C.E.O_Remuneration

Introduction C.E.O remuneration has been observed as significant in extenuating divergence of interest b/w executives & share--holders in firms. It has been widely observed that remuneration packages may potentially play a significant role in empowering and motivating executives. Therefore it is significant to find out how firms set C.E.O remuneration packages & whether there is a link b/w financial performance & remuneration. In comparison to studies conducted in United States on C.E.O remuneration in U.K is quite restricted. Key conclusions from conducted studies are that there is a weak relation b/w C.E.O pay & financial performance in U.K firms. One probable clarification for such weak statistical findings is that previously researchers have relied heavily on total cash pay as the main source to measure C.E.O remuneration. Thus, one can criticize those studies for their analysis excluding equity--based component of remuneration. They omit potentially financial performance--sensitive component of remuneration, e.g., share options & share awards. As a result, they ignore interesting differences in extent to which cash & equity--based components of remuneration are affected by firm financial performance.Hampel (2008) report led to changes in disclosure rules about information on executive remuneration packages in firm annual reports & made it possible to analyse total remuneration rather than cash only component of remuneration (salary bonus). Objective of the Study The objective of this research is to shed a new light on relation b/w C.E.O remuneration & firm financial performance in U.K firms. It contributes to studies for U.K firms by employing a broader measure of remuneration, which includes cash & equity--based components of C.E.O remuneration, & also C.E.O wealth based on C.E.O's holdings of share options & share awards. Thus, researchers investigate relation b/w C.E.O pay & financial performance employing a unique, hand--collected panel data set of 390 U.K non--financial firms from FTSE All Share Index for period 1999–2005. Furthermore, in our empirical analysis researchers control for a comprehensive set of governance variables; institutional ownership, executive & non--executive managerial ownership, proportion of non--executive directors on board, board size, C.E.O age & tenure. As argued by previous researchers, governance mechanisms (that is, ownership structure & board characteristics) can reduce potential agency problem b/w executives & share--holders &, thereby influence way firms set their remuneration packages. We examine whether governance variables influence level of C.E.O remuneration & pay financial performance sensitivity. Importance of Study The empirical results indicate that pay financial performance elasticity for U.K C.E.Os is 0.075 for cash remuneration, indicating that a ten percentage increase in shareholder return corresponds to an increase of 0.75% in C.E.O cash remuneration. pay financial performance elasticity for total direct remuneration is 0.095, which is higher than elasticity for cash remuneration. Total direct remuneration includes cash remuneration, value of share options & share awards (L--T--I--Ps, that is, long term incentive plans) granted during year. These findings are similar to findings from previous U.K studies. In comparison to previous findings for U.S C.E.Os, pay financial performance elasticity for U.K C.E.Os seems to be lower. Our findings also suggest that governance variables have a significant impact on level of C.E.O cash & total direct remuneration, while they do not influence C.E.O pay financial performance elasticity for cash & total direct remuneration. However, when researchers focus on pay financial performance sensitivity of options granted during each year, our results show institutional share ownership has a positive & significant impact on C.E.O pay financial performance sensitivity of options. Additionally, our results indicate that longer C.E.O tenure is associated with lower pay financial performance sensitivity of option grants suggest in entrenchments effect of C.E.O tenure. We also investigate relation b/w C.E.O wealth & firm financial performance by computing C.E.O effective ownership (or share--based C.E.O pay financial performance sensitivity), which is based on aggregate C.E.O share holdings, option holdings & L--T--I--P holdings. We find that both median share holdings & share--based pay financial performance sensitivity are lower for U.K C.E.Os than U.S C.E.Os. Even though researchers observe an increase in average share--based pay financial performance sensitivity during sample period that increase has not been substantial. Overall, our findings suggest that governance reports in U.K, such as Greenbury Report (1996) that proposed C.E.O remuneration be more closely related to financial performance, have not been totally effective. In the last decade many studies reports looking to rectify governance issues in U.K were conducted. These studies have assisted focus concentration on significance of such issues. Cadbury  report viewed institutional investors as having significant responsibilities in governance. It also suggested that firms must set up remuneration reviewing committees. In reply to suggestions, irresistible preponderance of public firms has established remuneration reviewing committees. They are comprised of non--executive management. The Greenbury Report (1996) concentrated specifically on executive remuneration policies & suggested that all long term incentive schemes paid by firms, including share options, must be subject to challenging financial performance criteria. It also suggested use of L--T--I--Ps over option grants & ruled out common practice of discounting options by 15% of grant date share price. Report suggested that these measures must consider financial performance relative to a group of comparable firms. It highlighted that directors must not be rewarded for increases in share prices (or any other indicators) which might reflect inflation or general market movements, i.e. which are not directly related to managerial actions. These recommendations met with widespread approval & rapid implementation. Hampel (2008) report has further made it a requirement for U.K firms to disclose U.S style remuneration information, allowing for more detailed remuneration analyses. Hampel (2008) stresses need to pay non--executives fixed fees & recommends barring of giving them incentive remuneration such as L--T--I--Ps. recommendations of all three reports were combined to form part of London Share Exchange (LSE) Combined Code, by which all firms listed on LSE must abide. More recently, Higgs (2004) report also emphasized that U.K firms must establish a transparent procedure for developing policy on executive remuneration & for fixing remuneration of individual directors. Additionally, it was suggested that executive directors’ remuneration must be structured so as to relation rewards to corporate financial performance. Generally, these studies played a pistol role in enforcement of detailed disclosure rules for U.K executive remuneration. Now, U.K firm annual reports consist of sufficient information about executive remuneration packages to calculate total remuneration. Previously it was impossible to assess total remuneration for executives just because of the poor disclosure requirements for U.K firms. Background of the Study The last quarter of a century has seen an explosion in academic research on executive compensation. From one to two studies per year prior to 1985, the number of studies has grown almost exponentially since then. Early studies primarily focus on executive pay and company size and/or company profits. They included pioneering work by Roberts (1956), Baumol (1962), Ciscel and Carroll (1980), and Lewellen and Huntsman (1970). Interestingly, the amount of research seems to increase whenever there is a spike in overall CEO compensation. Likewise, academic activity is more pronounced during economic downturns rather than during economic booms. The heightened interest in academic research parallels popular media coverage of the subject and the regulative activity of the government. This seems to reinforce the general feeling that during “good economic times” few care how much the CEOs make (Bebchuk & Fried, 2004). The published literature on the CEO compensation and company performance has been immense in both, scope and content. It spanned economics, accounting, finance, strategy, law, organizational behavior, and several other businesses, social and scientific disciplines and fields of study. Table 6 lists most of the key studies and at the same time it gives the flavor of the magnitude of the topic. Theoretical Framework Theoretical underpinnings cover the prevailing economic or behavioral paradigms that pertain to corporations and to the executive compensation. They provide remuneration models that are used to set the compensation strategy or to explain the existing CEO pay structure. The scope of inquiry on the subject of CEO compensation is broad, ranging from longitudinal studies to classical statistical methods. The studies were undertaken from the economic, social, political and behavioral perspectives. What have emerged are five bodies of theory, each providing a unique explanation or model of executive compensation. These theories are: neoclassical theory of the firm, managerial theory of the firm, agency theory, tournament theory, and social comparison theory. This section evaluates these dominant contemporary compensation theories that are unique to the CEO compensation, and discuss how these theories are used in establishing executive compensation policies within the U.K. corporations. Literature Review An ongoing shift in the roles played by management, boards, and outside forces over the past several years have transformed the process by which executive compensation programs are developed. Management’s longtime leadership in driving the design of pay plans has given way to much closer involvement and more stringent oversight by corporate Boards, who in turn are much more cognizant of the views of critical stakeholders, from activist shareholders and proxy advisory groups to government regulators and elected officials. As companies deal with the fallout from options backdating, spring-loading, accounting restatements, and other pay controversies, new SEC disclosure rules are providing a wider window into the working of corporate pay programs by requiring companies articulate both their structure and their underlying philosophy. CEO Compensation Framework The determinants of the executive compensation can be analyzed and interpreted through the general framework depicted in Figure 1 below. The figure shows that the CEO compensation can be studied in terms of total amount of cash pay received by a executive (salary and/or bonus), short and long term equity compensation (stock grants and/or options), on the correlation of executive remuneration and his/her performance, and perquisites received. The determinants affecting the CEO pay can be grouped in five general categories: structure or components of CEO pay, criteria, governance, contingencies, and theoretical underpinning. Criteria are set of factors that have direct bearing on the CEO. Firm size usually indicates complexity of the enterprise. Larger firms tend to have larger management hierarchy, more pay bands, and higher job responsibility . Market conditions in particular industry have the overall impact on executive pay, yet they are least impacted by the chief executive actions. The relative pay scales within the specific industry serve as benchmarks and are often relied upon when setting the executive’s pay amounts and mix. CEO’s personal credentials, namely his/her work experience, schooling, social status, and tenure also affect pay. Company’s hierarchical structure plays a role in executive’s remuneration. Typically, more structured organizations rely more on the fixed pay components in the compensation package than variable ones. Everything being equal, higher structure companies tend to pay more, if for no other reason then to keep the levels differentiated. The performance for CEOs is typically gauged through the accounting standard such as earnings per share, stock growth, and return on investment. CEO Compensation Framework The governance structure primarily focuses on the ownership make-up and the active control of the firm. It involves principals, large and/or institutional shareholders, and managers. The important factors are the degree of influence they exert on the corporation in general, and more importantly, on the specifics of pay-setting policies. Under the law, corporations are required to have a board of directors. The board has the responsibility to represent and protect the interests of the stockholders (principals). It has a power to hire and fire CEO (Dyl, 1989). Furthermore, each board of directors is required by law to have a compensation committee. This committee is made up of outside directors. They directly impact the pay-setting process, both in terms of mix, measurement, and allocation. Contingencies affecting the CEO’s pay characteristics are both internal and external. The external contingencies primarily affect the mix of the compensation package (tax laws), the amount and performance criteria (culture), and the long term pay orientation (strategy and R&D). Internal contingencies are typically tied to performance criteria and to the corporate governance of the particular firm (Finkelstein & Boyd, 1998). The objective of this study is to isolate and remove the effects of most of the external contingencies by focusing this study on a particular industry sector, namely automotive sector in United States, where similar firms face similar external contingencies. Attaway (2008) who studied CEO compensation in computer and electronics industry, Veliyath and Bishop (1996) who focused on CEO pay and performance in healthcare industry, Sottile (2008) who looked at CEO compensation among Greenfield companies as firms went public, to name a few, made similar set of assumptions when investigating particular industry sector. Theoretical underpinnings are operative paradigms that provide compensation models that are used to set the pay strategy or to explain the existing CEO pay structure. Compensation Strategy An explicit and detailed executive compensation strategy is an important tool with which to attract, retain, and reward quality executives. Before each of the components of the total executive compensation strategy is looked at, it is critical to understand the major factors that shape an organization’s strategy and shows why the strategies are different at different organizations. These factors can be further subdivided into two new major groups - those factors that are of external nature and to those factors that pertain to internal nature. Davis and Edge (2004) list seven external factors that impact total rewards. These are listed and discussed below: Industry Executive compensation varies significantly from industry to industry in terms of mix, level of pay, incentives, benefits, and perquisites. However, base salary differences are not that significant. The largest predictor of base salary is revenue within the industry. Bonus levels vary much more and are primarily affected by the differences in industry performance. Industry Financials Executive pay packages are affected differently by the different growth rate in the industry, margin levels realized within the industry, and the expected return to shareholders given the degree of inherent risk. Low margin