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South African Journal of Economic and Management Sciences

On-line version ISSN 2222-3436
Print version ISSN 1015-8812

S. Afr. j. econ. manag. sci. vol.20 n.1 Pretoria  2017 



Chief Executive Officer and Chief Financial Officer compensation relationship to company performance in state-owned entities



Mark H.R. Bussin; Marvin Ncube

Gordon Institute of Business Science, University of Pretoria, South Africa





BACKGROUND: Optimal contracting continues to dominate boardroom and dinner discussions worldwide in light of the 2008 global financial crisis and especially in South Africa, due to the growing income gap. Increased scrutiny is being placed on South African state-owned entities (SOEs), as a result of the seemingly poor performance of SOEs. Some of the SOEs are reported to have received financial bailouts from taxpayers' money, while executives are raking in millions of rands in remuneration, provoking some concerns on the alignment of executive pay to company performance in SOEs.
AIM: The study will assist remuneration committees and policymakers in the structuring of executive pay in SOEs to ensure alignment to company performance.
SETTING: The study sought to assess, based on empirical evidence, if there is a positive relationship between Chief Executive Officer (CEO) and Chief Financial Officer (CFO) remuneration and company performance in South African SOEs in the period between 2010 and 2014. All 21 Schedule 2 SOEs were included in the study.
METHODS: The research was a quantitative archival research methodology. Correlation and multiple regression analysis were the main statistical techniques used in this study.
RESULTS: Contrary to popular media, a positive relationship between CEO and CFO remuneration (fixed pay and short-term incentives) and company performance in SOEs was observed. Company size appears to be the key determiner of fixed pay in SOEs. The positive relationship was mainly noted on absolute profitability measurements like EBITDA (earnings before interest and tax and depreciation and amortisation) and net profit.
CONCLUSION: SOE remuneration committees and policymakers should maintain the positive relationship; however, more emphasis should be placed on financial efficiency measurements so as to enhance efficiencies in SOEs.




The executive remuneration of South African state-owned entities (SOEs) has come under increasing scrutiny because of their perceived poor performance and as a result of being in a country with one of the worst economic inequalities in the world (Naidoo 2012). The increasing income gap in South Africa between rich and poor split along racial lines has resulted in numerous questions being raised about the seemingly excessive top management remuneration. Naidoo (2012) cites a 2012 Price Waterhouse Coopers report stating that executive directors of large-capital companies earn on average R10m/year (R4m/year guaranteed package, R2m performance bonus and R4m in share plan benefits). In contrast, SA's lowest-paid workers earn around R3500 per month or R42 000 per year. This equates to a pay gap of 250-300 times. It is no different in SOEs. The average pay gap ratio between Eskom's top management and workers is 93:9 (Naidoo 2012).

Globally, the executive remuneration debate has intensified following the 2008 global financial crisis as bankers were seen to have given themselves excessive remuneration, despite the poor performance of the institutions (Choe, Tian & Yin 2014). Equally, SOEs have not been immune to this debate. For example, the Spanish government in 2012 announced that it was cutting executive pay by up to 35% for companies supported by taxpayers' money in order for the executives to share in the pain of austerity measures (Tremlett 2012). Furthermore, the Chinese government announced it would be cutting the salaries of the top executives in Banks and SOEs in order to reduce inequality (Wright 2015). The State-Owned Assets Supervision Commission of China recently called for all SOE salaries to be strictly linked to business performance, it emphasised that salary increases should be in line with the increases in company profits (Juan 2015).

Some authors have questioned whether the exponential growth in executive compensation in the past two decades is consistent with shareholder interests (Bebchuk & Fried 2004; Jensen & Murphy 1990). Chief Executive Officer (CEO) compensation is crucial in mitigating the potential conflict of interest between executives and shareholders, as it is used as an instrument of aligning shareholders' and executives' interests (Ozkan 2011). Prior studies by Murphy (1999); Core, Guay and Larcker (2003); Jensen, Murphy and Wruck (2004) and Devers et al. (2007) conducted on mostly listed companies, have not been consistent on the impact of executive compensation on company performance. The studies have raised doubt on the ability of executive compensation to align with shareholder and executive interests.

