent level with a low t value (t = 1.856). It shows that there is weak direct relationship between directors remuneration and the proportion of independent non-executive directors. In other words, the higher proportion of independent non-executive directors does not contribute direct towards minimizing the amount of directors remuneration. Moreover, the relationship was found to be positive rather than negative relationship as per the hypothesis. Hence, the hypothesis is rejected.

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Hypothesis 3: Firm with CEO-duality is more likely to have higher directors remuneration. With regard to CEO duality, the low t value (t = 0.575) shows that there is no significant direct relationship between directors remuneration and the occurrence of CEO duality. It reveals that the occurrence of CEO duality will not affect the level of directors remuneration. Hence, the hypothesis is rejected.

Hypothesis 4: Ownership concentration is negatively related to directors remuneration. In term of ownership concentration, the results show a high t value (t = -3.100) indicate that there is a significant direct relationship between directors remuneration and ownership concentration at 1 percent level. This reflexes that when there exist a block-holding, it is easier to exercise control over the board decision, as such dispute in decisions making will be mitigated, especially in the case of directors remuneration. Hence, the hypothesis is supported.

Hypothesis 5: Managerial ownership is negatively related to directors remuneration. The low t value (t = -1.110) shows that there is a no significant direct relationship between directors remuneration and managerial ownership. This means that share ownership by the executive directors will not affect the level of remuneration of the board of directors. Hence, the hypothesis is not supported.

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Hypothesis 6: Firm with higher independent non-executive director ownership is more likely to have lower directors remuneration. With regard to the independent non-executive directors ownership, the result show that there is no significant effect on directors remuneration with its low t value (t = 0.828). It reveals that the higher the independent non-executive directors ownership has no any effect on the level of directors remuneration. Hence, the hypothesis is not supported.

Hypothesis 7: The larger the firm size, the higher will be the directors remuneration. Firm size was found to be positively affects directors remuneration at 5 percent significant level with t value of 2.116. It shows that the larger the firm size, the more lucrative will be the remuneration package that drawn up for the board of directors. Hence, the hypothesis is supported.

Hypothesis 8: Firm that achieved better financial performance will pay higher directors remuneration. Firm performance in term of ROA was found to be positively contributed to the higher directors remuneration at 1 percent significant level with the high t value of 3.116. This shows that Malaysian public listed companies do actually tie their directors remuneration to the firm performance. Hence, the hypothesis is supported.

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Hypothesis 9: Firm remuneration.

with

higher

leverage

will

pay

lower

directors

The result shows that the firm leverage is positively affect the level of directors remuneration at 1 percent significant level with t value of 2.807. This finding reveals that the level of leverage wont stop the company from paying its directors excessively and the existence of Malaysian public listed company that actually financed their directors remuneration via external borrowing. As the direction of relationship was differ from what had been hypothesized, hence, the hypothesis is rejected.

Table 4.13

Linear Regressions of Directors Remuneration Standardized

Independent Variable coefficients Board size Board independence CEO-duality Ownership concentration Managerial ownership Independent non-executive directors ownership Firm size Firm performance Leverage F Statistics Adjusted R Durbin-Watson N ***Significant at 1% level ** Significant at 5% level * Significant at 10% level

0.305*** 0.159* 0.048 -0.310*** -0.110 0.008 0.193** 0.435*** 0.389*** 6.287*** 0.289 2.266 118

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Previous research had found a non-linear relation on the managerial ownership (Vethanayagam et al., 2006). As such, conform to previous studies; further analysis had been done to splits the ownership into four categories as below: 1) Managerial ownership less than 5 percent; 2) Managerial ownership between 5 to 25 percent; 3) Managerial ownership between 25 to 45 percent; and 4) Managerial ownership more than 45 percent The piecewise linear regression analysis equation then is:

REM =

+ 1 BSIZE - 2 BDIND + 3 DUAL - 4 OWNCON 5 MOless5 6

MO5.25 7 MO25.45 8 MOmore45 9 INEDINT+ 10 FSIZE + 11 FPERF 12 LEV + Where;REM BSIZE BDIND DUAL OWNCON MOless5 MO5.25 MO25.45 MOmore45 INEDINT = = = = = = = = = = Directors remuneration Board size Proportion of independent non-executive directors CEO duality Ownership concentration Managerial ownership less than 5% Managerial ownership between 5% to 25% Managerial ownership between 25% to 45% Managerial ownership more than 45% Independent Non-executive directors ownership (2)

