Jurnal Komite Remunerasi

Accounting Research Journal
Remuneration committee independence and CEO remuneration for firm financial

performance
Patti Cybinski Carolyn Windsor
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Remuneration
Remuneration committee committee
independence and CEO independence
remuneration for firm
197
financial performance
Patti Cybinski
Department of Accounting, Finance & Economics, Griffith University Nathan,
Brisbane, Australia, and
Carolyn Windsor
Faculty of Business, Bond University, Gold Coast, Australia
Abstract
Purpose – As a result of the Australian Government Productivity Commission’s recommendation to
mandate remuneration committee independence for ASX300 companies, this study aims to investigate
whether voluntary remuneration committee independence aligns chief executive officer (CEO) total
pay and bonuses with firm financial performance.
Design/methodology/approach – A series of hypotheses test the research question using multiple
regressions for a sample of 143 ASX300 companies during 2001. This time was prior to strengthen
corporate governance regulation, but after mandated executive remuneration disclosure, thus
capturing varying levels of voluntary remuneration committee independence.
Findings – This study shows firm size is an influential factor in the relationship under investigation.
ASX300 large firm remuneration committees link CEO total remuneration and bonuses to firm
financial performance. Smaller ASX firm remuneration committees do not link either type of CEO
remuneration to performance despite remuneration committee independence. Findings are mixed for
medium-sized ASX300 firms.
Research limitations/implications – Limitations include the necessary time restriction to 2001 for
sampling the ASX300 firms. The implication of this study’s findings is that the proposed public policy
for mandatory remuneration committee independence is not universally effective in linking CEO
remuneration to firm financial performance for ASX300 firms.
Originality/value – This study contributes to the limited research on voluntary remuneration
committee independence in relation to CEO remuneration and firm financial performance in the
Australian context.
Keywords Chief executive officer, Firm financial performance, Remuneration committee independence
Paper type Research paper
1. Introduction
Public anger about executive pay excesses has increased since corporate, regulatory,
and political leaders were implicated in the global financial crisis that harmed
community well-being (Stiglitz, 2010). Although Australian executive pay is relatively
modest by international standards, compensation for Australian executives in the
50 to 100 largest companies has increased by as much as 300 per cent in real terms Accounting Research Journal
Vol. 26 No. 3, 2013
between 1993 and 2007 (Fels, 2010). Moreover, nearly all the growth in reported pp. 197-221
executive pay for the top 300 companies is attributed to increases in incentive pay q Emerald Group Publishing Limited
1030-9616
(Fels, 2010). DOI 10.1108/ARJ-08-2012-0068
ARJ Australian governments however have been successfully persuaded to let the market
26,3 regulate corporate executive remuneration. Statements of good practice, such as the
ASX Corporate Governance Council’s (2003, 2007) Corporate Governance Principles and
Recommendations “Remunerate fairly and responsibly”, largely guide remuneration
practice for Australian executives. Further, government legislative intervention is most
prevalent for remuneration disclosure and shareholders’ binding[1] vote on
198 remuneration (Sheehan, 2009, 2012). To appease public anger, the Prime Minister
requested the Productivity Commission[2] to review the regulation of executive and
director remuneration for the following reason:
[. . .] the prime motivation for this inquiry is a widespread perception that executives have
been rewarded for failure or simply good luck. And certainly in some periods and for some
CEOs, pay outcomes appear inconsistent with a reasonably efficient executive labour market
(Australian Government Productivity Commission, 2009, p. xxvi).
Our study is motivated by the Commission’s recommendation to regulate the formation
and composition of independent remuneration committees for companies included in
the S&P ASX 300 index (hereafter referred to as ASX 300 companies). The Commission
argues that independent remuneration committees reduce conflicts of interest. These
conflicts include executive board members who are able to make decisions about their
own pay (Australian Government Productivity Commission, 2009). This key
recommendation number (2) proposes a new ASX listing rule specifying that.
The ASX Corporate Governance Council should introduce an “if not, why not”
recommendation specifying that remuneration committees:
.
have at least three members;
.
comprise (NEDIRs), a majority of whom are independent;
.
be chaired by an independent director;
.
have a charter setting out procedures for non-committee members attending; and
.
meetings (Australian Government Productivity Commission, 2009, p. 9, xxxvii).
The research question under investigation is whether remuneration committees

composed entirely of independent directors effectively ensure that chief executive officer
(CEO) pay relates directly to firm financial performance. Australian remuneration
committee composition is mainly voluntary and guided by the ASX Corporate
Governance Council (2007) best practice that formally recommends boards to establish
remuneration committees. The Council suggests that remuneration committees comprise
a majority of independent directors, chaired by an independent director with a minimum
of three members (Australian Government Productivity Commission, 2009). In 2011,
regulation of executive compensation standards has increased with the ASX introducing
the listing requirement (ASX Listing Rule 12.8) that ASX 300 companies form a
remuneration committee comprising entirely of NEDIRs (Kent et al., 2012).
As a consequence, of the Commission’s key recommendation and the 2011 ASX listing
rule the purpose of this study is to specifically examine whether independent
remuneration committees reduce conflicts of interest by effectively linking CEO pay
with firm financial performance for ASX300 companies in 2001. Since 2001 was a time of
unregulated formation and composition of remuneration committees, the regulatory
context at the time is central to this study in a similar way to Rainsbury et al. (2009)
who examined the impact of voluntary formation of another board subcommittee, the Remuneration
audit committee, in an unregulated New Zealand context. We examine the period 2001 to committee
capture whether ASX300 firm boards had voluntarily established remuneration
committees and to measure the impact of varying degrees of remuneration committee independence
independence. The year 2001 was just before major regulatory changes to strengthen
corporate governance, but after mandated executive remuneration disclosure in the
Australian context. 199
We examine this research question through a series of regression models that are
tested against their corresponding implied hypotheses about existing associations. This
study starts with the simplest association between CEO remuneration and firm financial
performance, then evolves to models that test the importance of other intervening
variables, which could impact on this association either individually or through their
interaction effects. The first hypothesis examines whether a positive relationship exists
between CEO remuneration and firm financial performance, since shareholders use
rewards to induce CEO agents to work on the owners’ behalf and reduce agency
opportunism (Fama, 1980; Fama and Jensen, 1983). A rejection of this hypothesis
indicates no evidence of CEOs being rewarded for their performance or, alternatively,
that the model is incomplete and that important intervening factors associated with the
CEO remuneration for firm financial performance relationship have been overlooked.
Through further modelling, our study examines remuneration committee independence
and firm size. Interactions provide the opportunity to gain more insight about the
research question by analysing further than the initial result (Hayes and Matthes, 2009).
Since we expect that firm financial performance does not act alone in relation to
CEO remuneration, we also include interaction effects that some of these factors may
have with the performance measure on remuneration. A two-way interaction between
firm financial performance and remuneration committee independence was first
included in the model as a means of testing whether remuneration committee
independence aligns CEO remuneration with financial performance. Finally, we
investigate the model with a three-way interaction to test the combined impact of firm
financial performance, remuneration committee independence, and firm size on CEO
remuneration since all of these factors could influence CEO remuneration. We then
repeat the modelling process for CEO bonuses.
This study contributes to the limited research on voluntary remuneration committee
independence, in relation to CEO remuneration and firm financial performance, prior to
the proposed regulation of remuneration committees. Further, this study’s findings
contribute towards more informed public policy associated with corporate governance
about the impact of regulation on remuneration committee formation and composition
since the Productivity Commission’s (2009) recommendation to mandate remuneration
committee independence for ASX300 companies. The Commission made its
recommendation on the basis that these ASX300 firms are considered large and large
firms have the resources to establish effective remuneration committees to ensure CEOs
are paid for performance (Australian Government Productivity Commission, 2009).
We find that firm size is significantly associated with the link between CEO
remuneration, remuneration committee independence, and firm financial performance.
The study shows, however, that ASX300 firms are not homogeneous in relation to
remuneration committee independence aligning CEO remuneration to financial
performance. ASX300 large firm remuneration committees align CEO total
ARJ remuneration and bonuses to firm financial performance. Despite their remuneration
26,3 committee independence, smaller ASX300 firm remuneration committees are weakly
linked to CEO remuneration including bonuses and financial performance. Findings
are mixed for ASX300 medium-size firms with the most independent remuneration
committees aligning CEO bonuses with performance.
The remainder of the paper is organised in the following way: Section 2 discusses
200 studies relevant to the dependent and independent variables in the model development
process; while Section 3 explains the research design. Section 4 tests the research
question through a series of regression models and explains the analysis and Section 5
concludes the study.
2. Variables and relevant studies

