Managerial Remuneration and Disciplining in the UK: A Tale of Two Governance Regimes

Abstract

We simultaneously analyze two mechanisms of the managerial labor market (CEO turnover and remuneration schemes) in two different regulatory regimes, namely before and after the sweeping governance reforms adopted in the UK in the 1990s. We employ sample selection models to examine firms in a pre-Cadbury Code period (1988-1993) and a post-Combined Code period (1998-2004). CEOs’ compensation and CEO replacement are performance-sensitive in both periods. There is little evidence of outside shareholder monitoring, whereas powerful CEOs successfully resist replacement irrespective of corporate performance. With regard to CEO remuneration, we sketch a nuanced picture as we find some evidence supporting the alignment of interests hypothesis, but also supporting the managerial power or skimming model for managerial remuneration practices in the UK prior to the governance reforms. In particular, equity-owning CEOs compensate disappointing stock performance by augmenting their monetary compensation. Our results are consistent with the widely perceived failure of internal governance mechanism in tackling the agency problems associated with managerial pay: these mechanisms have relatively little impact on executive remuneration. We also conclude that the regulatory effort undertaken in the UK over the 1990s has had at best a moderate effect on increasing executives’ accountability and performance sensitivity of their turnover.

Keywords: corporate governance, agency costs, CEO remuneration, disciplinary CEO turnover, ownership and control, entrenchment, sample selection model

JEL Classification: G30, G32, G34, J33