industries, for example, work hard on controlling costs and their cash flow. Consequently, they are more reluctant to design compensation plans that are heavy in cash compensations, such as high base pay or annual performance bonuses. Rather, they rely more on long term securities incentives. The same thing can be said of the start-up organizations, which typically have a finite amount of cash on hand and need it primarily for operating expenses. Industry Stage of Development The industry’s life cycle has a significant impact on both the mix and level of executive compensation. The new industries such as information technology, biotech or software developers to name a few, typically structure their executive compensation mix around low cash compensation levels and significant upside opportunities through longterm non-cash incentives, primarily stock options. This is due to the fact that substantially all of the firms in this sector are small start-ups. As the market growth and revenues increase, these start-up firms will shift focus towards the higher levels of, cash compensation, with correspondingly less focus on, and lower levels of, stock option usage. On the other end of the life cycle spectrum, an industry that is mature, and often characterized to be on the decline, is the automotive industry. Industry consolidation has occurred, even global consolidation, and thus the industry is exemplified by huge, mature organizations, and company hierarchy that have been in operation a long time. In mature companies cash compensation levels are high, short-term and long-term incentives are numerous and diverse, and there are generally significant executive perquisites and supplemental benefits. This level of total rewards could not be supported, financially or culturally, in the emerging firms that were used in the example above Research and Development and Long-term Orientation of the Industry A longer product or service cycle in industry correspond to a longer-term orientation and long-term focus. Consequently, this leads to a greater emphasis and use of long-term incentives. Good examples of this type of industries are the pharmaceuticals. Executive Supply and Demand Industry growth rates impact supply and demand for executive talent within the industry. Rapidly growing sector such as heavily technical dot-com creates shortage of seasoned executives with managerial skills. This in turn shifts the compensation scale of the entire compensation mix higher, and often to the unsustainable levels. Once the sector gets saturated or starts to decline, the equilibrium is re-established, once again through the same principle of supply and demand. Degree of Competition within the Industry The degree of competition correlates with the overall industry stage of development. Early on in their life cycle companies compete on technical development and novelty of their products. Slowly this is supplanted by quality and customer satisfaction. Finally, price becomes the most important differentiator. Price in turn places significant pressure on margins. Compensation expense, being generally one of the largest controllable costs, is used to maintain or increase profit margins. Current and projected economic conditions Economic condition combined with other factors and economic indicators is very significant. Booming economy typically leads to growth and expansion. This in turn leads to increased demand for executive talent. As the talent pool shrinks, the wages and compensation tends to rise. In contrast, in the down economic period firms try to keep fixed costs down. As a result, there is little base salary movement. Furthermore, the supply of labor in a down economy is on the rise and the demand is low. This keeps compensation in check. In addition to seven major external factors, there are five internal factors that have significant effect on the total executive compensation levels and mix (Davis & Edge, 2004). These are: (1) organizational competitive position within industry and its method of competing, (2) firm stage of development, (3) firm financial position, (4) level of talent needed to compete, and (5) firm’s ability to attract and retain talent needed. The Components of CEO Pay The assortments of plans that make up the total chief executive compensation program are structured differently from firm to firm, reflecting differences in strategies and in corporate governance philosophy. Each firm chooses a mix of compensation elements that will most appropriately meet its objectives and reinforce its values relative to the importance of individual and team performance and risk and reward sharing. Furthermore, compensation plans’ variances are the function of firm’s organizational constraints, competitive practices, importance of various job functions in impacting results, and firm’s ability to tolerate variations in pay (Tauber & Levy, 2002). However, the purposes of each compensation element are reasonably consistent across organizations and over time. Table A summarizes these purposes and the intended effect that they have on the company and on the executive. Table A: Purposes of Compensation Mix Elements While the purpose of the compensation elements within the company remains relatively steady, the mix of the compensation elements varies greatly with the position and responsibility within the firm. In addition, the percentage of the mix within the executive group has been undergoing a shift toward the more incentive-based compensation elements. Figure 2 indicates that the variable portion of the executive compensation often comprises about 50 percent of the total pay mix. In fact, the salary portion of the pay package for the typical CEO has been steadily declining to just slightly over 21 percent in the past year. Long-term incentives (option grants and restricted stock awards) have been on the steady rise and account now for over 60 percent of mix. Heavy emphasis on these long-term incentives has been the main culprit in the escalating pay levels of top executives (Tauber & Levy, 2002). Base Salaries Base salary is a merit-based cash compensation component of the total CEO’s remuneration mix. Executive employment contracts almost always specify base salary and often provide for the automatic annual raises. Competitive benchmarking is typically used to determine base salaries. Benchmarking involves the use of general industry salary surveys supplemented by thorough analyses of targeted industry and management pay structure among the market peers. The determinants influencing this component are executive tenure, experience, education, age, skill levels, organizational size and complexity, market competition for top talent, and firm’s ability to pay. The importance of base salary, even though this component is steadily decreasing in a total compensation mix, is significant because it serves as a yardstick for most other components of compensation. For example, bonuses are typically expressed as a percentage of base salary. Similarly, option grants are calculated based on a multiple of base salary. Furthermore, salary levels are part of the equation which defines pension and severance benefits. Thus, each dollar increase in base salary has direct repercussions on many other components in the total compensation plan. Annual Bonus Plans Bonus plans are almost universal components of executive compensation mix in U.S. for-profit corporations. They are supposed to be based on prior year performance and are paid annually. Executive bonus plans can be described in terms of their basic performance components: measure, standards, and the structure of the pay-performance relations. Typically, no bonus is paid until the threshold performance is achieved. This threshold performance is expressed as a percentage of the performance standard. Target bonus is paid when the performance standard is reached. Accounting profits typically serve as the measurement of performance (Murphy, 1999). Like base salary, bonuses are direct cash compensation element of the total remuneration package. Stock Options Stock options are financial contracts that have pre-specified price, pre-specified term, and pre-specified expiration date. The recipients, in this case CEOs, are given the rights under pre-specified conditions mentioned to buy company share or stock, and once vested, to sell it at will. Stock vesting occurs over time. Typically 25 percent becomes exercisable in each of the four years after they have been granted. Expiration term is usually 10 years. These stock options that are given to the executives are non-tradable. They are forfeited if the executive leaves the firm before the options had become vested. On one hand, managerial rewards based on the stock options provide a direct connection b/w the increase in manager’s compensation and share price appreciation, since the net gains obtained from exercising options directly correlate, dollar for dollar, with the increase in the price of the stock. But on the other hand, stock options lose incentive value once the stock price falls sufficiently below the exercise price that the executive perceives little chance of exercising. Declining share price is not as effective incentive tool as is the share price that is appreciating in value. This loss of incentive is frequent reason, or justification, for re-pricing of the stock options following the grant (Hemmer, Matsunaga, & Shevlin, 1998). In addition to the clear financial incentives, stock options are even more popular component of the reward mix due to their favorable tax implications, both to the recipient and to the issuer. Hence, stock options are form of deferred compensation through which a recipient can manipulate his/her taxable income by controlling the amount and time frame of exercisable options. Black-Scholes (1973) formula is the best known and most widely used method for figuring out the firm’s cost of granting stock options to the executives. Restricted Stocks Twenty-eight percent of Standard & Poor’s 500-company chief executives received the restricted stock grants in 1992. That percentage steadily increased and it now stands at around 33 percent. These grants account for an average of 22 percent of CEO’s total compensation mix (Murphy, 1999). The restricted grants typically come up with the forfeiture clause whereby they are surrendered back under certain conditions such as insufficient employee longevity or untimely termination and departure. This stock restriction contains intrinsically favorable tax and accounting benefits. In general, CEOs do not pay taxes on the shares received until the restriction lapse, and the cost to the firm is amortized over the vesting period at the price that was in effect at the grant date. The average vesting periods, i.e., times until the restrictions are lifted, for restricted stock grants varies b/w the companies and b/w the industries - typically, it falls b/w two and four years (Kole, 1997). Perquisites There are numerous perquisites granted to CEOs. Some are granted to reinforce the rank and authority of the position and typically come with small financial burden to the company. These consist of items such as preferred parking spaces, company car, chauffer, memberships to exclusive clubs, and so on. These perquisites seem to be the most visible and often serve as the irritants to the subordinates. However, there are substantial perquisites that come with a huge price tag. These are frequently referred as silver and gold parachutes and encompass severance and retirement packages. For example, top company executives are routinely the beneficiaries of expanded and supplemental retirement packages. These supplemental plans are non-qualified for tax purposes. They vary greatly b/w the companies – some are based on credited years of service and not on actual years of service, others are based on inflation or company performance. This compensation is often ignored in research because it is difficult, often impossible, or at best arbitrary, to convert the future payments into current annual compensation. Furthermore, these payments are frequently not disclosed because the retired recipients are no longer company executives. These retirement plan contracts are complex in design, and even when reported on the filed proxy statements offer a challenge to the analysts to determine plans’ actual present value. This lack of transparency and vagueness of disclosure has labeled these plans the ultimate form of hidden, yet substantial compensation (Murphy, 1999). Above researchers have focused on C.E.O contracts providing financial performance wages, through for example bonuses, shares options or sharess, since these are clearly related to informal deficiencies in agency framework. An C.E.O's contract might, however, be constituted of other elements, such as pension plans, fringe benefits, sign--on fees & severance remuneration agreements. At risk of reversed causality researchers will in our empirical analysis also study severance remuneration. existence of such contracts ex ante might affect C.E.Os' financial performance & thus information about these reveals important firm heterogeneity (& ex ante contracts are less related to reversed causality). Our analyses address several problems. First, researchers study relationship b/w firm productivity, C.E.O financial performance wages & other remuneration plans & elements. Second, researchers repeat analyses for other firm financial performance measures such as post--tax profit, revenue & total costs. Finally, researchers study level of C.E.O earnings, & how this is related to firm productivity & to remuneration plan. A positive relationship b/w firm financial performance & level of C.E.O remuneration has been empirically observed over decades (Deckop, 1989; Jensen & Murphy, 1990; Mengistae & Xu, 2004). As financial performance becomes more uncertain, wages–financial performance sensitivity often drops (Aggarwal & Samwick, 1999; Mengistae & Xu, 2004), but allocation of responsibility to employees might disturb this empirically (Prendergast, 2002). Managerial power also seems to be positively related to remuneration levels (Randøy & Oxelheim, 2008), & certain empirical evidence might indicate C.E.O rent extraction (Bechmann, 2008). Experimental evidence points to fact that strict incentive plans might result in worse compliance than more loosely specified contracts (Fehr & Falk, 1999; Fehr & Schmidt, 2000), but this is dependent on level of incentives (Gneezy & Rustichini, 2000). Empirical tests of how structure of EXECUTIVE remuneration affects firm financial performance are much less prevalent (Murphy, 1999). results usually identify a positive relationship b/w C.E.O incentive plans & financial performance, but most studies do not attempt to identify causal relationships. Mehran (1996) observes a positive correlation b/w --based remuneration on firm financial performance (Tobin Q & return on assets) in ordinary least squares (OLS) regressions for 153 U.S manufacturing firms. OLS regressions of Jirjahn (2004) on data from 1000 German manufacturing firms revealed similarly higher value--added per workers whenever profit sharing for C.E.Os was provided. Collier & Wilson (1994) surveyed Chief Financial Officers of Fortune 1,000 firms on their educational choices. They find undergraduate work was spread among a larger number of schools than graduate education. When asked about their educational choices, they found that retrospective preferences were similar to actual choices. Palia (2000) examined how educational background of a EXECUTIVEimpacts types of firms they are selected to manage. He compared financial performance of individuals that earned