2.1 Dependent variables: CEO total remuneration and bonuses
The dependent variables in this study are ASX300 Australian companies’ CEO total
remuneration and CEO bonuses in dollar terms. CEO bonuses, in particular, have
received public attention because cash incentives in the form of bonuses have grown
exponentially with more emphasis on performance-related pay for company executives
since the 1990s (Australian Government Productivity Commission, 2009). In this study,
CEO total remuneration comprises the sum in dollars of the fixed component (base salary,
fringe benefits, and superannuation) and a short-term incentive component (bonuses).
For example, the total remuneration of the Brambles Brambles, (2001) CEO comprised
salary, cash allowances, bonuses, superannuation, motor vehicle, and retirement benefits.
Base salary is a fixed form of remuneration and is normally contingent on the
leadership skills and experience of CEOs. Similarly, fringe benefits such as motor
vehicles and superannuation payments are not contingent on performance criteria,
per se, and their relative amounts vary depending on the remuneration package
negotiated with the employer company. Jensen et al. (2004) indicate that these fixed
forms of remuneration should not be excessive when compared to the size or
performance of the firm. Also, any increases in fixed remuneration should be partly
contingent on improved firm financial performance.
Share options are not included in this study for the following reasons, although share
options are an important element of CEO remuneration ( Jensen et al., 2004). First, CEO
total remuneration is expressed in dollar terms, which makes it difficult to include share
options because of incomplete and vague reporting about their dollar value. Dollar value
also varies depending on when share options have been, or will be, exercised. If share
options are not traded there is no observed market valuation that can be included in
executive pay (Hutchinson and Gul, 2004). Moreover, the features of managerial share
options are such that they have little resemblance to options on stocks or securities in
general. This also makes it difficult to accurately value them using the Black and Scholes
(1973) option valuation model. Second, target-based incentive plans were by far the most
widely used for Australian CEO remuneration in our 2001 sample companies
(Hay Group, 1998). Cash (rather than shares or share options) is the predominant type of
payment under these plans with the requirement of being employed at the beginning of
the period (Godfrey et al., 2003). Thus, two-thirds of our sample 2001 companies either
did not compensate or report their CEO share options.
Jensen et al. (2004) argued that there is no optimal remuneration solution as
non-economic organisational features such as culture, structure, and strategies must
be considered. Executive remuneration is negotiated in a largely self-regulated labour Remuneration
market for senior company executives, resulting in a variety of executive remuneration committee
packages to enhance flexibility to suit each company’s characteristics and goals
(Sheehan, 2009). Therefore, our final sample of companies varied considerably in their independence
remuneration structure. Not all the companies disclosed remuneration elements (such as
superannuation), while other companies did not remunerate their directors with fringe
benefits (such as motor vehicles). Because base salary, fringe benefits, and 201
superannuation are fixed forms of remuneration, it was possible to combine the three
forms of compensation into a total remuneration package. For this study, we examined
CEO total remuneration and CEO bonuses as dependent variables.
2.2 Independent variables

In the following section, we discuss the relevant research associated with the
independent variables that are linked to CEO remuneration and bonuses including firm
financial performance, remuneration committee independence, and firm size.
2.2.1 Firm financial performance measure. The UK Cadbury Committee report
(Cadbury, 1992) was one of the earliest investigations into the integrity of corporate
governance. This committee recommended a voluntary code of best practice to include
a remuneration committee, as described by Ezzamel and Watson (1998, p. 222):
The remuneration of executive directors (those who are executives of the company on whose
board they sit) should be subject to the recommendations of a remuneration committee
(made up wholly or mainly of non-executive directors), which should ensure that large pay
awards were justified by increases in firm performance and shareholders’ wealth.
Corporate boards argue that senior executives, particularly the CEO, should be
rewarded for managing a profitable company that provides appropriate returns to the
owners, and, at the same time, for reducing the agency problem or management
opportunism (Fama and Jensen, 1983; Fama, 1980). From a managerialism perspective,
Berle and Means (1932, p. 25) identified flaws in the separation of ownership and
control, stating that “the separation of ownership from control produces a condition
where the interests of owner and of ultimate manager may, and often do, diverge, and
where many of the checks which formerly operated to limit the use of power disappear”
(cited Tosi et al., 2000, p. 302). Managerialist logic argues that without external
constraints, executives are more focused on increasing the firm size to increase their
pay rather than increasing profits and firm performance (Tosi et al., 2000).
The separation of ownership from control inspired agency theory ( Jensen and
Meckling, 1976), which is based on the premise that principals (the shareholders)
delegate duties to an agent (the CEO), who is expected to act in the interest of the
principal. Agency theory is widely applied in corporate governance research because it
simplifies assumptions about the two participating parties, shareholders and managers
whose interests are assumed to be clear and consistent (Daily et al., 2003). Agency theory
makes assumptions about managers’ behaviour: to illustrate, agents are assumed to
be risk averse and self-centred and therefore, agents’ interests may differ from those of
the principal. Opportunistic behaviour by the agent is possible as the agent may have
different objectives from the principal and, thus, pursue a self-serving agenda. The
board, through the remuneration committee, use a variety of incentives such as bonuses
and options in an attempt to align management pay with firm financial performance in
the interest of shareholders ( Jensen, 2000; Jensen et al., 2004).
ARJ Evidence is mixed regarding the link between CEO remuneration and firm
26,3 financial performance. While Merhebi et al. (2006) found a positive relationship
between CEO remuneration and firm financial performance in their Australian study,
earlier Australian research for the years 1987-1992, by Izan et al. (1998), reported
no link between CEO remuneration and firm financial performance. A later study
that examined Australian board structural independence (1999-2006) reported that
202 independent boards were no better than executive dominated boards in enforcing CEO
remuneration for financial performance (Capezio et al., 2011).
Shaw and Zhang (2010) argued, however, that remuneration committees are reluctant
to punish CEO remuneration for poor earnings, when those poor earnings result, in part, on
investment decisions that are expected to generate positive future returns. Examples of
positive investment decisions are research and development expenditures or
restructurings. Using a yearly change in return on assets (ROA) as one proxy for
performance, Shaw and Zhang (2010) found in their US study that punishment in CEO
cash compensation for poor firm financial performance does not systematically occur.
Their research also examined the CEO remuneration-performance relation for firms with
strong corporate governance. Their results provided further doubt on the role of ex post
settling up in CEO cash compensation. In addition, they investigated the role of accounting
earnings in CEO compensation plans. Shaw and Zhang (2010) found that CEO
remuneration-performance sensitivity weakens for poor earnings performance, which is
consistent with studies that find CEO cash compensation is shielded from transitory
accounting losses (Gaver and Gaver, 1998) and restructuring charges (Dechow et al., 1994).
ROA is, therefore, the primary measure of company financial performance in this
study because companies typically base the incentive components of CEO remuneration
on financial accounting based measures (Merhebi et al., 2006; Shaw and Zhang, 2010).
Further, the Australian Productivity Commission (2009, p. 70) stated that:
Researchers investigating the relationship between pay and corporate performance are
limited to using publicly-available indicators. Some have used regression analysis to identify
statistical relationships between indicators of corporate performance and executive
remuneration. This approach is reasonable provided the data are adequate and the
indicators correspond with those used by companies to determine executive remuneration.
In this study, we lag ROA by one year as we expect CEO compensation to be based on
firm financial performance for the prior year.
2.2.2 Remuneration committee independence. Some executives sit on boards, thus
creating conflicts of interest when setting executive pay. To reduce conflicts of interest
the Cadbury Committee (1992) recommended that the remuneration committee comprise
a majority of NEDIRs to enhance independent decision-making about executive pay.
Remuneration committees generally consist of independent NEDIRs to form an arm’s
length group to enhance the integrity of the decision-making process. The Corporations
Act 2001 (Cth) does not define independence of directors, and Australian boards
generally adopt their own definition. The ASX Corporate Governance Council (2007)
defines an independent NEDIRs as one “who is free of any business or other
relationship that could materially interfere with the independent exercise of their
judgment, or be perceived to do so” (as cited in Australian Government Productivity
Commission, 2009, p. 174).
In 1993, independent remuneration committee composition became core US
regulation introduced by the Securities and Exchange Commission (SEC) and the
Internal Revenue Service (Vafeas, 2003). These regulations were motivated by the Remuneration
concern that when executive directors participated in remuneration committees’ committee
executive pay contracts, the remuneration committee was compromised resulting in pay
contracts that favoured management (Vafeas, 2003). independence
Vafeas (2003) investigated the impact of the US regulations on the requirement of
remuneration committees to comprise a majority of NEDIRs. After analysing 271 firms
for the 1991-1997 period, he reported a declining trend in executive director 203
membership of remuneration committees However, based on the evidence, he could not
conclude definitively that shareholders benefited from the US regulations to enhance
remuneration committee independence. Vafeas (2003) suggested that firms with
remuneration committees comprising outsiders were able to fend off uninvited public
scrutiny of pay practices and complying with the SEC’s 1992 disclosure rules about the
governance of executive compensation.