The debates on executive compensation have essentially been split into two seemingly competing views. The first view contends that executive compensation is a result of efficient bargaining between executives and shareholders to mitigate the agency-principal problem, commonly referred to as the optimal contracting approach. The competing view contends that executive compensation is a result of 'greedy' powerful executives who essentially extract rents from companies and thus set their own pay, commonly referred to as the managerial power approach. These seemingly contrasting views have resulted in the ongoing debate on whether executive pay is linked to organisational performance, in line with the optimal contracting approach. The concept of pay for performance has largely been led by Jensen and Murphy (1990). In South Africa, there is growing discontent regarding executive compensation in SOEs, in light of the seemingly poor performance by the SOEs. Some of the SOEs, like the South African Broadcasting Corporation Limited (SABC) and South African Airways (Pty) Limited (SAA), have been reported in the media to be receiving or have received Government bailouts, yet the company executives are said to be raking in millions in salaries and bonuses (Business Tech 2014).

Most of the literature reviewed has focused primarily on the relationship between executive pay and company performance in listed companies. Academic literature relating to pay for performance relationships in SOEs is scarce. Most of the executive pay studies in SOEs have been done on listed Chinese SOEs and these studies have generally been inconclusive. It is therefore crucial to understand how South African SOEs set compensation packages and how they are linked to company performance, considering the critical developmental role that these organisations play in the economy and the importance of these entities to remain sustainable.


Research questions

Based on popular media reports and current debates between policymakers and academics, there appears to be a disconnection between executive remuneration and SOE performance. The aim of this study is to contribute to the literature relating to executive pay for performance in SOEs, especially unlisted SOEs in developing countries, where policymakers, academics and the general public have been debating the link between CEO pay to company performance. The following are the research questions:

Research question one

Is there a positive relationship between CEO and Chief Financial Officer (CFO) fixed pay and company performance over the period 2010-2014 in South African Schedule 2 SOEs?

Research question two

Is there a positive relationship between CEO and CFO short-term incentive payout and company performance over the period 2010-2014 in South African Schedule 2 SOEs?

Research question three

Which individual company performance measure is the best predictor of the CEO and CFO fixed pay component of compensation over the period 2010-2014 in South African Schedule 2 SOEs?

Research question four

Which individual company performance measure is the best predictor of the CEO and CFO short-term incentive component of compensation over the period 2010-2014 in South African Schedule 2 SOEs?


Literature review

Chief Executive Officer and Chief Financial Officer responsibilities

According to Shaw (2012), the CEO's main responsibility is to manage company resources within the context of a dynamic external environment in order to create value for the shareholders. Friedman (2014) states that the CFO's responsibility is to oversee and manage information and reporting systems. The author also notes that, while the CFO has a fiduciary duty to the shareholders and the board, he also reports to the CEO.

The SOX Act requires that the CFO and CEO certify the financial reports of companies listed in United States. In South Africa, the Companies Act of 2008, which came into effect on the 1 May 2011 requires that both the CEO and CFO certify the financial statements (Republic of South Africa 2011). Moreover, the CEO and CFO are the two executives who are generally the members of the company board in South African SOEs. This fact elevates the power and importance of CFOs beyond that of other executives. According to Hambrick and Quigley (2014), executives play a critical role in a company as they substantially shape the fate of companies. The CEO and CFO can be viewed as shareholder agents; thus, their primary role is to protect and grow shareholder value.

Company performance measurement

Bussin (2015) notes that there are three different measurements of company performance, that is, absolute financial performance measures (verified measures of performance within a specific year), financial performance ratios derived from absolute financial performance measures and market performance measures, assessed through the share price performance of the company. Various agency theorists argue that multiple performance measurements can be used by principals in an optimal contract, for the principals to be able to fully understand the effort put in by the agent in achieving shareholder value.

Conyon and He (2014) posit that once principals have a full understanding of the performance measurements that best reflect the agent's effort, more sensible and precise measures can be consistently used in the optimal contract as an indication of the agent's effort.

Goergen and Renneboog (2011) and Bussin (2015) argue that accounting-based performance measurements measure past performance and are subject to manipulation and thus might not be appropriate in determining executive past performance as rent-seeking CEOs are prone to manipulating the accounting measurements in order to achieve higher bonuses, evidenced by accounting scandals at Enron and Worldcom. According to Goergen and Renneboog (2011) and Wang and Xiao (2011), the most common accounting measures used to assess company performance are revenue, operating income or profit and earnings per share (EPS). However, based on literature reviewed, there appears to be no consensus on measuring company performance as various authors have used various measures of absolute financial performance to assess company performance in the pay to performance studies. Shaw (2012) used profit after tax, earnings before interest and tax and depreciation and amortisation (EBITDA), return on equity (ROE) and headline earnings per share (HEPS) in order to assess company performance, while Bussin and Nel (2013) used ROE, asset turnover, profit margin and leverage in order to assess company performance. Van Blerck (2013) used economic value added (EVA), share price performance and ROE. Theku (2014) used ROE, return on assets (ROA), Asset Turnover, Revenue, HEPS, change in share price and market capitalisation as measurements of company performance. Bussin and Modau (2015) used market value added, EVA, ROE and EPS.