their degree from top undergraduate or graduate schools to those who earned their degree from less prestigious schools. They found managers with lower quality educational backgrounds manage firms in regulated industries, while those with higher quality educational backgrounds manage firms in unregulated industries. Other reserachs that address this issue include Joskow, Rose & Shephard (1993) & Jensen & Murphy (1990). Hambrick & Masson (1984), & Capenter, Geletkanycz & Sanders (2004), discussed role of management team homogeneity as it relates to decision making speed. general argument is that homogeneous top management teams make strategic decisions more quickly & are more profitable than heterogeneous teams in stable environments. Westphal & Zajac (1996) examined 413, Fortune 500, firms & found that boards of directors prefer C.E.O’s who are demographically similar to themselves including on an educational basis. Greater similarity b/w board members & EXECUTIVE demographics result in higher EXECUTIVE remuneration. This body of literature suggests that EXECUTIVEselection must focus on individuals that provide homogeneity among leadership team. Across firms, single largest operating cost, on average, is employee remuneration or remuneration (Blinder, 1990; European Parliament, 1999; U.S Bureau of Labor Statistics, 2002). Thus, for firm to be successful, it must effectively manage not only what it spends on remuneration, but also what it gets in return. Contextual factors serve to place some limits on remuneration decisions. Legal, institutional (e.g., labor union), cultural, & market (product & labor) contextual factors vary across countries & often within countries, meaning that degree of discretion firm has in managing remuneration decisions will also vary. Nevertheless, firms typically have at least some discretion in remuneration design. This choice can have a major impact at every level of firm on decisions made by individuals (through its incentive effects), as well as who those individuals are (through its sorting or self--selection & selection effects). In other words, remuneration can be a major factor in successfully executing firm's strategy. Remuneration, can be defined & studied in terms of its key decision/design areas, which include (Gerhart & Milkovich, 1992; Milkovich & Newman, 2008) how wages varies across (& sometimes within) firms according to its level (how much'), form (what share is paid in cash versus benefits'), structure (how wages manyials depend on job content, individual competencies, job level/promotion, & business unit'), basis or mix (what is share of base wages relative to variable wages & what criteria determine wagesouts'), & administration (who makes, communicates, & administers wages decisions'). From a psychological perspective, Campbell & Pritchard (1976) observe that motivation can be defined in terms of its intensity, direction, & persistence. (Together with ability & situational constraints/ opportunities, motivation contributes to observed behavior.) Thus, to fully evaluate impact of wages on motivation, one must look not only at (enduring) effort level, but also degree to which effort is directed toward desired objectives. Subsequently, however, field of psychology went through its ‘cognitive revolution,’ which departed from reinforcement theory by focusing on cognitions such as self--reports of attitudes, goals, subjective probabilities, & values. Later theories such as goal--setting (e.g., Locke), expectancy (e.g., Vroom, 1964), & equity (Adams, 1963), all give cognitions a central explanatory role. At same time, they also continue to recognize importance of reinforcement processes as drivers of those cognitions & later behavior. potential value of studying cognitions as mediators is that factors other than remuneration & incentives might influence goal choice, effort choice, & behaviors. Measuring cognitions & self--reports might be helpful in understanding why remuneration & incentives do or do not work in a particular situations. In expectancy theory (Campbell & Pritchard, 1976; Vroom, 1964), behavior is seen as a function of ability & motivation. In turn, motivation (also referred to as effort or force) is viewed as a function of belief sregarding expectancy, instrumentality, & valence. Expectancy is perceived link b/w effort & financial performance. Instrumentality is perceived link b/w financial performance & outcomes & valence is expected value (positive or negative) of those outcomes. There is often a focus on remuneration's effect on instrumentality. For example, a strong PFP program is likely to generate stronger beliefs that financial performance leads to high wages than would a weak PFP program or a seniority--based wages system. However, motivation can be undermined not only by weak instrumentality (e.g., weak PFP), but also by weak expectancy (e.g., because of inadequate selection, training or job design) or valence (outcomes that are negative or not sufficiently positively valued). To control agency costs, principal must choose a contracting plan that is behavior--based (wages based on observation of behaviors) &/or outcome--based (wages based on outcomes/results such as profits, productivity, shareholder return). choice depends on factors such as relative cost of monitoring behaviors versus outcomes, their relative incentive effects, & degree of risk aversion among agents. A key issue is hypothesized trade--off b/w incentive intensity & risk. Generally, it is assumed that incentive intensity can be stronger under outcome--based contracts because they are more objective, & thus less subject to measurement error (Milgrom & Roberts, 1992). On other hand, employees, who generally rely on their job as their predominant source of income, are risk averse. Greater incentive intensity is associated, on average, with greater financial performance outcome variability (which also might not be entirely under agent's control) & thus, greater remuneration risk. Therefore, a compensating manyial to agent for taking on greater risk of an outcome--based contract is expected under agency theory. (An implication is that strong incentives increase labor cost, meaning that incentives must drive higher financial performance to be cost--effective.) Although is has been argued that trade--off b/w risk & incentives in designing contracts is main focus of agency theory (e.g., Aggarwal & Samwick, 1999; Prendergast, 1999), general focus on contracting in agency theory also suggests an assumption that financial performance, whether results--based or behavior--based or both, plays a key role in determining remuneration. In economics, while recognizing that agency costs can compromise wages--financial performance relationship, existence of substantial wages for financial performance among C.E.Os is generally taken as a given, at least in a country like U.S, where shares plans are source of most C.E.O wealth creation (Murphy, 1999). However, in other fields (e.g., management), there is greater skepticism regarding degree to which C.E.O remuneration & financial performance are related, with a greater role for power & politics generally being seen. (For a give--&--take on theses problems, see articles by Bebchuk & Fried, 2006; Conyon et al., 2006. See Devers et al. for a review of recent studies.) A review & empirical study by Nyberg et al. (2008) suggests that management literature has underestimated role of financial performance, & thus applicability of agency theory, in determining C.E.O remuneration. Gerhart & Milkovich (1993) called for remuneration research to include intervening variables (&) at ‘multiple levels' of analysis in studying remuneration & financial performance, because ‘if a link is found … possible mediating mechanisms can be examined to help establish why link exists & whether (or which) causal interpretation is warranted’ (p. 533). Beyond general mediating mechanisms discussed above, more detailed intervening variables might include employee attitudes, individual financial performance &/or competencies, & employee turnover (broken out by financial performance levels). Other relevant mediators, depending on particular goals of unit or firm, would be citizenship behavior, teamwork, climate for innovation, motivation, & engagement. Note that while Human Resources practices such as remuneration might be thought of as operating at level of firm or work unit, mediators discussed here are often conceptualized as individual level processes. Therefore, models (e.g., hierarchical linear modeling, Raudenbush & Bryk, 2002) designed to handle multiple levels might prove useful in empirical work addressing this type of mediaton. As noted previously, efficiency wage theory suggests that higher pay might have positive sorting & incentive effects. More specifically, observable benefits of higher pay might include (Gerhart & Rynes, 2004): higher pay satisfaction (Currall et al., 2005; Williams et al., 2006; for a review, see Heneman & Judge, 2000), improved attraction & retention of employees (for a review, see Barber & Bretz, 2000), & higher quality, effort, &/or financial performance (e.g., Yellen, 1984; Klass & McClendon, 1996). In discussing pay level from a public policy perspective, a distinction is sometimes made b/w ‘low road’ (low pay level) versus ‘high road’ (high pay level) human resource systems (Gerhart, 2007). 6 Using AMO model, a ‘high road' policy typically combines higher (‘efficiency') pay with high levels of worker responsibility & autonomy & often team--based work (O), all of which might require a higher quality workforce (A). To extent that high road Human Resources system is costly, due to not only high pay but also high investment in AMO areas broadly, it might not align typically as well with a cost leadership business strategy as would a less costly, low road strategy. Historically, this is perhaps most readily seen in way that firms often move low skill work offshore to locations where it can be done much more cheaply. More recently, there has been a great deal of attention given to movement of skilled work (e.g., writing computer code; tax preparation) offshore to less expensive locations. We return later to question of under what circumstances a high road, high pay level strategy is most likely effective. This is ironic because, inside of firms, it often seems to be cost that gets lion's share of attention. Cappelli & Neumark (2002) observe this same omission in much of broader literature on effectiveness of Human Resources systems. Indeed, they interpret their findings as indicating that high road Human Resources systems ‘raise labor costs … but net effect on overall profitability is unclear’ (p. 766). For example, roughly one--half of publicly traded firms on 100 Best Firms to Work For list offer shares options to all or nearly all employees (Fortune, 1999: 126). Third area of fit, internal alignment, has been least studied. work of Gomez--Mejia & Balkin (1993) has sought to identify overarching remuneration strategies, but more work is needed to document which aspects of pay tend to cluster together in firms & whether certain clusters are more effective &/or what contingency factors are most important. In any event, modest evidence that exists concerning degree of actual alignment b/w pay & other Human Resources strategy dimensions suggests that there is less alignment than one might wish (Wright et al., 2002). Finally, although fit is typically seen as an important goal, this should perhaps be tempered by possibility that fit can be a double--edged sword when it comes to remuneration & Human Resources systems. Gerhart et al. (1996) pointed out that system (& resulting workforce) that fits current business strategy might quickly become a poor fit if business strategy changes. A less tightly aligned set of Human Resources practices, where bets were hedged, might make a successful adaptation more likely. As Boxall & Purcell (2004: 56) put it: ‘In a changing environment, there is always a strategic tension b/w performing in present context & preparing for future.’ Perhaps in recognition of limitations of static vertical fit, some recent work on Human Resources systems emphasizes importance of agility in Human Resources systems & strategy (Dyer & Shafer, 1999) & relatedly, of flexibility (Wright & Snell, 1998), or what might be seen as a capability for achieving dynamic fit. As a key part of an Human Resources system, remuneration must then be evaluated on an ongoing basis to consider its contribution to flexibility. Some examples of remuneration programs that are seen as promoting flexibility are skill--based & competency--based pay, as well as broadbands (in place of more detailed pay grades). Determinants of CEO performance Business leaders are under strong and unrelenting pressure to perform. Though few top executives are actually fired, the business press reports almost weekly on business leaders who have chosen to resign for failing to meet expectations. In addition, executive pay programs and pay levels are under pressure, and not just for abuses. There is a basic demand for a return on the investment by owners. But, before any performance criteria are adopted by the board and corresponding reward contract is put in place, it is necessary to examine the key responsibilities of the top executives (Davis & Edge, 2004). CEOs typically set the vision, strategy, and leadership of an organization. They reap the glory (and financial rewards) during the good times and are expected to shoulder the blame when company performance drops. In today’s competitive and rapidly changing business environment being just successful in not good enough. Collins (2002) and his team posits that good organizations have to advance even further and become great organizations. To achieve this long-term goal, transformational leadership at the very top of an organization is paramount. Table 4 lists the organizational leadership framework with CEO responsibilities, capabilities, and ultimately, the results. The results are the criteria that ultimately matters to the principals (stockholders, i.e., owners), boards, and future investors. The great results don’t just happen – they are the product of great leadership framework. Designing an effective CEO compensation to achieve, or provide incentives in order to achieve desired results, is not a straight-forward science. Sometimes it is as much an art as it is a rational discipline. Companies use a myriad of performance metrics – all of which can be customized to fit a company’s circumstances and management style. Nonetheless, the long-term stock performance may be the paramount and ultimate yardstick of a chief executive’s performance. This is not, by any means, the only measurement used by the board of directors in assessing how well the top executive is doing. While accounting and economic “hard” numbers play a critical role in determining short and long-term remuneration, the “soft” metrics are sometimes just as influential. The soft metrics may involve parameters such as customer satisfaction, research and development initiatives, exceptional leadership skills in challenging industries (e.g., automobiles and labor unions), productivity and/or process improvements, and so on. In general, the financial metrics blend several targeted numbers such as sales and earnings to the more complex results that deal with success or failure of dispositions or acquisitions (Bhagat, Carey & Elson, 1999). They include figures such as EPS, ROE, ROA, return on capital, revenue growth, cash flow and EBITDA, or gross earnings. Few economists disagree that earnings growth is the most critical accounting metric. It is an indicator