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FSIZE FPERF LEV

= = = = = =

Firm size Firm performance Leverage intercept the estimate from the regression model the stochastic error term

From the result as shown in Table 4.14, R square is 0.277 which mean that with the inclusion of different level of managerial ownership; only 27.7 percent variance in directors remuneration is being explained by the variables. Although the model is significant at 1 percent level with F value 4.731, the results of the four different level of ownership were found to have no significant effect on directors remuneration with all the low t value ranging for -1.10 to 0.12. Thus, it reveals that no matter how much the managerial shareholding is, the level of directors remuneration will not be affected. Although past research on managerial ownership shows that different level of managerial ownership will affect firm performance in different manner (Vethanayagam et. al, 2006). However, when come to the issue of directors remuneration, the nonlinear relationship was too insignificant to affect the level of directors remuneration. It reveals the fact that monetary benefit in term of capital appreciation will not affect the intention to grasp for more wealth in term of remuneration. The detailed statistical analysis is shown in APPENDIX F. Casewise diagnostics is used to identify the outlier for which total 2 outliers were found and eliminated from the sample.

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Table 4.14

Linear Regressions of Directors Remuneration with Different Level of Managerial Ownership

Independent Variable coefficients Board size Board independence CEO-duality Ownership concentration MOless5 MO5.25 MO25.45 MOmore45 Independent non-executive directors ownership Firm size Firm performance Leverage F Statistics Adjusted R Durbin-Watson N ***Significant at 1% level ** Significant at 5% level * Significant at 10% level

Standardized

0.314*** 0.161* 0.035 -0.265*** 0.011 -0.106 -0.043 -0.085 0.005 0.186** 0.421*** 0.377*** 4.731*** 0.277 2.217 118

4.6

Summary of the Findings The findings of the study in this chapter are related to the hypothesis generated

in Chapter 2.

As a whole, it is concluded that board size, ownership concentration,

firm size, firm performance and leverage will affect the level of directors remuneration, while board independence, CEO duality, managerial ownership and independent non-executive directors ownership do not contribute towards the level of directors remuneration. A summary of the hypothesis testing is shown in Table 4.15.

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Table 4.15 Items Hypothesis 1

Summary of the Findings Hypothesis Board size is positively related to the level directors remuneration The proportion of independent non-executive directors negatively related to the level of directors remuneration. Firm with CEO-duality is more likely to have higher directors remuneration. Ownership concentration is negatively related to directors remuneration. Managerial ownership is negatively related to directors remuneration. Firm with higher independent non-executive director ownership is more likely to have lower directors remuneration. The larger the firm size, the higher will be the directors remuneration. Firm that achieved better financial performance will pay higher directors remuneration. Firm with higher leverage will pay lower directors remuneration. Accepted or rejected Accepted

Hypothesis 2

Rejected

Hypothesis 3

Rejected

Hypothesis 4

Accepted

Hypothesis 5

Rejected

Hypothesis 6

Rejected

Hypothesis 7

Accepted

Hypothesis 8

Accepted

Hypothesis 9

Rejected

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Chapter 5

DISCUSSION AND CONCLUSIONS

5.1

Introduction

This chapter further discusses the findings and important points derived from the findings of this study. Firstly, it begins with the recapitulation of the study followed by the discussion of the findings and its implication. Finally, this chapter closes with the limitation of the study and suggestion for future research, and then ended with conclusion.

5.2

Recapitulation of the study

By using 120 samples of Malaysian listed companies in the year 2005, the study is conducted to explore: a. the level of directors remuneration of Malaysia public listed companies; b. whether the board size has an impact on directors remuneration; c. whether the board independence has an impact on directors remuneration; d. whether the CEO duality has an impact on directors remuneration; e. whether ownership concentration has an impact on directors remuneration; f. whether managerial ownership have an impact on directors remuneration; g. whether the shareholding of independent non-executive directors have an impact on directors remuneration; h. whether firm size will affect the level of directors remuneration; i. whether firms financial performance has an impact on directors remuneration; and