Conyon and Peck (1998), in their UK study of remuneration committees and executive
pay for 94 companies in the period 1991-1994, reported the positive relation between the
proportion of NEDIRs on a remuneration committee and senior management pay and
sensitivity of pay to performance. In contrast, Daily et al. (1998) found no link between
excessive CEO remuneration and remuneration committee dominance by executive
directors in their study of 194 US firms for the period of 1991. These findings are supported
by Newman and Mozes (1999), who analysed 1992 US company data for 161 firms and
found no relationship between CEO remuneration and executive director participation in
the remuneration committee. However, they noted that under certain conditions executive
pay for performance is skewed in management’s favour.
Sun et al. (2009) argued that because the SEC rules mandated wholly independent
compensation committees for US listed companies in 2003, a new and
more comprehensive measure of compensation committee quality was required. To
measure compensation committee quality, in relation to stock option grants and future
firm performance, their study introduced and factor-analysed the following six
characteristics: CEO appointed directors, long-serving outside directors, CEOs from
other firms, high director stock ownership, busy outside directors (with three or more
additional board seats), and larger boards.
This study concentrates on remuneration committee independence, as the Australian
Government Productivity Commission (2009, p. xxxvii) proposed public policy to
mandate remuneration committee independence stated in their Recommendation 2 for
ASX300 firms. The aim of this study, therefore, is to investigate whether remuneration
committees comprising NEDIRs link CEO remuneration and bonuses with performance
of Australian companies for 2001. In our study, the proportion of NEDIRs comprising the
remuneration committee measures independence, defined by the ASX Corporate
Governance Council (2003, 2007), and is categorised into three levels for the regression
analyses that included factor interactions (Table I and II).
2001 company reports ASX300

Total firms in the dataset 300
Less trusts and unavailable firms 2001 reports due to (124)
insolvencies, mergers, or no longer trading on ASX
Less firms with incomplete data (33)
Total sample 143 Table I.
ARJ 2.2.3 Firm size and executive compensation. Firm size does influence executive pay, as
26,3 larger companies seem to be prepared to pay for increased job importance and
complexity to attract more talented people, thus explaining 25-50 per cent observed
increases in executive pay in larger firms (Australian Government Productivity
Commission, 2009). Tosi et al. (2000) examined the links between firm size, firm
performance, and CEO remuneration in their meta-analysis, which formed part of
204 a review of the empirical literature on the determinants of CEO remuneration. Their
hypotheses specifically focused on:
.
firm performance and CEO remuneration; and
.
firm size and CEO remuneration.
They found that firm size accounted for more than 40 per cent of the variance in total
CEO remuneration, while firm performance accounted for less than 5 per cent of the
variance. Merhebi et al. (2006) tested the link between firm size and CEO remuneration of
Australian companies (1990-1999) and found a significant and positive result. They
argued that some evidence exists regarding size as a proxy for performance and that
“larger firms clearly have the capacity for higher remuneration packages regardless of
performance” (Merhebi et al., 2006, p. 495). Baker et al. (1988) questioned the notion of
size as a proxy for performance when they found evidence that CEOs are able to increase
their pay by increasing the firm size, even when the size increase reduces the firm’s
market value. They further suggested this motivation “could explain some of the vast
amount of inefficient expenditures of corporate resources on diversification programs
that have created large conglomerate organizations” (Baker et al., 1988, p. 609).
Additionally, Tosi et al. (2000, p. 329) argued that their findings were consistent with:
[. . .] those theoretical explanations that emphasize organizational size as an important
determinant of total CEO remuneration; that is, indicators of firm size, taken together, explain
almost nine times the amount of variance in total CEO remuneration than the most highly
correlated performance measure. A lesser effect is demonstrated in the findings regarding
pay sensitivity as well as in the difference in the pay/performance or pay/firm growth
sensitivities. Changes in firm performance account for only 4 per cent of the variance in CEO
remuneration, while changes in firm size account for 5 per cent of the variance in CEO
remuneration. These results are consistent with Jensen and Murphy’s (1990) conclusion that
“incentive alignment” as an explanatory agency construct for CEO remuneration is weakly
supported at best.
A number of measures of firm size appear in the literature, including sales revenue, log of
net sales, net income, total assets (Hagerman and Zmijewski, 1979; Skinner, 1994), and
log of total assets (Reynolds et al., 2004). Hagerman and Zmijewski (1979) argue that no
measure of size is necessarily better than another. Therefore, we use total assets as a
proxy for firm size and partition our sample into thirds for large, medium, and smaller
firms to normalise the data (see Table III for mean total assets for each category).
3. Research design
Sample
To capture the varying levels of voluntary remuneration committee independence, we
expressly analyse data from ASX300 companies’ 2001 annual reports. The timeframe,
2001, is of interest because it is just after mandated executive remuneration disclosure,
but before the introduction of regulation to strengthen corporate governance including
the ASX recommendation for remuneration committee independence. In fact, little Remuneration
variation now exists in remuneration committee composition of ASX300 companies as
most now have independent remuneration committees. Further, Clarkson et al. (2011)
committee
concluded that extensive regulatory change between 2001 and 2009 had enhanced independence
oversight of the executive compensation process through strengthened corporate
governance regulations and increased transparency.
205
Overview of increased corporate governance regulation post-2001
We, therefore, examine ASX300 companies in a corporate governance context before the
enactment of legislation that increased regulatory scrutiny of directors’ responsibilities
in response to corporate collapses, such as Enron in December 2001. The US Congress
enhanced corporate regulation by enacting the Sarbanes-Oxley Act (SOX) (2002). These
new corporate governance rules and requirements affected US-based trading firms and
Australian companies associated with the US capital markets. Additionally, Australian
based transnational audit firms began to use elements of SOX in their audits of
Australian companies. The Australian Government’s Company Law Economic Reform
Program (CLERP), concerning corporate governance, soon followed and was enacted
as CLERP 9 in 2004. Moreover, the ASX Corporate Governance Council’s (2003, 2007)
Corporate Governance Principles and Recommendations were introduced and
encouraged firms to implement independent remuneration committees that included a
majority of NEDIRs.
Mandated executive remuneration disclosure pre-2001