of how well a CEO is running the business. It provides a summary measure of value added to the firm over a given period. For full understanding of this indicator it is important to compare earnings to historical values or to benchmark it against the similar firms or industry sectors (Carter et al., 2007). Guay (2008) states that the overwhelming numbers of the financial incentives given to CEOs are stock-price based. Accordingly, these chief executives hold disproportionately large portfolios of company stock and company stock options. Thus, their wealth is closely tied to shareholder performance. Large numbers of CEOs’ compensation packages simultaneously include annual bonuses. These cash based pay elements are typically based on firm’s accounting performance measures such as earnings per share, corporate income, and returns on assets and equity. Add to this a long-term performance plan that typically involves restricted stock shares, which is evaluated through both, longer-term measures such as progressive growth in earnings per share and/or ROI, and short-term measures such as the stock price. Each metrics from this enormous pool of financial metrics helps to paint a different picture of CEO performance. However, in the end, regardless of performance metrics used, the ultimate performance determinant is long-term stock price growth. Therefore, it is not surprising that compensation based on restricted equity grants held for the long term is growing in popularity. Regardless of the metrics, there is currently greater transparency and fewer mystiques associated with CEO’s reward and performance process. The new government regulations require firms to disclose how they measure performance and how they turn those measures into executive pay. Annual proxy statements filed with the SEC after December 2006 must adhere to the new disclosure requirements that are now in effect. Board of Directors Now that pay components and performance criteria has been identified, the study turns to the individuals that actually come up with the reward contract, namely the board of directors. The highest governing authority at any publicly traded U.S. firm is the board of directors. The primary responsibility of the board of directors is to, through the existing management structure, protect the stockholders’ interests, safeguarding their assets, and ensuring respectable return on their investment. Furthermore, acting as a primary internal control mechanism, the board of directors plays a significant role in safeguarding shareholder interests by designing executive compensation contracts and monitoring CEOs' behavior (Hermalin & Weisbach 2004; Murphy 1999). Other responsibilities of the board consist of evaluating the attractiveness of and pay dividends, recommendation on stock splits, overseeing share repurchase programs, approving firm’s financial statements, and recommend or strongly discourage acquisitions and mergers. Shareholders elect board of directors for multiple-year terms. Often these directors are part of the upper management, or outsiders with a vested interest in the firm, or independents who posses keen business ability or critical expertise that can be beneficial to the firm. Once elected, board of directors receives annual salary, stock options, additional pay for each meeting they attend, and various other benefits, which varies from firm to firm. There is no specific, fixed number of directors that sit on the board. It can vary considerably b/w firms. Some firms have only half-a dozen directors; others have over twenty. SEC requires that U.S. corporations have a board of directors, whose makeup exhibits independence, meaning that at least fifty percent of the directors cannot be employed or directly associated by the company. The intent of the regulation is to minimize the conflict of interest and maximize unbiased decision-making. Mandated by law, the boards of directors’ tasks include the establishment of two key committees, the audit committee and compensation committee. The audit committee selects and hires an outside independent auditing firm to generate company’s financial statements and reports. However, the ultimate responsibility for the accuracy and the use of fair and reasonable estimates and accounting practices in those reports lies with the board of directors as well as with the CEO. Ultimately, the board and the CEO must sign the audit reports and SEC filings. It is compensation committee’s responsibility to set top executive’s pay levels and pay mix. Pay mix is typically comprised of merit-based base pay, annual incentive-based bonus, and long- and short-term incentives that are securities-based. In recent years this pay-setting process and the unjustifiably absurd levels of CEO pays that resulted from this process has come under heavy criticism. Shareholders are crying foul. The CEO compensation packages go well over what is required to attract and keep top talent. Even poor CEO performance is often heftily rewarded. All these excesses come at the expense of the company, its employees, its shareholders, and its stakeholders. The effectiveness of the board of directors and their ability to govern is a function of corporation’s particular ownership structure. In an owner dominated firms the board is marginalized and the owner, in essence controls the corporation. In firms where no dominant shareholder or investor exists, the board of directors must act and protect these shareholders (fiduciary responsibility) at all time. This may sometimes involve firing the CEO, making changes to the corporate structure that are unpopular with management, or turning down acquisitions because they are too costly. In rare and extreme case, the owner or the controlling shareholder may occupy both key positions in a firm – the CEO and the Chairman of the Board. In such a case members of the board are analogous to a lame duck in politics and are at the will of the owner. Nevertheless, these directors still have responsibilities mandated by law and SEC that they have to fulfill (Kennon, 2008). Laws and Regulations Affecting CEO Compensation The CEO compensation reference work would be incomplete without a review and discussion of current and anticipated changes in corporate governance. There is consensus that too many governance regulations and processes were flawed in the past, not necessarily causing, but allowing and often resulting in corporate abuses, including fraud The Neoclassical Theory of the Firm The neoclassical theory of the firm states that the goal of the firm is to maximize profits, and consequently, shareholders’ wealth. Profit maximization is achieved only if one can produce goods at the lowest possible cost. Steiber (1987) suggests that profit maximization model should be used as a standard of efficiency against which all other business endeavors and behaviors can be judged. Furthermore, neoclassical theory’s strives to understand price-guided resource allocation. This is in contrast to other economic theories where resource allocation is management-guided. According to the theory, the firm is not central to the transformation of resources. It is a proverbial “blackbox”, into which resources go in and goods come out, with little attention paid to the actual processes that were used in this transformation. Under perfect competition, the transformation accords with the dictates of known technology and prices. Management’s influence on the process is minimal. Neoclassical theory is focused on specialization, not on managed coordination. The theory has no serious treatment of business ownership. This is not surprising in a theory whose core model presumes full knowledge and, therefore, no risk (risk becomes relevant if information is imperfect). The theory relies on internal and external corporate control mechanisms to ensure the rights of the principals and top management. These mechanisms, such as take-over threats, corporate governance schemes, and executive labor market, are used to fulfill and enforce the contracts b/w the parties. Thus, the incongruence b/w pay and performance is remedied through the market’s self correcting mechanisms. The executive compensation should be determined by marginal productivity - an increase in CEO pay should be proportionate to his/her contribution to the increase in output. In the absence of agency problems, all individuals associated with an organization can be instructed to maximize profit or net market value or to minimize costs. Corporate owners (principals) achieve this through a system or rewards and punishment, which closely mimic the market rates, in compensating individuals according to the level of their performance. These rewards, on top of base salary, include bonuses, stockownership, and promotions. The punishment - usually the declining compensation - is designed to discipline those that are not working toward the optimal output, and serves as a notice to adopt alternate course of action. The premise of the neoclassical theory is that there is a positive relation b/w the firm performance and executive compensation. An underlying assumption is that executives are hired to maximize principals’ goals, and that those that perform the best are rewarded the most. Managerialist Theory of the Firm The managerialist theory of the firm foundation lies on the early work of Berle and Means (1932) who wrote that the Marxist view of class relations has been fundamentally and irreversibly undermined over the course of the twentieth century by the reallocation in power and wealth away from owners to managers within an organization. Capitalist business elites derived their power from their personal wealth, in the form of their business assets. Their ownership of business enterprises was the basis of their wealth and power. Managerialist theorists claim that all this changed with the development of large-scale industry, and they hold that ownership in large companies has become increasingly irrelevant to business decision-making. Furthermore, they claim that the firms have grown in size and complexity and have expanded beyond the resources of Agency Theory Typically associated with the work of Michael Jensen and William Meckling who in early 1970s defined, tested and formalized the theory, the underlying agency problems in corporate governance have roots that go much deeper and can be traced all the way back to Adam Smith and the emergence of modern economics and free-market theory. Smith expressed concern that directors, who manage other people’s money, will not do it with the same degree of vigilance and diligence as they would if they watched over their own money (cited in Jensen & Meckling, 1976, p.35). Berle and Means were the first researchers in the twentieth century to formally examine the agency problems in modern corporations. They first identified, and then addressed in great detail, the special relationship that existed b/w the owners and top managers of large, public corporations. Specifically, they described the changes in the structure of the corporation, where the principal property owners surrendered or exchanged their wealth to those in control (agents) and consequently, become simply the recipients of the wages of capital (Berle and Means, 1932, 2). Tournament Theory Tournament theory was postulated by economists Lazear (1993) and Rosen (1986) in their attempt to align microeconomic theory with observed reality as it related to U.S. corporations and executive salary structure. The theory describes certain situations where compensation differences are based not on marginal productivity - those that add more valuable contributions to the outputs are paid more than those that contribute less - but instead based upon relative differences in performance b/w the executives. The level of a one’s skill is less important than how he/she ranks relative to others with whom he/she competes. Individuals are frequently promoted not on merit or for being the best at their jobs but for being only better than their rivals (O’Reilly et al., 1989). It is an inward-looking process resembling a lottery where managers pool part of their expected compensation to create a prize that would go to the best one. Using sport of tennis as an analogy, a tennis champion does not have to be so much better than the other finalist. The champion has to be just good enough to beat the other finalist - by a single point is sufficient – to claim the grand prize, which is often twice the amount of the second place prize (Hartford, 2006). Another unique feature of the tournament theory is that it eliminates external market and industry factors, of which managers have no control, from consideration when evaluating performance. To further attract and stimulate “competitors” the theory postulates steep salary gradient b/w the pay levels. The compensation hierarchy often resembles tournament structure, with disproportionally higher rewards toward the top. The essence of the tournament theory argument is that this unequal and significantly higher pay should serve something of a prize that makes the higher position attractive and which motivates individuals to go for it and to try to achieve it (Shaughnessy, 1998). The critics of the theory say that when rewards are used as the only motivational factor, most individuals become less efficient. This is especially true when the rewards are unfairly decided (Kohn, 1998). Even if it did work, it would only apply to the selected few that have a reasonable shot at getting the job. The vast majority would actually be demoralized since they have no chance of winning the prize (they are not in the tournament) regardless of how well they perform. The Social Comparison Theory Social comparison theory provides yet another model or criterion for explaining CEO compensation. In essence, the theory suggests that the compensation levels of those that do evaluating and pay-setting may play a role in determining the pay levels of the one being evaluated. To better understand executive pay, in addition to the economic factors and labor market dynamics, we need to look at the social and psychological settings in which decisions about that pay are made. Decisions about the amount and mix of CEO remuneration are made by a compensation committee of a corporation’s board of directors. Typically, the process starts by committee members reviewing the benchmark report on executive compensation in particular industry or market sector, compiled by outside consulting firm who, needless to say, was hired by the CEO. Benchmark usually implies comparison standard done on those deemed “best in class.” This report and its recommendations are used only for reference by the committee. The committee’s discussion on how much the CEO should be paid is often driven by peer group comparison. The outside board members who typically comprise the compensation committee are, more often than not, chief executives of another company in related industry. Hence, their best gauge for what a CEO should be paid is their own compensation package. According to O’Reilly, Mein & Crystal (1989, p.261), this peergroup comparison “sets the first number of the pay amount and then you adjust off that.” Furthermore, same researchers found that - after controlling all other compensation factors such as company size, CEO performance and tenure – the more the compensation committee members were paid, the more the CEO would make. Specifically, they found that CEO could get equivalent pay raise if he/she doubled the company’s return on equity, or if he/she appointed someone on the compensation committee who made $100,000 more annually in salary. Reciprocity and a feeling of indebtedness to