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j. whether leverage will affect the level of directors remuneration. The first objective of the study can be examined through descriptive statistics; the remaining nine objectives are achieved through multiple regression analysis between board size, proportion of independent non-executive directors, CEO-duality, ownership concentration, managerial ownership and independent non-executive directors ownership, firm size, firms performance and leverage towards directors remuneration. Nine hypotheses were formulated to achieve these research objectives. The findings of the study revealed that there is a significant relationship between board size and directors remuneration. Thus, hypothesis 1 is supported. As for the board independence, it was hypothesize that board independence will have negative impact on directors remuneration but the findings revealed that there is positive relationship between the variables. Hence, hypothesis 2 is rejected. The third hypothesis regarding the impact of CEO duality on director remuneration was found to be insignificant and as such was rejected. In term of ownership structure, the relationship between ownership concentration and directors remuneration had been tested and had great support from the data analyzed. Therefore, hypothesis 4 is well supported. The relationship between managerial ownership and directors remuneration was found to be insignificant. The insignificant relationship was further tested with different levels of managerial ownership and found that even with narrow scope of managerial ownership, non of the ownership level has significant impact on directors remuneration. Thus, hypothesis 5 is rejected. Hypothesis 6 was formulated to test whether independent non-executive directors ownership will influence directors remuneration. It was found that no

99

significant influence of independent non-executive directors ownership towards directors remuneration, and hence, hypothesis 6 was rejected. Result had shown that firm size was positively related to directors remuneration, and hence, hypothesis 7 had been well supported. As for firms performance, it was found that financial performance measured by return on assets to have significant positive relationship with directors remuneration, and hence, hypothesis 8 was supported. Hypothesis 9 regarding the impact of leverage on directors remuneration was rejected due to the positive relationship which was found to be exist between the variables that was in contradiction with the expected negative relationship.

5.3

Discussion of the Findings

The findings highlighted some interesting points on the extent of how board characteristics, ownership characteristics and firm attributes have an impact on directors remuneration. Some of the findings of this study are consistent with and also contradictory to the findings of previous researches.

5.3.1

Board size and Directors remuneration

This study revealed a significant positive relationship between board size and directors remuneration, which means that when the board size grows bigger, the quantum of directors remuneration will also increase. This finding is consistent with the finding of Core et al. (1999) and Ghosh et al. (2003) who found that CEO compensation increase when board is larger.

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There are several possibilities that might contribute to this positive relationship. Firstly, the positive relationship might be contributed by the positive correlation between board size and firm size. Firm size had been proved to be the most important determinant of directors remuneration through the series of past research. As the firm size increase, the need for more manpower and the level of expertise in top management will also increase. This will contribute to larger board size and also the quantum of directors remuneration. Secondly, this may be contributed by better firm performance. The result of the correlation analysis suggests that board size is positively correlated with firm performance which suggests a direct impact on directors remuneration based on payfor-performance system. As a company achieves higher profitability, it will be more afford to employ more director of different expertise to support companys operation and to pay higher remuneration to attract and retain the expertise. As such, when a company is well-performed, more directors will be recruited and thus the level of directors remuneration will also increase. Thirdly, this may be due to inefficient monitoring when board size grows larger. This is consistent with the finding of Jensen (1993) and Ghosh et al. (2003) that larger boards are associated with higher compensation due to the dilution in decision making power while the CEO who dominate the board have the sole power to determine the remuneration package. As suggested by previous research, the board of directors might purposely increase the size of the firm by issuing new shares so that to finance a more lucrative remuneration packages.

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5.3.2

Board Independence and Directors remuneration

This study revealed that independent non-executive directors do not play important role in limiting managerial discretionary behavior, especially on directors remuneration. This finding is consistent with Conyon et al. (1998) and Firth et al. (1999) who did not found any link between board independent and directors remuneration. What surprise us is the positive relationship that found between the board independence and directors remuneration. Though the level of significant was found to be low but it does actually reflect the inefficient board monitoring. This finding reveals that the appointment of independent non-executive directors on the board does not serve any purpose except for compliance and the independent non-executive directors are not acting for the betterment of the company. It also gives an insight on the possibility of collaboration between the executive and non-executive directors in drafting excessive remuneration packages for board as a whole. As such, the degree of independence among Malaysian public listed companies is in doubt. This might be due to the tenure of service and past business relationship with the companies. The appointment of close friend, political alliance and retiree as independent non-executive director is also a very common scenario that happened in corporate world. Moreover, the independent non-executive directors are not actively participate in the company operation and have to depend on the executive directors to get the companys information, thus they will tend to act softly rather than take an aggressive stand against the executive directors. As such, their appointment is only as symbolic rather than as a watchdog of shareholders wealth.