Australian regulation mandated disclosure of directors’ and executives’ remuneration
with the introduction of the Company Law Review Act 1998, revised May 1999
(Australian Securities and Investments Commission, 1998). Section 300A required
executive remuneration to be disclosed by listed Australian companies for financial
years after 1 July 1998. The Act requires financial statement disclosure of emoluments
of the five most highly remunerated officers. Originally, executive remuneration was
disclosed in bands and not the actual amounts paid to executives. This requirement
was removed and the accounting standard required companies to disclose aggregate
remuneration of all executive officers whose remuneration for the financial year is
$100,000 (Australian Accounting Standards Board (AASB) (1999) 1034).
The amended AASB 1034 became operative for companies at financial year end
30 June 2001, so our sample of companies covers this specific period for the end of
the financial year 2001. AASB (2005) 101 superseded this standard in July 2004
Level n
REMCindep
0 Lowest proportion: firms with no remuneration 27
committee or a minority of NEDIRs – least
independent
1 Firms with a majority of NEDIRs on remuneration 42 Table II.
committees Remuneration committee
2 100 percent NEDIRs on remuneration committees – 74 independence as
most independent proportion of NEDIR at
Total 143 three levels
ARJ (operative 1 January 2005) to comply with the International Accounting Standards and
26,3 executive remuneration was specifically guided by AASB (2004) 1046 Director and
Executive Disclosures by Disclosing Entities.
Events influencing final sample

Other contextual events influenced the collection of our sample of 2001 company
206 financial reports. These events include the internet bubble crash in March 2001 that
resulted in several corporate collapses and general investor turmoil in the following
years’ financial reports (Boyer, 2005). For example, we looked for several IT companies
that were in our 2001 sample, but found they were non-existent in 2002, either insolvent
or merged. The 11 September 2001 attack on New York’s Twin Towers also resulted in
further investor turmoil that exacerbated the impact of the internet bubble crash.
Additionally, we found ASX300 company composition after 2001 was affected by high
changeability (survivorship) due to mergers, insolvencies, and, to some extent, the
re-privatising of public companies, making it difficult to sustain a longitudinal study
with a reasonable sample of the original 2001 ASX300 companies.
Our final sample of companies in this study consists of 143 large publicly listed
Australian companies. The companies were chosen from the S&P/ASX 300[3] database
for 2001. Given that compulsory disclosure of corporate governance practices and
executive remuneration has only existed since late 1998 in Australia, extending the scope
of this study prior to this period would be pointless, as appropriate data to carry out the
study would not be publicly available. Further, we concluded that the effectiveness of
various committees, such as remuneration committees, could not be evaluated before 2000
because these committees were in the process of being established in many companies.
We individually downloaded S&P/ASX300 company reports for 2001 from
FinAnalysis, supplemented with data from Connect4 databases. From the 300 firms,
the sample consisted of 176 firms after excluding 124 firms that comprised trusts and
firms whose reports were unavailable owing to insolvencies, mergers or no longer
trading. Out of the initial 176 companies, a final sample of 143 companies had the
appropriate CEO remuneration and remuneration committee information. Surprisingly,
our sample included 45 companies that chose not to compensate their CEOs with
incentives. This is contrary to the recommendations of various committees, such as the
Cadbury Committee, and previous research (Baber et al., 1996; Beatty and Zajac, 1994;
Brunello et al., 2001; Carpenter and Sanders, 2002) which suggests that an effective
mechanism for aligning management’s interest with that of shareholders is to
compensate managers with short- and long-term incentives that are linked to firm
financial performance. Table I describes the sample used in this study.
Each report in our final sample of 143 was manually examined to collect information
pertinent to this study. This hand-collected data included the dollar amounts for the CEO
remuneration components required for the dependent variables. The proportion of
NEDIRs on the remuneration committee was also hand collected for the categorical
independent variable remuneration committee independence. Essentially, the sample
companies had to disclose base salary, superannuation, fringe benefits, bonuses, share
options, and corporate governance information about the composition of remuneration
committees. FinAnalysis provided data for accounting information, ROA, and dollar
value of total assets to measure the independent variables, firm financial performance,
and firm size.
3.1 Measurement of variables Remuneration
CEOtotal is the dependent variable measured as the natural logarithm of CEO committee
remuneration comprising the dollar sum of base pay, superannuation, fringe benefits,
and bonuses reported in 2001 ASX300 company reports. independence
CEObonus is the other dependent variable measured as the natural logarithm of the
short-term incentive for performance (in dollars) as part of CEO total remuneration
from the 2001 ASX300 company reports. 207
ROAlag1 is a continuous independent variable that is a measure of company
performance resulting from management’s productive use of company assets. ROA is
calculated as earnings before interest (total assets less outside equity interests) and is a
key measure of a company’s profitability, equal to a fiscal year’s earnings divided by its
total assets. ROA essentially shows how much profit a company is making on the assets
used in its business. ROA is lagged, as CEO compensation in our 2001 sample would
have been based on firm financial performance for the prior year (2000).
REMCindep is measured as a proportion (percentage) of NEDIRs in the committee.
It was calculated by summing the number of NEDIRs in the committee and dividing
that figure by the total number of directors in that committee. Table II reports the
categorisation of REMCindep into three levels as follows: companies with no
remuneration committees or remuneration committees with a minority proportion of
(NEDIRs) are designated as 0; companies with a majority proportion less than 100 per
cent of NEDIRs on the remuneration committee are designated as 1; and, those
companies having all NEDIRs on the remuneration committee are designated as 2.
Size is an independent variable measured as total assets ($ value) categorised into
three levels of approximately equal number of firms: smaller firms ¼ 0, medium
firms ¼ 1, and larger firms ¼ 2 (with the mean total assets for each category shown in
Table III). Transformation of firm Size into log total assets is unnecessary as this is
a categorical variable and, therefore, treated as a categorical variable in the
regression models.
Industry is a categorical variable to control for industry differences. Industry groups
comprise the ten sectors of the Global Industry Classification Standard (GICS) used by
the ASX for industry classification (Australian Securities Exchange, 2010a, b). For
analysis purposes, this study classifies ten industry sectors into four industry groups
based on similarities in the nature of the industry. As outlined in Table IV, Panels A and
B, industry is categorised: energy and mining ¼ 1, industrials ¼ 2, consumer ¼ 3, and
services ¼ 4.
4. Model development and results