the CEO also play strongly in determining the top executive pay. Majority of the outside board directors that make up the compensation committees were, at one time or another, appointed to or recommended for those plum board positions by the CEO. This theory has empirical support from Gomez-Mejia & Wiseman (1997) who found that those board members who were appointed by the existing CEO were on the average 12 percent more generous in their salary recommendation and approval for that particular CEO then the committee members who did not owe their position to that CEO. Social status of the CEO relative to the social status of the compensation committee is often a factor. Social status here refers to actions and characteristics of an individual such as the education level, elite schools attended, noted accomplishment in the community, membership in various social organizations, and pedigree. With all other performance determinants being equal, the studies show (O’Reilly et al., 1989) that if CEO was perceived as being of higher social status than the compensation committee members, he/she tended to be compensated higher. The opposite was also found to be true. Measures of organizational performance are primarily rooted in economic and market factors. While some researchers, such as McGahan (2008), argued that there is no single best measure to gauge the performance of the top executive, others such as Kaplan and Norton (1993) observed that a mix of different measures yields the best understanding of this complex relationship. Regardless of the number of performance indicators used, there is still no consensus in the academia as to the accepted performance criteria. Scholars have used different definitions of company performance when investigating the relationship b/w CEO pay and firm performance. Nevertheless, over time, three performance groupings have emerged as the dominant criteria of firm performance. These are stockholders equity (book value of the firm), firm’s stock performance (return on common stock and change in market value), and profitability indicators made up of accounting factors such as profits, earnings per share (EPS), and return on investment or assets. Research specifically designed to seek the correlation b/w stockholders equity and CEO performance has produced mixed results. Most studies found no relationship or, at best, very mild positive relationship. If one is to believe the agency theory, CEOs have every reason to believe that they should expect significant and proportional rewards based on the financial returns to the stockholders, i.e., rise in the stock price. However, several key studies such as Kerr and Bettis (1987), Hill and Phan (1991), and Gilson and Vetsuypens (1993), that investigated this link came up short – their results were inconclusive or they found no statistically significant relationships. Murthy and Salter (1975) relied on a sample of 53 CEOs in order to test the compensation practices as they related to firm’s organizational strategy. Their goal was to discover how differences in various corporate profits affected executive pay characteristics. The researchers found that 35 executives showed no significant relationship b/w their total pay and their firm’s return on equity. Furthermore, 21 executive exhibited no relationship when gauged against the profitability parameter of EPS. O'Reilly, Main and Crystal (1989) studied the three models of pay-setting and pay design for the top executives. These models were marginal product theory, tournament theory, and the social comparison theory within the external board’s directors. Data was collected from 105 firms then regresses onto ROE, sales, size, and assets, using CEO compensation as dependent variable. Study’s findings showed that sales only had significant impact on CEO compensation. Other performance determinants had small negative coefficients (ROA, firm size), or were positive but insignificant (ROE). Importantly, the study found positive relationship b/w the CEO pay and the pay of the board of directors, for a range of specifications. These findings lead to the conclusion that CEO pay setting is mostly established through social comparison. However, in past decade firms, mainly Fortune 250, have hired executive remuneration consultants to implement a pay system for C.E.Os of firm. In a firm, a remuneration committee & Human Resource department is responsible for hiring a consultant to devise a pay for C.E.O or tailor actuarial services like health plan, retirement plan or insurance plans for employees. The consultant hired, offers expertise service pertaining to “various legal & tax--related aspects of executive remuneration practices”4. However an Human Resources consultant’s job is not limited to offering executive remuneration advice. Some of other diverse function of an Human Resources consultant involves designing pay practices appropriate for organizational changes such as Mergers & Acquisitions, spinoffs, & restructurings. Consultants also maintain extensive knowledge about recent developments in pay practices & different forms of remuneration & benefits prevailing in “peer firms”. Access to proprietary surveys that have more detailed information about industry pay practices than is publicly disclosed, makes consultant’s service for a firm even more valuable. From point of view of shareholders, lower base pay tied to more cash bonuses & equity based pay tied to firm financial performance would be more convincing of firm’s efforts of trying to nurture long--term benefits of firm. In a study by Graef Crystal done in 1973 on C.E.O's of major firms found that C.E.Os earned about 45 times that of average worker. The pay gap continued to rise in 1990 to 140 times & today it is just below 500 times that of average worker (Executive Excess, 2002). It is position of Bob Kievra (2004) that corporations need to supply large remuneration packages to attract & retain good management personnel. This is often negotiated by forecasting remuneration packages that are based on projected increases in shareholders' wealth as a result of anticipated increase in management financial performance. If stockholder wealth is a result of management financial performance then shareholders should be able to justify high executive pay. However, recent studies have suggested that C.E.O pay is not linked to financial performance (Gomez--Mejia, Luis Wiseman, Robert M. 1997) but rather their influence over board of directors, as well as a strong relationship b/w a firm's size on executive pay. In a study, Sridharan (1996) proposes C.E.O influence on his board of directors is a major factor in determining executive pay. Results from her study have suggested that C.E.Os with higher influence over board of directors receive more remuneration than a C.E.O with less influence. In many cases C.E.O's & their subordinates are also members of organization's board of directors. Graef Crystal stated in an interview, "in many firms, Enron for instance, C.E.O's handpicked board of directors is made up of C.E.Os of other firms, each of whose own future pay hikes may depend on how big a raise he gives C.E.O whose board he sits on" (Executive Excess 2002). One study of executive financial performance found that 20 percent of firms are interlocked, which means that there is at least one executive on a board of directors that sits on his board. The study showed that salaries of C.E.Os in interlocked firms are higher than those who are not (Hallock 1997). Sridharan (1996) also found a positive relationship b/w C.E.O pay & value of firm's assets. A meta--analysis by Tosi, et al. (1996) found that firm size accounted for 54 percent of determinant factor in C.E.O pay, & not financial performance (Gomez--Mejia 1997). According to Rakesh Khurana, C.E.O pay that is tied to firm profits tends to depend on factors outside C.E.O's control. The industry of firm accounts somewhere b/w thirty to fifty percent of variance of a firms financial performance or it's likelihood of it's survival. That factor can depend on what year it is or how well economy is doing at time which accounts for twenty percent of firm's variance. Now this is not to say that C.E.Os do not make a difference, but these factors alone negate what a single individual in C.E.O position can do to affect a firm's financial performance. (Executive Excess, 2002). Many investors & shareholders have demanded a push toward pay for financial performance, but despite aggressive push, earning power of C.E.O's has been largely unaffected. Some C.E.Os have listened & have set an example for others to follow. For instance C.E.O of Eli Lilly & Co., Sydney Taurel, in a fiscal year he took a $1 in salary, down from $1.3 million from previous year. The C.E.O hoped to make up difference in financial performance bonuses for turning around troubled firm; however firm shares fell 32 percent at end of fiscal year. This meant that he could not justify a bonus & was paid one dollar. As can be expected, C.E.O remuneration is more complex than that of Sydney Taurel. Most executive remuneration packages are generally composed of an annual salary, annual incentive awards, long term incentive rewards, stock options & other forms of equity remuneration. C.E.O's may take a reduction in salary, but often times they are off--set with stock options & incentives. EMC Corp.'s, Joseph M. Tucci had no change in his 1 million dollar annual salary, but his bonus was trimmed from $700,000 to $675,000, however MR. Tucci was granted 75,000 shares in stock at a exercise price of one cent (Kierva 2004). One of main questions raised when it comes to executive remuneration is whether C.E.Os are making deals more for their own benefit than for benefit of their shareholders. According to James P. Melican of Proxy Governance Inc., "Mergers are tarnished when it appears that managements have negotiated lucrative employment contracts for themselves with acquiring firm." (Barrett et al.). In today's economic society, firms are merging quite frequently. Sometimes it seems as if huge payouts executive's get from a merger are benefiting C.E.Os whose firms flaws made them susceptible to takeover. Another argument against outrageous executive pay is that it is downright wrong. Morality comes into question when a person is making thousands of times more money than some people, especially when some of those people are starving (Newton 242). C.E.O's should be more aware of their earnings & realize that they have more than enough money. With all problems in this world, a person with millions of dollars should be able to make a huge difference by sacrificing some of their earnings. Outsourcing, a major issue in today's political arena, has also been linked to excessiveness of C.E.O remuneration. Since firms are willing to do anything to drive up stock prices, C.E.O's must adhere to this standard. Cost cutting is easiest way to raise profits (Newton 240). Once again, easiest way to cut costs is to decrease payroll. Firms are also saving a lot of money by cutting their research & development. This gives advantage to foreign firms who spend time & money creating better products & selling them to American consumer. Of course one cannot blame C.E.Os for money they make. Executive remuneration plans are ultimately decided by board of directors. According to an article in Business Week, "Too many boards are composed of current & former C.E.Os who have a vested interest in maintaining a system that is beneficial to them" (Borrus et al.). Many boards are failing in general to defend their investors, which they are legally required to stand up for. Determining C.E.O pay is not most important thing board does. Picking a C.E.O, debating about strategy, & voting on major purchases are all more important. However, paying C.E.O is most visible thing a board does. C.E.O pay is the, "window into boardroom" for most investors, according to Linda Scott, director of corporate governance at TIAA--CREF (Colvin). Directors should not just give into stereotypical expectations for C.E.O pay when negotiations take place. If they do, investors can't have much confidence that board will uphold rest of their responsibilities. Not only do firms provide lavish benefits in addition to high salaries, they also protect executives from losses in a falling market. Some firms award huge option grants regardless of poor financial performance, while others make financial performance goals easier to reach (Borrus...). Today's C.E.O remuneration system is clearly out of whack. It provides no incentive for outstanding financial performance. Corporations should never re--price or swap stock options that are losing value. Besides, no firm would give out free shares to stockholders to protect them from a failing market. Even though it is obvious that executive remuneration is very generous, some defend C.E.Os & their paychecks. According to Walter Williams of Capitalism Magazine, "all C.E.Os shouldn't be tarnished for misdeeds of a few any more than researchers'd tarnish all newspaper reporters because of a few among their ranks were liars..." (Williams). Williams is referring to recent uproar of citizens due to business scandals such as Enron & WorldCom. Williams then refers to Jack Welch, C.E.O of General Electric which bolstered GE's worth to around $500 billion. He claims that C.E.Os that turn their firms into billion dollar enterprises are worth their salaries because their salary is only a fraction of value that firm has grown. Competition is another defense of high C.E.O remuneration. If a firm finds & hires a C.E.O who does a wonderful job & in turn raises firm's value, then he is worth every penny he receives. His pay is what keeps him at that firm, & keeps other firms from luring him to work for them (Williams). As Elan Journo put it in his article, "Why are C.E.O's Paid so Much'", "the answer is that successful C.E.Os are as indispensable to their firms as Super Bowl--winning quarterbacks are to their teams" (Journo). A C.E.Os success depends upon their long range plans for firm. An executive's strategy must include several factors. The C.E.O must have a plan to grow business in face of competitors, not only in America but globally as well. The C.E.O must lead their firm, which usually consists of teams of thousands of workers. Integration & coordination b/w top levels & lower levels of corporate level is imperative. In order to successfully manage, as well as plan for a firm's future, a well rounded, exceptional C.E.O is needed. Critics claim that since C.E.Os are so vital to a firm's success their remuneration packages should be so high. Obviously, in today's society, media can play a big role in any high profile issue. Several critics claim that scandal over C.E.O pay is only a big issue because media makes a big deal out of it. Alan Reynolds wrote an article titled "C.E.O Pay Parade" for Cato Institute. He warns readers that, "Nearly every major newspaper & business magazine has its own uniquely dubious way of handling way stock options are valued as executive pay" (Reynolds). The media can manipulate any statistic so it reveals outcome they desire. When reading any information regarding numbers & statistics, readers should beware of this. Another fault of media is that they will lump together value of new stock with cash salaries & bonuses which blur actual amount of cash a C.E.O is to receive. There is no room left for risk involved in some of stock options C.E.Os are receiving remuneration from or fluctuation of stock price. Also, when an executive sells off his assets it should not be considered any different than selling a home because it does not make investor wealthier, therefore