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5.3.3

CEO-duality and Directors remuneration

The occurrence of CEO-duality had been proven to be positively affect the level of directors remuneration through the past research by Elloumi et al. (2001), Kakabadse et al. (2004) and Muslu (2005). However, this study revealed that in the context of Malaysia, CEO-duality does not have significant impact on directors remuneration which is consistent with the finding of Abdullah (2004). The inconsistency of finding is mainly due to the background of directorship. Firstly, in the Western country, the separation of ownership and management are often more clearly identified. Owner will normally not involve in companys operation but manager will be appointed to run the business. As such, when the situation of CEOduality occurred, the power of decision making that rested on the same person may lead to mismanagement in the expense of shareholder in term of excessive directors remuneration especially in the absent of controlling shareholder. However, in the context of Malaysia, ownership and management are often hardly separated especially in family and state controlled company. In the occasion where the chairman who is the major shareholder or the founder of the company and at the same time holding the position CEO, the main aim might shift from getting benefits from the company to growth with the company. As such, the remuneration package drawn up will be more reasonable as capital appreciation will compensate for the lower remuneration. In actual fact, the CEO-duality in this occasion may lead to increase in shareholders wealth which is consistence with the finding of Donaldson et al. (1991) that ROE improved by combining the role of the chair and CEO position.

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5.3.4

Ownership concentration and Directors remuneration

The study supported the negative relationship between ownership concentration and directors remuneration. This result is also consistent to the research finding from Crespi et al. (1998), Dogan et al. (2002) and Core et al. (1999) that the level of compensation is lower when there is an external block-holder. In the context of Malaysia, the main reasons for high level of ownership concentration are the significant amount of family and state control. As suggested by Dogan et al. (2002) that the level of ownership concentration is a proxy for the intensity of shareholder supervision. Thus, when ownership is more concentrated, shareholders would have better information and be better placed to monitor manager efforts. As such, the level of directors remuneration will be well-controlled and can be tie more closely to companys performance rather than based on the discretion of the manager.

5.3.5

Managerial Ownership and Directors remuneration

The study fails to support the negative relationship between managerial ownership and directors remuneration. To re-confirm the insignificant relationship, further findings on the different levels of managerial ownership also shown insignificant result regardless of the level of ownership. This result is contradictory to the research finding from Firth et al. (1999) that directors share ownership is associated with lower compensation. The insignificant relationship might be due to the low level of managerial ownership among Malaysia public listed company that unable to create any significant impact on the level of directors remuneration. Refer to the descriptive statistic; the

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mean value of managerial ownership for Malaysia is as low as 12.7 percent. Compared to the finding of Firth et al. (1999), Hong Kongs managerial ownership is at 44 percent for which a negative and statistically significant coefficient was found between managerial ownership and directors remuneration. This study is consistent with the finding of Andjelkovic et al. (2000) who found that none of ownership variables is statically significant to affect the level of directors remuneration in New Zealand with the mean value for managerial ownership at 12 percent which is close to Malaysian situation.

5.3.6

Independent Non-executive Director Ownership and Directors Remuneration

The study fails to support the negative relationship between independent nonexecutive director ownership and directors remuneration. This result is contradictory to the research finding from Abdullah (2006) that the extent of shareholding by nonexecutive directors is negatively associated with the level of directors remuneration. The inconsistency in finding may due to different definition of variables. This study has taken the shareholding of independent non-executive directors; in contrast with Abdullah (2006) that include both independent and dependent non-executive directors. Non-executive director can be person that connected or have business relationship to the board member of the company. In the other hand, the appointment of independent non-executive director has been clearly stated in the listing requirement that each board must have at least one third of independent non-executive director or minimum 2 of them of which must not have any relationship with the company. As

105

such, their appointment is merely for the compliance purpose. Moreover, due to interlocking directorate; independent non-executive director will be busy monitoring their own business rather than be a watch dog in the organization that he does not have significant interest. Thus, there is not much power that they can and willing to exercise to influence the board decision especially with their minimal voting right.

5.3.7

Firm size and Directors Remuneration

The study supported the positive relationship between firm size and directors remuneration. This result is consistent with the finding of Conyon et al. (1998), Firth et al. (1999) and Elayan et al. (2001). In fact, Dogan et al. (2002) stated that firm size is the best documented empirical regularity regarding the level of executive compensation. The larger the firm size, the higher will be the profitability and the available cash flow. As such, large companies are able to offer more lucrative remuneration packages as compared to small business entity.