State-owned entities

There is no comprehensive legislative definition of national or provincial SOEs in the South African statues (Bronstein & Olivier 2015). The starting point for defining national or provincial SOEs is the PFMA Act 1 of 1999, which lists public entities in Schedules 2 and 3. Major public entities like Eskom, Transnet and Telkom are listed in Schedule 2. According to 'Introduction' section of the PFMA Act 1 of 1999, national public entities are defined as government business enterprises or an entity that is substantially funded from tax revenues or levies or other statutory funds. Thus, government business enterprises are more self-sufficient and commercial than the remainder of the ordinary entities. Most of the entities that are substantially funded from tax revenues are classified under Schedule 3 entities, while major government business enterprises are classified as Schedule 2 enterprises. Most of the Schedule 2 SOEs have come under scrutiny in recent years in the media because of the seemingly excessive executive salaries in spite of the poor performance of the SOEs.

According to Thomas (2012), SOEs primarily drive a developmental agenda in developing countries through the provision of basic services such as water and electricity, and thus profit maximisation is not their main goal. However, Thomas (2012) notes that the funding model prevalent at most of the major SOEs is generally profit driven, which is at odds with the provision of basic resources at the lowest cost possible to the populace. It is this conflict between social objective versus the profit motive that raises debates on executive remuneration in SOEs, that is, whether the executive compensation should be based on company performance measured through accounting measurements or the company achieving its social objectives. However, it is apparent that for the SOEs to remain financially sustainable, a closer alignment of pay for performance is necessary.

Pay for performance relationship

Agency theory suggests that a high pay-performance relationship motivates top executives to enhance their input and improve corporate performance (Amzaleg et al. 2014). Numerous studies relating to the relationship between CEO pay and company performance have been done in South Africa. A study by Shaw (2012) on executive pay to performance relationship in the South African financial industry over a 6-year period (2005-2010) noted a moderate to strong relationship between CEO remuneration and company performance. However, the study noted that the moderate to strong relationship noted was in decline during periods of economic downturn, and thus, CEOs tended to use managerial power in uncertain economic periods to draw high pay than for their pay to be in accordance with the company performance. Moreover, Shaw (2012) observed a shift from variable pay to fixed pay in the remuneration structure of CEOs as a result of the declining company performance. The restructuring of the CEO remuneration results in a lower pay to performance relationship as most of the variable pay is linked to company performance.

In a study by Bussin and Nel (2015) on the pay to performance sensitivity in the South African retail and consumer goods industry over a 6-year period (2006-2011), the authors observed a weak relationship between CEO pay and company performance, based on Du Pont analysis measurements. A negative relationship was noted between CEO guaranteed pay versus ROE. Thus, Bussin and Nel (2015) note that there is no alignment between CEO compensation and company performance in this industry.

A study by Van Blerck (2013) supported the findings by Shaw (2012) as Van Blerck (2013) noted in the study of the relationship between executive remuneration and company performance based on EVA over a 10-year period (2002-2011) that, unlike United States, South African banks showed a strong positive relationship between executive pay and company performance and this could serve to explain why South African banks survived the 2008 financial crisis.

Theku (2014) also supported the findings by Shaw (2012), Van Blerck (2013) in the study of 30 South African mining companies listed on the Johannesburg Stock Exchange (JSE) over a period of 5 years (2009-2013). In the study, the author noted that in most of the mining companies there was a moderate to strong relationship between CEO remuneration and company performance. Furthermore, Bussin and Modau (2015) supported the observations by Shaw (2012), Van Blerck (2013) and Theku (2014), in the study of executive remuneration relationship to company performance in 26 firms listed on the JSE over a 7-year period (2006-2012). In the study, Bussin and Modau (2015) noted that there was a positive relationship between CEO pay and company performance based on ROE. However, similar to observations by Shaw (2012), Bussin and Modau (2015) observed that during periods of economic uncertainty, such as after the 2008 financial crisis, there has been a restructuring of CEO remuneration among firms. Post 2008, most of the variable pay linked to company performance has been restructured to be fixed, thus resulting in a declining correlation between CEO pay and company performance.

Approaches and theories

Corporate governance

Corporate governance is defined as a collection of rules and policies, which affect how a company is controlled or monitored (Donaldson 2012). Corporate governance serves to ensure that executives are working mainly for the benefit of shareholders by trying to increase the economic value of the firm (Chalevas 2011). Conyon and He (2011) also support the above view, as they note that, accordin