it should not be counted as income. The exclusion of stock sales from executive remuneration is important because it isn't pay. Another point made by those that blame media is that paying for financial performance does not mean comparing future pay to last year's stock financial performance. According to Reynolds, "If shareholders wanted C.E.Os to be paid on basis of what happened to their stock last year, C.E.Os could be paid entirely with a January bonus" (Reynolds). If this were true, executives would have no incentive to do better in future. Incentives that are linked to future should not also be linked to past fluctuations in share prices. In financial literature many elements of Executive remuneration, relationships b/w these elements & outcome of firms have been major topics for several decades, & have motivated development of several theoretical frameworks. agency framework has theoretically proved to be one of most important & influential frameworks for understanding C.E.O wages by providing a strong link b/w firms' financial performances, C.E.Os' efforts & their remuneration contracts. Most theoretical agency models yield predictions that imply a positive relationship b/w financial performance & wages. Other frameworks, e.g. managerial power approach (Bebchuk et al., 2002) or that of intrinsic motivation (Deci, 1975; Bénabou & Tirole, 2004), provide motivation for why financial performance wages not necessarily will increase financial performance. Naturally these frameworks have acted as motivations for a wide range of empirical studies. Our primary goal in this reserach is to study empirically relationship b/w firm financial performance & C.E.O remuneration. This begs question why must one expect to find strong evidence for notion that C.E.O remuneration affects firm financial performance' If primary goal of C.E.O remuneration is to realign interests of owners with interests of C.E.O, this does not necessarily affect financial performance. Owners might have interests, not only in dividends & shares price, but also in reputations & other traits unobserved by us. Since profits might affect firm value, dividends & shares prices, it seems, however, strange to assume that owners on average must not be interested in improving firm profits. In productivity literature high--powered incentive plans can provide C.E.O with incentives to strive for excellence, thereby also improving firm productivity. Improved productivity implies improved revenue–cost ratio, i.e. a firm is able to produce a similar output level using less input, thereby increasing its revenues relative to its costs. Our hypotheses are thus that researchers must observe positive relationships b/w C.E.O financial performance wages & productivity, revenue & costs, while relationship b/w profits & financial performance wages is a priori ambiguous. Above researchers have focused on C.E.O contracts providing financial performance wages, through for example bonuses, shares options or sharess, since these are clearly related to informal deficiencies in agency framework. An C.E.O's contract might, however, be constituted of other elements, such as pension plans, fringe benefits, sign--on fees & severance remuneration agreements. At risk of reversed causality researchers will in our empirical analysis also study severance remuneration. existence of such contracts ex ante might affect C.E.Os' financial performance & thus information about these reveals important firm heterogeneity (& ex ante contracts are less related to reversed causality). Our analyses address several problems. First, researchers study relationship b/w firm productivity, C.E.O financial performance wages & other remuneration plans & elements. Second, researchers repeat analyses for other firm financial performance measures such as post--tax profit, revenue & total costs. Finally, researchers study level of C.E.O earnings, & how this is related to firm productivity & to remuneration plan. A positive relationship b/w firm financial performance & level of C.E.O remuneration has been empirically observed over decades (Deckop, 1989; Jensen & Murphy, 1990; Mengistae & Xu, 2004). As financial performance becomes more uncertain, wages–financial performance sensitivity often drops (Aggarwal & Samwick, 1999; Mengistae & Xu, 2004), but allocation of responsibility to employees might disturb this empirically (Prendergast, 2002). Managerial power also seems to be positively related to remuneration levels (Randøy & Oxelheim, 2008), & certain empirical evidence might indicate C.E.O rent extraction (Bechmann, 2008). Experimental evidence points to fact that strict incentive plans might result in worse compliance than more loosely specified contracts (Fehr & Falk, 1999; Fehr & Schmidt, 2000), but this is dependent on level of incentives (Gneezy & Rustichini, 2000). Empirical tests of how structure of EXECUTIVE remuneration affects firm financial performance are much less prevalent (Murphy, 1999). results usually identify a positive relationship b/w C.E.O incentive plans & financial performance, but most studies do not attempt to identify causal relationships. Mehran (1996) observes a positive correlation b/w --based remuneration on firm financial performance (Tobin Q & return on assets) in ordinary least squares (OLS) regressions for 153 U.S manufacturing firms. OLS regressions of Jirjahn (2004) on data from 1000 German manufacturing firms revealed similarly higher value--added per workers whenever profit sharing for C.E.Os was provided. Collier & Wilson (1994) surveyed Chief Financial Officers of Fortune 1,000 firms on their educational choices. They find undergraduate work was spread among a larger number of schools than graduate education. When asked about their educational choices, they found that retrospective preferences were similar to actual choices. Palia (2000) examined how educational background of a EXECUTIVEimpacts types of firms they are selected to manage. He compared financial performance of individuals that earned their degree from top undergraduate or graduate schools to those who earned their degree from less prestigious schools. They found managers with lower quality educational backgrounds manage firms in regulated industries, while those with higher quality educational backgrounds manage firms in unregulated industries. Other reserachs that address this issue include Joskow, Rose & Shephard (1993) & Jensen & Murphy (1990). Hambrick & Masson (1984), & Capenter, Geletkanycz & Sanders (2004), discussed role of management team homogeneity as it relates to decision making speed. general argument is that homogeneous top management teams make strategic decisions more quickly & are more profitable than heterogeneous teams in stable environments. Westphal & Zajac (1996) examined 413, Fortune 500, firms & found that boards of directors prefer C.E.O’s who are demographically similar to themselves including on an educational basis. Greater similarity b/w board members & EXECUTIVE demographics result in higher EXECUTIVE remuneration. This body of literature suggests that EXECUTIVEselection must focus on individuals that provide homogeneity among leadership team. Across firms, single largest operating cost, on average, is employee remuneration or remuneration (Blinder, 1990; European Parliament, 1999; U.S Bureau of Labor Statistics, 2002). Thus, for firm to be successful, it must effectively manage not only what it spends on remuneration, but also what it gets in return. Contextual factors serve to place some limits on remuneration decisions. Legal, institutional (e.g., labor union), cultural, & market (product & labor) contextual factors vary across countries & often within countries, meaning that degree of discretion firm has in managing remuneration decisions will also vary. Nevertheless, firms typically have at least some discretion in remuneration design. 1 This choice can have a major impact at every level of firm on decisions made by individuals (through its incentive effects), as well as who those individuals are (through its sorting or self--selection & selection effects). In other words, remuneration can be a major factor in successfully executing firm's strategy. Remuneration, can be defined & studied in terms of its key decision/design areas, which include (Gerhart & Milkovich, 1992; Milkovich & Newman, 2008) how wages varies across (& sometimes within) firms according to its level (how much'), form (what share is paid in cash versus benefits'), structure (how wages manyials depend on job content, individual competencies, job level/promotion, & business unit'), basis or mix (what is share of base wages relative to variable wages & what criteria determine wagesouts'), & administration (who makes, communicates, & administers wages decisions'). From a psychological perspective, Campbell & Pritchard (1976) observe that motivation can be defined in terms of its intensity, direction, & persistence. (Together with ability & situational constraints/ opportunities, motivation contributes to observed behavior.) Thus, to fully evaluate impact of wages on motivation, one must look not only at (enduring) effort level, but also degree to which effort is directed toward desired objectives. Subsequently, however, field of psychology went through its ‘cognitive revolution,’ which departed from reinforcement theory by focusing on cognitions such as self--reports of attitudes, goals, subjective probabilities, & values. Later theories such as goal--setting (e.g., Locke), expectancy (e.g., Vroom, 1964), & equity (Adams, 1963), all give cognitions a central explanatory role. At same time, they also continue to recognize importance of reinforcement processes as drivers of those cognitions & later behavior. potential value of studying cognitions as mediators is that factors other than remuneration & incentives might influence goal choice, effort choice, & behaviors. Measuring cognitions & self--reports might be helpful in understanding why remuneration & incentives do or do not work in a particular situations. In expectancy theory (Campbell & Pritchard, 1976; Vroom, 1964), behavior is seen as a function of ability & motivation. In turn, motivation (also referred to as effort or force) is viewed as a function of belief sregarding expectancy, instrumentality, & valence. Expectancy is perceived link b/w effort & financial performance. Instrumentality is perceived link b/w financial performance & outcomes & valence is expected value (positive or negative) of those outcomes. There is often a focus on remuneration's effect on instrumentality. For example, a strong PFP program is likely to generate stronger beliefs that financial performance leads to high wages than would a weak PFP program or a seniority--based wages system. However, motivation can be undermined not only by weak instrumentality (e.g., weak PFP), but also by weak expectancy (e.g., because of inadequate selection, training or job design) or valence (outcomes that are negative or not sufficiently positively valued). Research Methods The sample covers 7--year period 1999–2005 for 390 non--financial firms from FTSE All Share Index. We have an unbalanced panel with 2304 firm--year observations. We include both cash & equity based remuneration components for sample period. Although disclosure for director remuneration in U.K has significantly improved following Greenbury (1996) & Hampel (2008) reports, remuneration information is still not available in electronic form & must be hand--collected from annual reports. Furthermore, remuneration information for stock options & L--T--I--P awards is not reported in same tabular form across different firms, making remuneration data collection more challenging. Although there is a large studies on C.E.O remuneration using data for U.S firms, studies for U.K firms is relatively limited. To date, research on executive remuneration in U.K has concentrated mainly on cash component of remuneration, which is available in electronic form. For example, Conyon (1997) uses only cash remuneration data for a sample of 213 large U.K firms b/w 1989 & 1993 & shows that remuneration committees, an increasingly popular institutional device for setting top pay in U.K, may have some influence on director remuneration but his result is not particularly robust. He concludes that there is only mixed evidence. He also finds that separating roles of chairman & C.E.O might potentially mitigate agency problems associated with top pay setting, plays a minor role in influencing director pay.  Gregget al. (2008) examine relationship b/w executive cash remuneration & firm financial performance for a sample of large U.K firms over period 1994–2002. Their findings show that overall there is little relationship b/w cash remuneration & financial performance.  Mainet al. (1996) consider both cash & equity--based components of executive remuneration for a sample of 60 firms for period 1983–1989. Their findings show that sensitivity of total remuneration including share options to share financial performance for highest paid director is rather small. Hence, their data is for an earlier period, when target of creating shareholder wealth was not as commonly emphasized as it is today. Additionally, from that period to today governance mechanisms have changed considerably in U.K. For example, recent empirical evidence shows that institutional investors have become active in their attitude towards corporate issues in U.K (see, Ozkan, 2007). Thus, one would expect that a study analysing a more recent period could provide a different set of results. There is another strand of remuneration studies consisting of studies that consider both cash & equity--based components of C.E.O remuneration for U.K firms using one--year data. Conyon & Murphy (2000) analyse differences in C.E.O pay & incentives in U.S & U.K for 1997. Their findings show that after controlling for economic determinants of C.E.O pay, C.E.O remuneration in U.S is higher than in U.K based on their sample for fiscal year 1997. Ozkan (2008) examines influence of governance mechanisms on level of C.E.O remuneration for a sample of 414 U.K firms for year 2004. Her findings show that firm financial performance does not have a significant impact on C.E.O remuneration, while measures of board & ownership structures explain a significant amount of cross--sectional variation in total C.E.O remuneration, which is sum of cash & equity--based remuneration. One major caveat of those studies is that although they use a detailed composition of C.E.O remuneration including both cash & equity--based components, their analysis is only limited to 1--year data, & this may affect their results (see, Murphy, 1985). This study contributes to studies by using a unique, hand--collected panel data set of 390 U.K non--financial firms from FTSE All Share Index for period 1999–2005 to empirically examine relation b/w C.E.O pay & financial performance incorporating both cash--based & equity--based components of C.E.O remuneration. Agency theory suggests that governance mechanisms could reduce conflicts of interests arising from separation of ownership & control in modern firms. Governance mechanisms that have been examined (in various contexts) include equity ownership by institutional share--holders, outside block holders, proportion of executive & non--executive directors, managerial ownership, board characteristics, C.E.O's age & tenure. In our empirical analysis, researchers also explore whether governance variables including ownership & board structure characteristics of firms influence level of C.E.O remuneration & also pay financial performance relation for C.E.Os in U.K firms. Institutional