Too Good to be True: Board Structural Independence as a Moderator of CEO Pay-for-Firm-Performance

Abstract

Whether voluntary or mandatory in nature, most recent corporate governance codes of best practice assume that board structural independence, and the application by boards of outcome-based incentive plans, are important boundary conditions for the enforcement of Chief Executive Officer (CEO) pay-for-firm-performance; that is, for optimal contracting between owners and executive agents. We test this logic on a large Australian sample using a system Generalized Method of Moments (GMM) approach to dynamic panel data estimation. We find that Australian boards exhibiting best practice structural arrangements - those chaired by non-executives and dominated by non-executive directors at the full board and compensation committee levels - are no more adept at enforcing CEO pay-for-firm-performance than are executive-dominated boards. These findings suggest that policy makers' faith in incentive plans and the moderating influence of structural independence per se may be misplaced. Our findings also hold significant implications for corporate governance theory. Specifically, the findings lend further support to a contingency-based understanding of board composition, reward choice and monitoring; an approach integrating the insights afforded by behavioural approaches to Agency Theory and by social-cognitive and institutional understandings of director outlook, decision-making and behaviour.