Through a series of evolving models, we test the research question: whether
remuneration committee independence (REMCindep) effectively links CEO total
Size at three levels Level Mean of assets $M SD n
Smaller firms 0 148 779 46

Medium-sized firms 1 787 37 49 Table III.
Larger firms 2 18,980 47,950 48 Firm size (total asset –
Total mean 143 $ millions) at three levels
ARJ
Panel A: industry groups based on GICS code and industry sector
26,3 Industry groups GICS code Sector
1. Energy and mining 10 Energy
15 Materials
2. Industrials 20 Industrials
3. Consumer 25 Consumer discretionary
208 30 Consumer staples
4. Services 35 Health care
40 Financials
50 Telecommunication services
55 Utilities
Panel B: the no. of firms for each industry group
Industry sector
1. Energy and mining 33 (23.132%)
2. Industrials 21 (14.673%)
3. Consumer 44 (30.674%)
Table IV. 4. Services 45 (31.521%)
remuneration (CEOtotal ) and bonuses (CEObonus) with prior year’s firm financial
performance (ROAlag1) for the period of 2001.
A higher ROA indicates management’s ability to use company assets efficiently in
serving shareholders’ economic interests. Therefore, we expect a positive association.
The link between CEO total remuneration and firm financial performance is first tested
without taking into consideration the effect of remuneration committee independence.
We use the general linear model (GLM) procedure in SPSS. This is a flexible statistical
model that incorporates normally distributed dependent variables and categorical or
continuous independent variables (McCullagh and Nelder, 1989; Nelder and
Wedderburn, 1972). GLM allows factors (and interactions of factors) as predictors,
rather than just continuous variable predictors, in the models we are estimating; and is
appropriate because this research relied on considering the interactions between factor
variables.
Model 1: regression – CEO total remuneration and firm financial performance
CEOtotal ¼ b0 þ b1 ROAlag1 þ b2 Industry þ e
Model 1 showed a non-significant relationship for the link between CEO

remuneration and firm financial performance (Table V, p ¼ 0.977). We argue,
however, that Model 1 is incomplete and other important factors are involved in
explaining CEO remuneration outcomes. Other factors deemed important in the
literature (i.e. remuneration committee independence and firm size) are tested by
considering Model 2.
Model 2 examines and tests the impact of an independent remuneration committee
as a corporate governance intervention. The independence of the remuneration
committee is represented by the proportion of NEDIRs on that committee, categorised
into three levels as follows: 74 firms had remuneration committees comprising
100 per cent of NEDIRs (i.e. the most independent remuneration committees); 42 firms
had remuneration committees with majority NEDIR composition; and 27 firms had no
Remuneration
Variable F p-value
committee
Intercept 26,256.166 0.000 independence
Industry 0.147 0.932
ROAlag1 0.004 0.952
Likelihood ratio x 2 ¼ 0.462, df ¼ 4 ( p ¼ 0.977)
Notes: Significance at: *p , 0.10, * *p , 0.05, * * *p , 0.01 and * * * *p , 0.001 (all p-values are 209
two-tailed):
CEOtotal ¼ b0 þ b1 ROAlag1 þ b2 Industry þ e
Table V.
CEOtotal – natural logarithm of CEO total remuneration ($) comprising base pay þ superannuation/ Model 1 CEO total
fringe benefits þ bonuses; ROAlag1 – return on assets for the prior year 2000; industry – industry remuneration and firm
groups based on GIC sectors, 1 – energy and mining, 2 – industrials, 3 – consumer and 4 – services financial performance
remuneration committees or remuneration committees with a minority of NEDIRs

(i.e. the least independent remuneration committees, see Table II).
Model 2: regression, a two-way interaction model for CEO total remuneration on firm
financial performance and remuneration committee independence
CEOtotal ¼ b0 þ b1ðROAlag1*REMCindepÞ þ b2 Industry þ e
where: b1 is now a vector of coefficients for the various levels of the interaction term in
the model.
In Model 2, we test the effect of a two-way interaction between firm financial
performance and remuneration committee independence on CEO remuneration. This is
to investigate whether remuneration committees control CEO pay in line with firm
financial performance in at least some partitions of the group of firms characterized by
the different levels of remuneration committee independence. For theoretical reasons,
the main effects ROAlag1 and REMCindep are not included because the interaction
effect between them is significant in Model 2 ( p ¼ 0.01). To set up a model that includes
these two main effects, and interpret their coefficients and hypothesis tests as main
effects, is not theoretically justified or correct when their interaction effect is significant,
except under limited conditions (Hayes, 2005, pp. 452-456; Irwin and McClelland, 2001;
Jaccard and Turrisi, 2003, p. 24).
The two-way interaction model for CEO total remuneration is significant (F3,136 ¼ 3.7;
p ¼ 0.01, Table VI) indicating that independent remuneration committees are
significantly associated with the relationship between CEO total remuneration and
prior year’s firm financial performance. We examine the three coefficient parameter
estimates for the interaction term in Table VII to ascertain in which subgroup/s of
remuneration committee independence the association between CEO remuneration and
firm financial performance is significant, and whether it is a positive or negative one. We
find that for the most independent remuneration committees (with 100 per cent NEDIR
composition) the association between performance and CEO remuneration is significant
and positive ( p ¼ 0.06, Table VII). However, for the least independent remuneration
committees (with either no remuneration committee or a minority of NEDIRs) the
association between firm financial performance and CEO remuneration is significant and
negative ( p , 0.05, Table VII).
ARJ
Variable F p-value
26,3
Intercept 2,624.072 0.000
ROAlag1*REMCindep 3.717 0.013 * * *
210 Notes: Significance at: *p , 0.10, * *p , 0.05, * * *p , 0.01 and * * * *p , 0.001 (all p-values are
two-tailed):
Table VI. CEOtotal ¼ b0 þ b1 ðROAlag1* REMCindepÞ þ b2 Industry þ e
Model 2 CEO total
remuneration and CEOtotal – natural logarithm of CEO total remuneration ($) comprising base pay þ superannuation/fringe
two-way interaction benefits þ bonuses; ROAlag1 – return on assets for the prior year 2000; REMCindep is the proportion of
between firm (NEDIRs) on the remuneration committee (RC), categorised into 0 – firms with no RCs or a minority NEDIRs,
performance and the least independent RCs; 1 – a majority of NEDIRs on firm RCs but less than 100 per cent; 2 – 100 per cent
remuneration committee NEDIR composition, the most independent RCs; industry – industry groups based on GIC sectors, 1 –
independence energy and mining, 2 – industrials, 3 – consumer and 4 – services
Variable b SE t p-value
Intercept 13.67 0.158 86.467 0.000