investors as monitors In many countries including U.K institutional investors have become dominant share--holders in financial markets. Large share--holdings may allow institutional investors to exert greater impact on corporate issues.9 For a sample of U.S firms, Hartzell & Starks (2004) find that institutional investors play an active role in designing executive remuneration. In addition, Sapp (2008) find that institutions as major share--holders influence executive remuneration for a set of publicly listed Canadian firms. A recent study by Ozkan (2008) finds that institutional ownership has a significant & negative impact on level of C.E.O remuneration for a sample of U.K firms for year 2004. Her findings are consistent with recent anecdotal evidence that institutions as large share--holders have become more active in their monitoring role. One major limitation of her analysis is that it is based on 1--year data. This paper adds to studies on C.E.O remuneration by investigating relation b/w C.E.O pay & financial performance for a panel of U.K non--financial firms for period 1999–2005 while controlling for institutional share ownership, block holder ownership, & board structure variables. Furthermore, different from Ozkan (2008), researchers investigate whether institutional share ownership has an impact on C.E.O pay financial performance sensitivity. Board of director characteristics The governance reports in U.K, such as Cadbury (1993),Greenbury report(1996) & Hampel report (2008) focused attention on firm board's monitoring role & emphasized contribution that non--executive directors may make to this process. Coreet al. (2008) find that less independent outside directors are associated with greater C.E.O remuneration for his sample of U.S firms. Oakley & Iliopoulou (2006) find that less independent & larger boards award C.E.Os significantly higher bonuses & salary post M&As for 100 completed bids in U.K over1998–2002 period. For a sample of 414 U.K firms in 2004, Ozkan (2008) finds that proportion of non--executive directors has a positive impact on C.E.O remuneration suggesting that non--executive directors do not play a monitoring role. However, she does not test whether share ownership by executive &/or non--executive directors would induce them to provide effective monitoring. In this paper, researchers investigate both impact of proportion of non--executive directors & share ownership by non--executive & executive directors on C.E.O remuneration packages. Following Ozkan (2008) & other previous researchers, researchers also include board size (that is, sum of number of executive & non--executive directors) as a control variable. Executive & non--executive directors' share--holdings  The separation of ownership & control in firms creates potential for conflicts of interest b/w directors & share--holders. There is an extensive studies that supports notion that managerial ownership may help align interests of directors with those of share--holders. That is, with increased managerial ownership, directors would be less likely to divert resources away from value maximization as they bear part of costs of their actions. Thus, one would expect higher director share--holdings might limit excessive C.E.O remuneration packages leading to a negative relationship b/w managerial ownership & C.E.O remuneration (i.e. incentive alignment effect). Hence, relationship b/w directors’ ownership & alignment of shareholder & directors’ interests may be non--monotonic, implying that marginal effect of increased directors’ share ownership depends concurrent level. At higher levels of directors’ ownership outside investors might find it difficult to monitor directors’ behavior since higher ownership gives directors more direct control over firm, increasing their ability to resist outside investors’ pressures. Increased managerial ownership may also give directors greater voting power & control, which could lead to their entrenchment. Furthermore, higher director share--holdings might inhibit external corporate control market &, in so doing reduce effectiveness of internal monitoring. For instance, existence of an external control threat might increase likelihood that board of directors would feel pressured to take action against a poorly performing C.E.O (see, e.g., Stulz, 1989). Consequently, entrenched directors who are relatively free of external discipline could provide less effective monitoring, which could lead to excessive levels of C.E.O remuneration. The net impact of these two effects would determine sign of relationship b/w managerial ownership & C.E.O remuneration. To test hypothesis non--monotonic nature of relationship b/w managerial ownership & C.E.O remuneration researchers estimate a quadratic model that implies existence of a turning point. That is, as managerial ownership increases, researchers expect to observe first a negative (i.e. incentive alignment), then a positive effect (i.e. entrenchment) exerted by managerial ownership on C.E.O remuneration. Non--executive & executive directors could have different incentives for monitoring corporate management. on--executive's main task is to review financial performance of both board & executive directors (Cadbury, 1992). They usually work part--time & have positions on more than one firm board, & are paid relatively less than executive directors. Given that monitoring requires both time & effort, non--executive directors’ share--holdings provide them with incentives to do active monitoring. Additionally, their concern about their own reputations & future career prospects might provide them with incentives to be effective in monitoring. Thus, in this paper researchers examine separately impact of executive & non--executive directors’ ownership on C.E.O remuneration. Previously, Bhagat & Black (2002) attempt to investigate separately impact of share ownership by executive & non--executive directors on firm value using U.S data. However, in context of C.E.O remuneration there have been no empirical studies examining role of executive & non--executive directors using their ownership. So, one of aims of this paper is to fill this gap in studies. C.E.O age & horizon problem We control for C.E.O's age & tenure, which is defined as number of years he has been C.E.O. One would expect that older C.E.O age & longer C.E.O tenure might lead to entrenchment. Older C.E.Os & C.E.Os with longer tenure might have more power to design their remuneration packages. However, a C.E.O with longer tenure might also have larger share ownership from previous share awards & options. Consequently, relation b/w C.E.O tenure & remuneration level would be expected to be ambiguous. Ethical Concerns Researcher is fully aware of the ethical issues involved in this work. Responsibility for every procedures as well as ethical issues associated to the project rests with the major investigators. Research will be conducted in such a way that the integrity of the research enterprise will be maintainedֽ and negative after-effects which might diminish the potential for future research were avoided. The choice of research issues will be based on the best scientific judgment and on an assessment of the potential benefit to the participants and society in relation to the risk to be borne by the participants. This study will be related to an important intellectual issue. The researcher is aware of any potential harmful effects; in such circumstancesֽ and the chosen method was used after consultation with colleagues and other experts. Full justification for the method chosen was given. The research will be conducted in a competent fashionֽ as an objective scientific project and without bias. The research will be carried out in full compliance withֽ and awareness ofֽ local customsֽ standardsֽ laws and regulations. The researcher is familiar withֽ and respectֽ the host culture. The principal investigators' own ethical principles will made clear to all those involved in the research to allow informed collaboration with other researchers. Potential conflicts will be resolved before the research begins. The research will be avoided undue intrusion into the lives of the individuals or communities they study. The welfare of the informants had the highest priority; their dignityֽ privacy and interests will be protected at all times. Freely given informed consent will be obtained from all human subjects such as librarians who will provide the literature sources. Reliability In evaluating studies, several methodological concerns emerge. Perhaps most important are reliability and validity. Reliability assessment is a core component of behavioral research and can be incorporated easily into direct observations for determining optimal levels of performance. However, only 48% of the studies (excluding those using computerized assessment) reported reliability measures on the comparison assessment. Results were worse for assessing the social importance of the effects (28 % reporting reliability), the social significance of the goals (4% reporting reliability), and validation of the appropriateness of procedures (8% reporting reliability). Several procedures have been used that can provide reliability of the questionnaire measurement methods, including test--retest, odd--even, Kendall's coefficient, Pearson r coefficient, and the equivalent-forms method. Validity Social validation procedures are valid to the extent that they measure what they claim to measure. It is critical that good internal and external validity be estate" fished for social validation procedures. The external validity of the assessment procedures reviewed here is questionable. The dimensions researchers believe they are measuring may have little relation to what is actually being measured and that face validity is inadequate as the sole criterion for evaluating the validity of assessment devices. One way to assess validity would be to have the social validation assessment developed or reassessed by a panel of "experts" or judges who are not involved directly in the research. Another method would be to have a social validation assessment of the social validation instrument. For instance, after responding to a questionnaire, raters would respond to a second questionnaire that told them the purpose of the first questionnaire and asked them to rate how well they thought the questions assessed the purpose. In addition, researchers need to be aware of halo effects, biases toward leniency or severity, central tendency responses, and position or proximity biases of raters, which may artificially enhance the reliability of measurement without improving response accuracy or validity. Results, Analysis and Discussion Model Specification & Estimation To investigate link b/w C.E.O remuneration & firm financial performance researchers use several different approaches that have been used in remuneration literature. In section 6a, researchers use a regression model which attempts to explore relation b/w level of C.E.O remuneration & firm financial performance after controlling for corporate governance variables & other firm--specific characteristics. In section 6b, researchers focus on changes in C.E.O remuneration in order to further test relation b/w C.E.O remuneration & firm financial performance. We use a regression model similar to one from Conyon & Murphy (2000). In section 6c, researchers examine link b/w C.E.O wealth & shareholder wealth. Our procedure is similar to Conyon & Murphy (2000). We calculate a measure for stock--based pay--financial performance sensitivity. This measure is computed based on C.E.O shareholdings, stock option holdings & stock award (L--T--I--Ps) holdings. Finally, in section 6d researchers attempt to investigate relation b/w pay--financial performance sensitivity of stock options granted during a year (flow measure) & corporate governance mechanisms. We follow Yermack's (1996) methodology to compute option grant sensitivity. The relation b/w level of Ceo remuneration & firm financial performance In this section researchers focus on level of C.E.O remuneration & attempt to explain how level of remuneration is related to firm financial performance after controlling for firm size, growth opportunities & corporate governance variables. We estimate following model; where ɛit is error term, & dependent variable, ln(remuneration) is log of remuneration, which is measured by either cash remuneration (the sum of salary & bonus) or total direct remuneration (the sum of salary, bonus, value of stock options & L--T--I--P granted during year). Following prior studies on C.E.O remuneration, industry--specific effects & time--effects are also included. In our estimation standard errors are robust to clustering at firm level. Firm financial performance is measured by shareholder return. Corporate governance variables include institutional ownership concentration, blockholders ownership concentration, number of blockholders, directors’ ownership concentration (the sum of executive & non--executive directors’ share ownership), board size & percentage of non--executive board members on board.14 Control variables are firm size, which is measured by firm's sales, & growth opportunities (which can be measured by Tobin's Q).15 Previous researchers have pointed to potential endogeneity problem in executive remuneration models. Following Hartzell & Starks (2004) researchers use lagged explanatory variables to minimise endogeneity problem in our regression model. Tobin's Q does not have significant impact on level of C.E.O cash & total remuneration. The results in Tables 2(A) & (B) also show that there is a positive & significant association b/w C.E.O remuneration & board size. This positive slope is consistent with an interpretation that problems with coordination, communication, & decision--making can hinder board effectiveness, which might be revealed as higher remuneration for C.E.Os as number of directors increases. Thus, our finding is consistent with previous studies, which argue that larger boards are less effective in monitoring & more susceptible to influence of C.E.O power Additionally, results show that firms with a higher proportion of non--executive directors offer higher cash & total remuneration for C.E.Os. This result can be considered as consistent with findings of  Frankset al. (2002). Their results suggest that non--executive directors do not perform a disciplinary function in U.K firms. They find that non--executive directors tend to entrench management by reducing board turnover in poorly performing firms. The results from Tables 2(A) & (B) demonstrate that level of C.E.Os’ cash remuneration & total remuneration is negatively & significantly related to institutional ownership concentration, which is measured as sum of institutional shareholdings & also by sum of four largest institutional shareholdings. This result suggests that institutional shareholders provide monitoring for C.E.Os’ remuneration level. It is also consistent with theoretical literature regarding role of large shareholder; that is, institutions have greater influence when they have large shareholdings in firms. Our empirical results provide support for anecdotal evidence that recently institutional investors have become more active in U.K corporations & also they support results from Ozkan (2008). However, this finding is contrary to previous empirical evidence reported by Cosh & Hughes (1997) &  Frankset al. (2002) that institutional shareholders in U.K firms are passive. We also find that blockholder ownership & number of blockholders have a negative & significant impact on C.E.O remuneration level. Blockholders play a significant role in determining