5.3.8

Firms performance and Directors Remuneration

This study found that firm performance was found to be positively correlated with directors remuneration. This finding is conforming to the agency theory which suggests that the level of pay is an increasing function of firm performance in term of stock return or accounting profitability. It is also consistent with previous research by Main et al. (1996) and Firth et al. (1999) who found a positive link between pay and performance.

106

According to Towers Perrin (2003), Malaysia companies have made a quick to strengthen the relationship between pay and performance as compared to others Asian countries. As such, the significant positive linkage between pay and performance is actually a good indicator for Malaysian public listed company in compliance to the best practices that suggested by the Malaysian Code of Corporate Governance. This finding will act as a boaster in investor confident as it suggests the existence of good corporate governance structure within Malaysian public listed company.

5.3.9

Leverage and Directors Remuneration

The firms leverage was found to have positive relationship with directors remuneration. This finding was contradict with the hypothesis and the finding of Jensen (1993) who found that the board obligation to fulfill an enforceable contract decrease the possibility of opportunistic behavior and reduce the amount of cash flow that they can freely allocated. The occurrence of positive relationship between leverage and directors remuneration indicate an unhealthy debt financing was in place. It reveals that Malaysian public listed companies are not utilized available fund effectively and the possibility of using external fund to finance the excessive directors remuneration. However, it can also be argue that a firm that suffering financial difficulties may need to employ a more experience and well verse manager to manage and restructure the firm for future growth, as such, despite the high leverage, higher remuneration had to be offered.

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5.4

Implications of the Study

The results of the study would imply some implications to the public listed companies, and the regulatory bodies. This study will provide insights on how listed companies structure their board and how the corporate governance factors influence the level of directors remuneration. To improve control over directors remuneration, several measures had been introduced by Malaysian Code of Corporate Governance and other regulatory bodies. Firstly, it had been well supported that directors remuneration increase when the board is larger. As no optimal board size been identified, it is up to companies to decide their own board size which is mainly based on the firm size and companies structure. However, in deciding the level of directors remuneration, a compensation committee must be set-up which majority must be filled up by independent non-executive directors. As the compensation committee members were selected from the board of directors, the efficiency of the committee depends much on the board of directors itself. Thus, the board quality as a whole must be improved before an efficient remuneration committee can be formed. Secondly, in accordance to the Bursa Malaysia listing requirements, public listed companies must have one third or at least two independent non-executive directors. This requirement had been well complied by all the public listed companies selected. However, the question that the regulator may face is on how independent of these directors are with the existence of inter-locking directorate, gray directorship and symbolic directorate? Ideally, independent non-executive directors should have

108

proficient education background; sound work experiences, positive attitudes and willing to take up the responsibility as the watchdog of the organization. Thirdly, as the level of corporate governance been enhanced after the Asian financial crisis, the occurrence of CEO-duality has been reduced significantly. In this new corporate world, chairman will sit on the board while the company operation left in the hand of CEO. However, there is no clear regulation to define the relationship between both of them. In a family controlled company, when both positions had been filled up by the family members though formally no CEO-duality exists but in actual fact there is a concentration of power within the organization. In the state control company, normally a strong background politician will appointed as symbolic chairman of the company, as they are not actually involve in business world, the real power will be rested in the hand of CEO. In term of ownership, shareholders should be able to remedy the imperfect decision making process if given powers to monitor the compensation scheme. Consistently, this study found that companies with high ownership concentration are less likely to pay excessive directors remuneration. As the level of ownership

concentration is a proxy for the intensity of shareholder control, when ownership is concentrated, shareholders will have better information for monitoring the board effort and have their remuneration tied more closely to the companys performance. However, in the challenge of globalization, Malaysia companies will move from closely held stocks structure to widely held firms as what happened in United States where no single owners will have significant control rights. To prepare Malaysia for this challenge,

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appropriate corporate governance mechanism should be designed to protect the shareholders and to boost shareholders confident. Managerial ownership and independent non-executive directors ownership shall continue to act as a measure to reconcile the extent of effort and the level of remuneration. Through share-ownership, the interest of the board will be aligned with the shareholders because of economic benefits. As such, the regulator shall consider uplifting the restriction of ownership imposed on the manager and independent nonexecutive director to create a free stocks market. The linkage of firm size and firms performance to directors remuneration indicate a good start for Malaysian companies in setting up a more competitive remuneration package. In term of financial leverage, steps have to be taken to limit the usage of external funding in paying excessive directors remuneration. Although there is impossible to set up regulation to limit the directors remuneration payout for high leverage firm, it is possible to draw up a financial rating guideline for the financial institution to limit the granting financial assistance to the firm that suffering high level of leverage. By limiting the available external financing, the available cash flow to pay excessive directors remuneration will be constrained. Lastly, the adoption of pay-for-performance compensation scheme has been long established in western countries. Core et al. (2003) stated that incentive compensation link executive pay to company performance measures and thus aligns interest of executives with those of shareholders. As such, instead on focusing on agency cost and finding more efficient way to monitor the board character, compensation shall be used to counteract the agency conflict. High pay is not a

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problem, if it yields a higher performance. It is not how much to pay that matter but how they are paid that matters.