Energy and mining 2 0.056 0.210 20.265 0.792
Industrials 2 0.163 0.241 20.675 0.501
Consumer 2 0.125 0.193 20.648 0.518
Services 0a
ROAlag1*[REMCindep ¼ 0] 2 0.024 0.012 21.996 0.048 * *
ROAlag1*[REMCindep ¼ 1] 0.026 0.018 1.449 0.150
ROAlag1*[REMCindep ¼ 2] 0.025 0.013 1.883 0.062 *
Notes: Significance at: *p , 0.10, * *p , 0.05, * * *p , 0.01 and * * * *p , 0.001 (all p-values are two-
tailed); athis parameter is set to zero because it is redundant:
Table VII. CEOtotal ¼ b0 þ b1 ðROAlag1* REMCindepÞ þ b2 Industry þ e
Model 2 CEO total
remuneration parameter CEOtotal – natural logarithm of CEO total remuneration ($) comprising base pay þ superannuation/fringe
estimates for two-way benefits þ bonuses; ROAlag1 – return on assets for the prior year 2000; REMCindep is the proportion of
Interaction between firm NEDIRs on the remuneration committee (RC), categorised into 0 – firms with no RCs or a minority NEDIRs,
financial performance the least independent RCs; 1 – a majority of NEDIRs on firm RCs but less than 100 per cent; 2 – 100 per cent
and remuneration NEDIR composition, the most independent RCs; industry – industry groups based on GIC sectors, 1 –
committee independence energy and mining, 2 – industrials, 3 – consumer and 4 – services
This explains the lack of significance for Model 1, since the CEO remuneration for firm
financial performance relationship is neither consistently significant nor consistently
positive for all three levels of remuneration committee independence. The model fit is
significant ( p ¼ 0.07 , 0.1), using the maximum likelihood ratio x 2 test. However,
the model fit can be improved by including firm size as a three-way interaction term with
the other two independent variables.
Model 3: regression – a three-way interaction model for CEO total remuneration on Remuneration
firm financial performance, remuneration committee independence and firm size committee
Prior research by Tosi et al. (2000) and Merhebi et al. (2006) examined firm size and
financial performance separately in relation to CEO remuneration. These studies suggest independence
that large firms generously pay their CEOs and executives and size was found to be a
more important criterion than financial performance alone. Recall that our study
contributes to corporate governance research and associated public policy by examining 211
whether varying levels of remuneration committee independence align CEO total
remuneration with firm financial performance for ASX 300 companies in an essentially
voluntary context. Although we examine ASX300 firms, these firms vary in size and are
not homogeneous. Firm size (Size) is categorised into the following three levels (described
in Table III): smaller firms (n ¼ 46, mean 148, SD 77 in $m), medium firms (n ¼ 49, mean
787, SD 373 in $m), and large firms (n ¼ 48, mean 18,980, SD 47,950 in $m). This
categorisation of size allows analysis of the model with a three-way interaction below:
CEOtotal ¼ b0 þ b1ðSize*ROAlag1*REMCindepÞ þ b2 Industry þ e
where: b1 is a vector of coefficients for the various levels of the interaction term in the
three-way interaction model (Friedrich, 1982; Jaccard and Turrisi, 2003). For Model 3,
Table VIII reports a significant high-order relationship (F12,130 ¼ 8.94, p ¼ 0.001)
between the dependent variable, CEO total remuneration (CEOtotal ) and the three-way
interaction with firm size (Size), prior year’s firm financial performance (ROAlag1), and
remuneration committee independence (REMCindep). Model 3 is a much better fit than
Model 2, as indicated by the maximum likelihood x 2 test ( p , 0.001). Table IX reports
further analysis of this three-way interaction revealing that firm size matters, with very
significant positive associations for large firms ( p , 0.01) between CEOtotal and firm
financial performance (ROAlag1) for all three levels of remuneration committee
independence (REMCindep).
The results for the three-way interaction are particularly strong ( p , 0.001),
especially for large firms with remuneration committees comprising 100 per cent
Variable F p-value
Intercept 12,175.206 0.000

Size*ROAlag1*REMCindep 8.940 0.000 * * * *
Notes: Significance at: *p , 0.10, * *p , 0.05, * * *p , 0.01 and * * * *p , 0.001 (all p-values are
two-tailed):
CEOtotal ¼ b0 þ b1 ðSize* ROAlag1*REMCindepÞ þ b2 Industry þ e
Table VIII.
CEOtotal – natural logarithm of CEO total remuneration ($) comprising base pay þ superannuation/ Model 3 CEO total
fringe benefits þ bonuses; Size – total assets ($ value) categorised into thirds: 0 – smaller firms, 1 – remuneration and
medium firms, 2 – larger firms; ROAlag1 – return on assets for the prior year 2000; REMCindep is the three-way interaction
proportion of NEDIRs on the remuneration committee (RC), categorised into 0 – firms with no RCs or a between firm size, firm
minority NEDIRs, the least independent RCs; 1 – a majority of NEDIRs on firm RCs but less than financial performance
100 per cent; 2 – 100 per cent NEDIR composition, the most independent RCs; industry – industry and remuneration
groups based on GIC sectors, 1 – energy and mining, 2 – industrials, 3 – consumer and 4 – services committee independence
ARJ
26,3
Intercept 13.554 0.141 96.452 0.000
Energy and mining 20.312 0.186 21.680 0.095
Industrials 20.171 0.204 20.838 0.404
Consumer 20.324 0.170 21.908 0.059
212 Services 0a
[Size ¼ 0 smaller]*[REMCindep ¼ 0]*ROAlag1 20.023 0.011 22.184 0.031 * *
[Size ¼ 0 smaller]*[REMCindep ¼ 1]*ROAlag1 20.016 0.021 20.751 0.454
[Size ¼ 1 med]*[REMCindep ¼ 0]*ROAlag1 20.014 0.030 20.467 0.641
[Size ¼ 1 med]*[REMCindep ¼ 1]*ROAlag1 0.059 0.025 2.335 0.021 * *
[Size ¼ 2 large]*[REMCindep ¼ 0]*ROAlag1 0.152 0.051 2.970 0.004 * * *

[Size ¼ 2 large]*[REMCindep ¼ 1]*ROAlag1 0.126 0.025 4.991 0.000 * * * *
[Size ¼ 2 large]*[REMCindep ¼ 2]*ROAlag1 0.139 0.023 6.153 0.000 * * * *
Table IX. CEOtotal ¼ b0 þ b1 ðSize*ROAlag1*REMCindepÞ þ b2 Industry þ e
Model 3 CEO total
remuneration parameter CEOtotal – natural logarithm of CEO total remuneration ($) comprising base pay þ superannuation/
estimates for three-way fringe benefits þ bonuses; Size – total assets ($ value) categorised into thirds: 0 – smaller firms, 1 –
interaction between firm medium firms, 2 – larger firms; ROAlag1 – return on assets for the prior year 2000; REMCindep is the
size, remuneration proportion of NEDIRs on the remuneration committee (RC), categorised into 0 – firms with no RCs or a
committee independence, minority NEDIRs, the least independent RCs; 1 – a majority of NEDIRs on firm RCs but less than 100
and firm financial per cent; 2 – 100 per cent NEDIR composition, the most independent RCs; industry – industry groups
performance based on GIC sectors, 1 – energy and mining, 2 – industrials, 3 – consumer and 4 – services
NEDIRs and for firms with a majority of NEDIRs ( p ¼ , 0.001). Results are weaker
( p , 0.005) for firms with no remuneration committees or a minority NEDIRs. For
medium and smaller size firms, the only significant positive association between CEO
total pay and prior year’s firm financial performance occurred for medium-sized firms
with remuneration committees comprising a majority of NEDIRs ( p , 0.05).
Interestingly, a significant negative relationship between CEOtotal and prior year’s
firm financial performance was found for smaller firms with no remuneration
committees or remuneration committees with a minority of NEDIRs (the lowest level of
remuneration committee independence). This last result suggests that smaller firms
with the least independent remuneration committees recompense their CEOs even when
these firms are not performing financially. The results also show the ineffectiveness of
remuneration committees to align CEO total pay with firm financial performance for
smaller firms regardless of the composition of the remuneration committee.
4.1 CEO bonuses

