Firm Performance, Corporate Governance, and Executive Compensation in Financial Firms: Evidence from Indonesia

Abstract

Although previous empirical evidence concludes that the firm performance is positively related to executive compensation, but sometimes reality indicates otherwise. Many companies providing a huge compensation package for their executives, in fact, have the company value tend to be normal or even worse. For example, Stanley O'Neal, the former CEO of Merrill Linch & Co., receives compensation up to 161.5 million U.S. dollars, though the company suffers huge losses up to 8.4 billion U.S. dollars. This suggests that firm performance does not always determine the amount of compensation executives receive.Thus, high executive compensation does not necessarily solve the agency problem. Hence, the internal control mechanisms are required by a company. Jensen and Meckling (1976) argue that the agency problem can be solved not only with compensation but also with the implementation of good corporate governance mechanisms. According to Jensen and Meckling (1976), there are two corporate governance mechanisms that can help control the agency problem; that is managerial ownership and institutional ownership. In the context of Indonesia, a very few research on executive compensation has been conducted. Thus, we are heavily interested in investigating further whether firm performance and corporate governance mechanisms are determinants of executive compensation. Sample of this study comprises 13 financial companies listed during the period 2007-2009 on Indonesian Stock Exchange. This research uses panel data. Controlling for firm size, the results show that return on assets, outside directors, and institutional ownership significantly affect executive compensation, but total shareholder returns does not.

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