5.5

Limitation of Study

Although the amount of directors remuneration can be easily obtained from the companys financial statement, most companies chose to disclose what minimum required by the listing requirement. Due to the limitation of disclosure, the level of directors remuneration that refers to in this study is in total rather than splitting into executive and non-executive directors. At the same time, the value of stock options that granted to directors was also been excluded due to unavailable of data. As such, this study is unable to give a clear indicator of what the actual earning of the board of directors but only the cash remuneration. Secondly, this study unable to address the issue of fairness in directors remuneration as there is no guideline in setting up directors remuneration and what constitute a fair remuneration package. Instead, this study had measured directors remuneration in absolute amount. Thirdly, the entire ownership variable that refers to in this study is only the direct shareholdings. Due to unavailable of data, indirect interests were omitted. The indirect control through a third company might be significant especially in the family controlled company. Most of the third companies that hold majority of the company shares are of private limited company which no annual report is available for public. As such, the actual level of interest cannot be clearly justified.

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Lastlyly, due to time limit constraint, the study was conducted base on only one years information, i.e. year 2004. The result base on one year study may not be strong enough to make solid conclusion.

5.6

Suggestions for Future Research Base on the limitation of the study, future researches on similar topic are

recommended to make changes in certain areas. First of all, the number of year under studied shall increase from one year to at least three years. By doing this, it will produce a more precise and consistent results to the similar study on this field. Furthermore, the trend throughout the years on comparing the level of directors remuneration is able to obtain. This consideration will narrow down the gap of different companies performance due to economic situation. Secondly, due to the revolution of financial reporting standard, the level of disclosure had been increased significantly. As such, future research might be able to address the limitation of data that current study faced by including actual remuneration of individual director and value of stock options that granted to individual directors. Besides, future research might study the factors that influence the level of remuneration of executive and non-executive director separately. By doing this, the actual level of earning for board of director will be ascertained in a more precise manner. Thirdly, future research may look into the effect of board efficiency to the directors remuneration. The examination of efficiency may be done to the board as a whole or zoom down into the conduct of the committees, especially the remuneration committee and audit committee.

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Finally, besides the independent variables mentioned in this study, future research may consider adding personal characteristic of director in term of education qualification, working experiences, political background and tenure of service are some of example for future researchers to consider as variables.

5.7

Conclusion

This study examine the relation between directors remuneration and the board characteristic in term of board size, board independent and CEO-duality, ownership characteristics in the respect of ownership concentration, managerial ownership and independent non-executive directors interests and firm attribute in term of firm size, firms performance and leverage. The findings of the study support the premise that shareholders economic interests are best served when the board size is small and the ownership is well concentrated. As such, it implies that directors remuneration will be well controlled in company that is relatively small and held by the same group of people. In the other hand, board independent, CEO-duality, managerial ownership and independence non-executive directors interest was found to be not significantly affecting the level of directors remuneration. In contrast to previous studies, we found no evidence of relationship between the corporate governance variables on the level of directors remuneration. Instead, the sole determinant of variation in directors remuneration appears to be the firm attribute in term of firm size, leverage and performance. The results of the study revealed a positive sign on Malaysias corporate culture as directors remuneration is dependant on the economic factors rather than

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been controlled by the board itself. As such, it shown that Malaysia companies are moving towards linking pays to performance which is consistent with the move of the world. Nevertheless, there are still much things that should be done in corporate governance so as to boost investors confident especially in increasing disclosure transparency. In current state where the data disclosed to public is incomplete, there is high possibility of some forms of compensation will go unnoticed and give the impression of lower remuneration among Malaysian companies. This may lead the executive directors to use non-cash forms of compensation to avoid public scrutiny. More transparency reduces the costs to obtain information on remuneration and improve the accountability of the directors. Disclosure is clearly an interesting tool to solve the agency problems on directors remuneration and effectively lead companies to pay directors based on company performance.

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