CEO bonuses represent short-term incentives that should be based directly on firm
financial performance. Therefore, similar to previous arguments, an independent
remuneration committee should control CEO incentive pay or bonuses for performance.
The testing process of Models 1-3 is a similar process as for Models 4-6, but with
CEO bonuses as the dependent variable.
Model 4: regression – CEO bonuses and firm financial performance Remuneration
CEObonus ¼ b0 þ b1 ROAlag1 þ b2 Industry þ e committee
independence
Model 4, with CEO bonuses (CEObonus) as the dependent variable, is not significant
( p ¼ 0.22) indicating that our sample of firms showed no evidence of aligning CEO
bonus pay with prior year’s performance (Table X). As before, we argue that this model
is incomplete and other intervening variables are involved. Thus, we include 213
remuneration committee independence in Model 5 to improve the model fit, as in
Models 1-3 that tested CEO total remuneration as the dependent variable.
Model 5: regression – a two-way interaction model for CEO bonuses on firm financial
performance and remuneration committee independence

CEObonus ¼ b0 þ b1 ðROAlag1*REMCindepÞ þ b2 Industry þ e
In Model 5 we test CEO bonuses and the two-way interaction between firm financial
performance and remuneration committee independence. The result was not
significant ( p ¼ 0.238), as shown in Table XI. The two-way interaction shows only
marginal significance ( p ¼ 0.1). We conclude that our sample of firms, when
partitioned by the independence level of their remuneration committee, show no
evidence of aligning CEO bonuses with prior year’s firm financial performance within
any subgroup of remuneration committee categorised at three levels of independence.
Model 6: regression model – a three-way interaction model for CEO bonus on firm
financial performance, remuneration committee independence and firm size
Next, in Model 6, we investigate the association between the dependent variable CEO
bonus, and the three-way interaction between firm size, prior year’s firm financial
performance, and remuneration committee independence. Table XII Model 6 reports a
significant three-way interaction (F9,129 ¼ 2.24, p , 0.05), but not as strong as for
Model 3 that shows CEO total remuneration ( p , 0.001). Just as for CEO total
remuneration, Table XIII reports further analysis of Model 6 interaction and shows a
strong positive relationship between CEO bonuses and prior year’s financial
performance (ROAlag1) for large firms at all three levels of remuneration committee
independence (REMCindep). The relationship is strongest ( p , 0.002) for large firms
Variable F p-value
Intercept 102.202 0.000

ROAlag1 0.589 0.444
2
Likelihood ratio x ¼ 5.73, df ¼ 4 ( p ¼ 0.22)
tailed):
CEObonus ¼ b0 þ b1 ROAlag1 þ b2 Industry þ e Table X.
Model 4 CEO bonuses
CEObonus – natural logarithm of CEO bonuses; ROAlag1 – return on assets for the prior year 2000; with firm financial
industry – industry groups based on GIC sectors, 1 – energy and mining, 2 – industrials, 3 – consumer and performance
4 – services
ARJ
Variable F p-value
26,3
Intercept 106.083 0.000
ROAlag1*REMCindep 2.727 0.101
214 Notes: Significance at: *p , 0.10, * *p , 0.05, * * *p , 0.01 and * * * *p , 0.001 (all p-values are two-
tailed):
CEObonus ¼ b0 þ b1 ðROAlag1*REMCindepÞ þ b2 Industry þ e
Table XI.
Model 5 CEO bonuses CEObonus – natural logarithm of CEO bonuses; ROAlag1 – return on assets for the prior year 2000;
and two-way interaction REMCindep is the proportion of NEDIRs on the remuneration committee (RC), categorised into 0 – firms
between firm financial with no RCs or a minority NEDIRs, the least independent RCs; 1 – a majority of NEDIRs on firm RCs but
performance and less than 100 per cent; 2 – 100 per cent NEDIR composition, the most independent RCs; Industry –
remuneration committee industry groups based on GIC sectors, 1 – energy and mining, 2 – industrials, 3 – consumer and 4 –
independence services
Variable F p-value
Intercept 40.354 0.000

Size*ROAlag1*REMCindep 2.244 0.023 * *
tailed):
CEObonus ¼ b0 þ b1 ðSize*ROAlag1*REMCindepÞ þ b2 Industry þ e
Table XII. CEObonus – natural logarithm of CEO bonuses; Size – total assets ($ value) categorised into thirds: 0 –
Model 6 CEO bonuses smaller firms, 1 – medium firms, 2 – larger firms; ROAlag1 – return on assets for the prior year 2000;
and three-way interaction REMCindep is the proportion of NEDIRs on the remuneration committee (RC), categorised into 0 – firms
between firm size, firm with no RCs or a minority NEDIRs, the least independent RCs; 1 – a majority of NEDIRs on firm RCs
financial performance, but less than 100 per cent; 2 – 100 per cent NEDIR composition, the most independent RCs; Industry –
and remuneration industry groups based on GIC sectors, 1 – energy and mining, 2 – industrials, 3 – consumer and 4 –
committee independence services
with remuneration committees comprising 100 per cent NEDIRs. This result shows
that the largest firms with the most independent remuneration committees consistently
paid CEO bonuses in line with firm financial performance, thus demonstrating that
CEO bonuses are somewhat controlled by independent remuneration committees for
this subgroup of firms.
We find a weaker result for large firms with remuneration committees having a majority
of NEDIRs or mid-level independence ( p , 0.05); while, those firms with no remuneration
committees or a minority of NEDIRs were weaker still ( p , 0.01). Table XIII also reports a
positive significant result for medium-sized firms with 100 per cent NEDIRs ( p ¼ ,0.05).
These results suggest that large and medium firm groups with 100 per cent NEDIRs on
their remuneration committees are the most effective in controlling CEO bonus incentives
in line with prior year’s firm financial performance. The results also show the
Remuneration
committee
Intercept 8.019 1.025 7.820 0.000 independence
Energy and mining 2 0.510 1.357 2 0.376 0.708
Industrials 2 2.613 1.490 2 1.754 0.082
Consumer 2 2.983 1.246 2 2.394 0.018
Services 0a 215
[Size ¼ 0 smaller]*[REMCindep ¼ 0]*ROAlag1 2 0.016 0.078 2 0.202 0.840
[Size ¼ 1 med]*[REMCindep ¼ 2]*ROAlag1 0.423 0.180 2.345 0.021 * *

[Size ¼ 2 large]*[REMCindep ¼ 1]*ROAlag1 0.359 0.184 1.948 0.054 * *
CEObonus ¼ b0 þ b1 ðSize*ROAlag1* REMCindepÞ þ b2 Industry þ e Table XIII.
Model 6 CEO total
CEObonus – natural logarithm of CEO bonuses; Size – total assets ($ value) categorised into thirds: 0 bonuses, parameter
– smaller firms, 1 – medium firms, 2 – larger firms; ROAlag1 – return on assets for the prior year estimates for three-way
2000; REMCindep is the proportion of NEDIRs on the remuneration committee (RC), categorised into 0 interaction between firm
– firms with no RCs or a minority NEDIRs, the least independent RCs; 1 – a majority of NEDIRs on size remuneration
firm RCs but less than 100 per cent; 2 – 100 per cent NEDIR composition, the most independent RCs; committee independence
Industry – industry groups based on GIC sectors, 1 – energy and mining, 2 – industrials, 3 – and firm financial
consumer and 4 – services performance
ineffectiveness of remuneration committees to align CEO bonuses with firm financial

performance for the smaller firms regardless of the composition of the remuneration
committee.
5. Discussion and conclusion

The Productivity Commission’s key draft recommendation (Australian Government
Productivity Commission, 2009, p. xxxiii) proposed a new ASX listing rule specifying
that “all ASX300 companies have a remuneration committee of at least three members,
all of whom are non-executive directors, with the chair and a majority of members
being independent” to avoid conflicts of interest when paying executives. Our study
examines whether remuneration committee independence aligns CEO compensation
with performance for ASX300 firms during 2001, a period of voluntary corporate
governance.
We show that firm size is an important factor in determining whether voluntary
remuneration committees align CEO remuneration with firm financial performance.
Companies having remuneration committees comprising all NEDIRs do not always
align CEO total pay or CEO bonuses with firm financial performance. Our study finds
that large firm remuneration committees align both CEO total remuneration and CEO
bonuses with firm financial performance at all levels of remuneration committee
independence; although, the most effective committees (i.e. with model coefficients
ARJ having the smallest p-values) have 100 per cent NEDIR membership. The study also
26,3 shows that smaller firm remuneration committees are ineffective in reducing conflicts of
interest in relation to CEO total remuneration and bonuses for firm financial
performance regardless of the level of their remuneration committee independence.
Results for medium-sized firms are mixed. Those medium-sized firms with
remuneration committees with a majority of NEDIRs link CEO total remuneration
216 with firm financial performance, while medium-sized firms with remuneration
committees comprising 100 per cent NEDIRs link CEO bonuses with firm financial
performance.
Our evidence suggests that the Australian Government Productivity Commission’s
(2009) recommendation to mandate independent remuneration committees to align
CEO remuneration with firm financial performance may not be effective public policy,
particularly for medium and smaller ASX300 firms. To address corporate CEO
remuneration excesses, policy makers need to be aware of additional factors, such as
remuneration committee quality (Sun et al., 2009), because larger firms have the
resources to attract and employ higher quality human and intellectual resources
including quality independent directors (Australian Government Productivity
Commission, 2009). Moreover, the CEOs of large firms are more likely to
achieve appropriate firm financial performance supported by extensive resources
(Merhebi et al., 2006).
Our study shows that CEOs of smaller firms receive full remuneration (including
bonuses), but that this remuneration has weak links to performance. This finding
suggests that the CEOs of smaller firms appear to attract less public and market scrutiny
than their larger counterparts and that smaller firms pay their CEOs regardless of
whether these firms perform or not. In the US regulatory context, where independent
compensation committees have been mandatory since 2003, Sun et al. (2009) found that
higher compensation committee quality, comprising a multi-dimensional measure, led to
a greater incentive alignment in executive compensation contracts in relation to future
firm financial performance. Future research could compare the 2001 sample of ASX 300
firms with a sample of 2012 ASX 300 firms to see the regulatory impact of increased
remuneration committee independence. Additionally, the quality of remuneration
committee composition in the more regulated Australian context could also be examined.
While our study provides evidence about remuneration committee independence
interventions in ASX300 companies, there are limitations. Our sample of firms was
restricted to 2001, a time when it was possible to capture varying levels of remuneration
committee independence prior to increased corporate governance regulations. As with
most social science research, the models used to test the hypotheses are not complete and
we acknowledge that other important factors or interaction terms may not have been
included when investigating the relationship between CEO total pay and firm financial
performance. Multicollinearity, however, becomes a problem if too many financial
variables are included in the same model. We also acknowledge that this study is
unlikely to be completely free of endogeniety because “the potential for endogeniety
exists for virtually all studies involving accounting, finance and economics variables”
(Chenhall and Moers, 2007, p. 177). As they suggest, we have attempted to deal with
potential endogeniety by identifying the dependent variable and
independent/explanatory variables to be included in the models based on theory and
prior empirical evidence.
Notes Remuneration
1. The Corporate Law Economic Reform Program (Audit Reform and Corporate Disclosure) committee
Act (2004) included s 250R(2) in the Corporations Act 2001 (Cth) as part of the legislative
reforms to the disclosure of director and executive remuneration. “Section 250R(2) requires independence
that a resolution that the remuneration report (attached to the directors’ report) be adopted
be put to shareholder vote at the annual general meeting (AGM) of listed companies. Section
250R(3) provides that this vote is to be non-binding. While a majority of voting shareholders
may vote against the proposed remuneration, the ultimate decision whether to accept the
217
report rests with the board” (Chapple and Christensen, 2005, p. 263). Shareholders’
non-binding vote on remuneration appears to have resulted in improved communication
between boards and shareholders and enhanced remuneration practices, despite initial
opposition by the local business community (Fels, 2010). The problem is that some boards
have ignored shareholders’ non-binding vote regarding executive remuneration (Fels, 2010).
In fact, the Australian Corporations Act was amended in 2011 to enact shareholders’ binding
vote or the Two Strike Rule. When there are two successive negative votes on board
remuneration reports at annual general meetings by 25 per cent or more of shareholders, the
company must formally respond by asking all board members except the CEO to stand for
re-election within 90 days. One-third of all board positions in Australian public companies
are elected every year (Sheehan, 2012).
2. The Productivity Commission undertook a public inquiry into the regulatory framework
around the remuneration of directors and executives of companies regulated under the
Corporations Act. The report was presented to the Australian Government on 19 December
2009 and released publicly on 4 January 2010. Specifically, the Commission was requested to
consider the following: the effectiveness of the existing framework for the oversight,
accountability and transparency of remuneration practices in Australia including; the role,
structure and content of remuneration disclosure and reporting; the scope of who should be
the subject of remuneration disclosure and; approving remuneration packages; the role of
boards and board committees in developing and approving; remuneration packages
(Australian Government Productivity Commission, 2009, p. v).
3. “The S&P/ASX 300 provides up to an additional 100 small cap stocks to the S&P/ASX200.
Index constituents are drawn from eligible companies listed on the Australian Stock Exchange.
This index is designed to address investment managers’ needs to benchmark against a
portfolio characterized by sufficient size and liquidity. [. . .]” (www.standardandpoors.com/
indices/sp-asx).
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Corresponding author
Carolyn Windsor can be contacted at: cwindsor@bond.edu.au
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Remuneration committee independence and CEO remuneration for firm financial

*Related content and download information correct at time of download.

The research question under investigation is whether remuneration committees

2. Variables and relevant studies

2.2 Independent variables

governance of executive compensation.

2001 company reports ASX300

Mandated executive remuneration disclosure pre-2001

Events influencing final sample

4. Model development and results

Size at three levels Level Mean of assets $M SD n

Smaller firms 0 148 779 46

Model 1: regression – CEO total remuneration and firm financial performance

CEOtotal ¼ b0 þ b1 ROAlag1 þ b2 Industry þ e

Model 1 showed a non-significant relationship for the link between CEO

remuneration committees or remuneration committees with a minority of NEDIRs

Intercept 13.67 0.158 86.467 0.000

Intercept 12,175.206 0.000

[Size ¼ 2 large]*[REMCindep ¼ 0]*ROAlag1 0.152 0.051 2.970 0.004 * * *

4.1 CEO bonuses

performance and remuneration committee independence

Intercept 102.202 0.000

Intercept 40.354 0.000

[Size ¼ 2 large]*[REMCindep ¼ 0]*ROAlag1 1.015 0.374 2.718 0.007 * * *

ineffectiveness of remuneration committees to align CEO bonuses with firm financial

5. Discussion and conclusion

Kent, P., Kercher, K. and Routledge, J. (2012), “Determinants of voluntary board

To purchase reprints of this article please e-mail: reprints@emeraldinsight.com

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[Size ¼ 2 large][REMCindep ¼ 0]ROAlag1 0.152 0.051 2.970 0.004 * * *

[Size ¼ 2 large][REMCindep ¼ 0]ROAlag1 1.015 0.374 2.718 0.007 * * *