total C.E.O remuneration as their ownership increases, total C.E.O remuneration declines. The negative relation is consistent with argument that blockholders act as a check on C.E.O pay level. One would expect that if block ownership is more concentrated, then those blockholders would coordinate their monitoring with relatively greater ease & exert pressure on management. Thus, they can help ensure that management does not expropriate wealth from shareholders in form of excess pay. We find that share ownership by executive directors has a significant & non--linear impact on C.E.O cash & total remuneration level. The estimated coefficient for non--executive directors’ ownership is negative & significant, but there is no significant non--linear relation b/w C.E.O remuneration & non--executive ownership. This result may be interpreted as evidence that non--executive board members provide monitoring when they have financial incentives. As reported in Table 1, during 1999–2005 period for our sample firms share ownership by non--executives was relatively lower than share ownership by executives, but still this level of share ownership by non--executives seems sufficient to give them incentive to have a significant impact on level of C.E.O cash remuneration. Finally, both C.E.O age & tenure have positive & significant impact on level of cash remuneration while their impact on level of total direct remuneration is positive but not significant. C.E.O pay--financial performance elasticity In this section, researchers follow approach by Conyon & Murphy (2000) & Murphy (2008) & estimate pay--financial performance elasticity for cash remuneration & total direct remuneration. The regression model is as follows; (2) where Δln(shareholder value)it, change in log shareholder value, is equal to continuously accrued rate of return on common stock andβ is elasticity of cash remuneration with respect to shareholder value. Table 3(A) shows coefficient estimates for equation (2). The findings in column (1) show that C.E.O pay--financial performance elasticity for cash remuneration in U.K firms is 0.075, that is, an additional ten percentage point shareholder return would correspond to an additional 0.75% increase in cash remuneration.18 In column (2) researchers add corporate governance variables, which include institutional ownership concentration, board size & proportion of non--executive board members on board, to regression model as control variables.19 Other control variables are firm size, which is measured by firm's sales, & growth opportunities (which can be measured by Tobin's Q).20 Our results show that these control variables do not have a significant impact on changes in C.E.O remuneration. Adding control variables do not increase explanatory power of regression model & value for C.E.O pay--financial performance elasticity for cash remuneration stays approximately same. Table 3(B) presents findings for total remuneration (the sum of salary, bonus, value of stock options & L--T--I--P granted during year). The C.E.O pay--financial performance elasticity for total remuneration in U.K firms is 0.095, that is, an additional ten percentage point shareholder return would correspond to an additional 0.95% increase in cash remuneration. Again, adding control variables does not seem to increase explanatory power of regression model. Based on our findings from regressions using level of C.E.O cash (total direct) remuneration & change in C.E.O cash (total direct) remuneration as dependent variables, researchers can conclude that there is a positive & statistically significant relation b/w C.E.O cash & total direct remuneration, & shareholder return. However, size of C.E.O pay--financial performance elasticity is small in comparison to elasticity for U.S C.E.Os. Next, researchers explore whether there is a link b/w C.E.O wealth & shareholder wealth. The relation b/w C.E.O wealth & shareholder wealth The link b/w C.E.O wealth & shareholder wealth can arise from C.E.Os’ stock & option holdings. We follow Aggarwal & Samwick (2004)& Conyon & Murphy's (2000) approach & calculate C.E.O stock--based pay--financial performance sensitivity. For C.E.O stock holdings, pay--financial performance sensitivity is fraction of shares that C.E.O owns. If a C.E.O owns 2% of shares outstanding in his firm, his pay--financial performance sensitivity from his stock holdings would be £20 per thousand pound change in shareholder wealth. For C.E.O stock option holdings, pay--financial performance sensitivity is computed by multiplying fraction of firm's stock on which options are written by option deltas.21 Thus, measure for C.E.Os’ effective ownership or stock--based pay--financial performance sensitivity is computed as; In equation (4), C.E.O's ownership is measured by number of shares owned & stock options held, which is weighted by option delta measuring stock options’ sensitivity to stock price, divided by total number of shares outstanding. This measure of C.E.O pay--financial performance sensitivity includes both stock & flow of stock options & awards (or L--T--I--Ps). As it has been argued by Hall & Liebman (2008)& Core & Guay (2008), one can underestimate pay--financial performance sensitivity if only new stock options & awards granted during a year are used in analysis. However, stock--based pay--financial performance sensitivity is also determined by C.E.O's personal portfolio choices. For instance,  Bettiset al. (2002) demonstrate that some C.E.Os can hedge part of their stock holdings. Ofek & Yermack (2000) also report that C.E.Os try to adjust their portfolios & sell some stocks when they recive new grants of stocks. The median for percentage of L--T--I--P holdings stayed stable at 0 while median for C.E.O share holdings increased from 0.06% in 1999 to 0.10% in 2005. The median stock--based pay--financial performance sensitivity increased from 0.35% in 1999 to 0.58% in 2005, while mean increased from 2.59% in 1999 to 3.02% in 2005. Although there has been an increase in stock--based pay--financial performance sensitivity, magnitude of that increase is not substantially large.22 Our findings show that for U.K C.E.Os in 2005, C.E.O wealth (based on stock & option holdings) rises by £30.2 for every £1000 increase in firm value. Conyon & Murphy (2000) find that in 1997 for U.S C.E.Os average & median stock--based pay--financial performance sensitivities are 4.18% & 1.48%, respectively, while for U.K C.E.Os average & median are 2.33% & 0.25%, respectively. Thus, confirming findings from Conyon & Murphy (2000), U.K C.E.Os in our sample seem to have lower stock--based pay--financial performance sensitivity than U.S C.E.Os. We also find that coefficient estimate for proportion of non--executive directors is positive but not statistically significant. Our results show that there is a negative & significant relation b/w board size & stock--based pay--financial performance sensitivity, suggesting that firms with larger board sizes seem to provide their C.E.Os with remuneration packages with lower stock--based pay--financial performance sensitivity. This finding is consistent with Yermack (1996) who finds that larger boards provide less efficient monitoring. We also find that coefficient estimate for C.E.O age is negative, indicating that older C.E.Os have lower stock--based pay--financial performance sensitivity. Previous researchers, for instance Mehran (1996), argue that older C.E.Os might prefer cash remuneration rather than equity--based remuneration since they have shorter employment horizon. Furthermore, coefficient estimate for C.E.O tenure is negative, suggesting that longer C.E.O tenure is associated with higher pay--financial performance sensitivity. This finding is also consistent with substitution hypothesis, which states that firms with weaker corporate governance (which can be measured by longer C.E.O tenure) would be expected to have higher pay--financial performance sensitivity as an alternative disciplining mechanism for C.E.Os. It has been commonly believed that C.E.Os with longer tenure are likely to become entrenched, by forming personal relations with directors & also appointing friends on board.23 The coefficient estimate for executive ownership is positive & significant suggesting that firms with high executive ownership have also high C.E.O pay--financial performance sensitivity. This finding is consistent with complementarity hypothesis which states that stronger corporate governance (which can be measured by higher executive ownership) is required to establish a C.E.O remuneration package with higher pay--financial performance sensitivity.24 This result does not provide support for Mehran (1996) who argues that managerial ownership & incentive--based remuneration can be viewed as substitute monitoring mechanism & firms use less equity--based remuneration when managers own a larger fraction of firm. Finally, researchers find that non--executive ownership has a positive but insignificant impact on stock--based pay--financial performance sensitivity. Table 1. Descriptive statistics Panel A: This table reports descriptive statistics of components of CEO compensation denominated in 1999 British pounds for 390 firms and 2304 firm-year observations over the period from 1999 to 2005. Total compensation is classified as base salary, cash bonus, stock options and long-term incentive plans (LTIPs). Table 1 (Continued). Panel B: This table reports descriptive statistics for firm characteristics, ownership and board structure for 390 firms and 2304 firm-year observations over the period from 1999 to 2005. Block-holder ownership is defined as percentage of total stock held by non-managerial and non-board members having 5% or more equity in firm. Table 1 (Continued). Panel C: This table reports descriptive statistics for firm characteristics for 390 firms and 2304 firmyear observations over the period 1999–2005. Shareholder return is calculated from the return index (which includes the dividends reinvested) provided by Datastream. Tobin's Q is measured as the sum of book value of assets plus market value of common stock minus book value of common stock divided by book value of total assets. Market capitalisation is measured as share price times number of outstanding shares. All monetary variables are in 1999 constant British pounds. Table 2 (Continued). Panel B: CEO's total direct compensation level and firm-specific This table shows coefficients from the regression of the CEO cash compensation level against the lagged cash compensation level, firm size (sales), firm performance (stock return), Tobin's Q, board size, proportion of non-executive directors on the board, percentage of total institutional share ownership, percentage of four largest institutional share ownership, outside blockholders’ ownership, executive and non-executive directors’ share ownership. Tobin's Q is measured as the sum of book value of assets plus market value of common stock minus book value of common stock divided by book value of total assets. Shareholder return is calculated from the end of year return index (which includes the dividends reinvested) provided by Datastream. Board size is measured as the total number of executive and non-executive board members. Block-holder ownership is measured as percentage of total stock held by non-managerial and non-board members having 5% or more shares of firm. All monetary variables are in 1999 constant British pounds. T-statistics (in parentheses) are calculated using the Huber-White-Sandwich estimator which adjusts for correlation within a cluster (firm) and ***, ** and * indicate that the coefficient is significant at the 1, 5 and 10% level, respectively. Table 3. Panel A: CEO pay-performance elasticity for cash compensation This table reports coefficient estimates for equation (2) using ln(Cash) compensation as the dependant variable. Cash compensation is the sum of salary and bonus, Tobin's Q is measured as the sum of book value of assets plus market value of common stock minus book value of common stock divided by book value of total assets, shareholder return is calculated from the end of year return index (which includes the dividends reinvested) provided by Datastream. Board size is measured as the total number of executive and non-executive board members. In Table 3 (A) we use observations that have the same CEO for at least two years in a row in order to be able to take a difference. All monetary variables are in 1999 constant British pounds. T-statistics (in parentheses) are calculated using the Huber-White-Sandwich estimator which adjusts for correlation within a cluster (firm) and ***, ** and * indicate that the coefficient is significant at the 1, 5 and 10% level, respectively. Table 3(B) presents findings for total compensation (the sum of salary, bonus, value of stock options and LTIP granted during the year). The CEO pay-performance elasticity for total compensation in UK companies is 0.095, that is, an additional ten percentage point shareholder return would correspond to an additional 0.95% increase in cash compensation. Again, adding control variables does not seem to increase the explanatory power of the regression model. Based on our findings from the regressions using level of CEO cash (total direct) compensation and change in CEO cash (total direct) compensation as dependent variables, we can conclude that there is a positive and statistically significant relation between CEO cash and total direct compensation, and shareholder return. However, the size of the CEO pay-performance elasticity is small in comparison to the elasticity for US CEOs. Next, we explore whether there is a link between CEO wealth and shareholder wealth. Table 3 (Continued). Panel B: CEO pay-performance elasticity for total direct compensation This table reports coefficient estimates for equation (2) using ln(Total direct compensation) as the dependent variable. Total direct compensation is the sum of cash compensation, value of stock options (valued on the date of grant using the Black-Scholes formula), and value of stock awards (or LTIPs which are measured at the face value of the shares on the grant date) granted during the year. Tobin's Q is measured as the sum of book value of assets plus market value of common stock minus book value of common stock divided by book value of total assets, Shareholder return is calculated from the end of year return index (which includes the dividends reinvested) provided by Datastream. Board size is measured as the total number of executive and non-executive board members. In Table 3 (B) we use observations that have the same CEO for at least two years in a row in order to be able to take a difference. All monetary variables are in 1999 constant British pounds. T-statistics (in parentheses) are calculated using the Huber-White-Sandwich estimator which adjusts for correlation within a cluster (firm) and ***, ** and * indicate that the coefficient is significant at the 1, 5 and 10% level, respectively. Table 4. Descriptive statistics This table reports descriptive statistics for CEO share option holdings, LTIP holdings, share holdings for 390 firms and 2304 firm-year observations over the period from 1999 to 2005. Following Conyon and Murphy (2000) we define the pay-performance sensitivity as: (Shares held as % of firm shares) + (Options held as % of shares) × (option delta) + (LTIP shares as % of firm shares) × (LTIP delta), where option delta is calculated by using Black-Scholes formula, and LTIP delta = 1. Table 5. CEO stock-based pay-performance sensitivity and governance characteristics This table reports coefficient estimates from the regression of CEO stock-based pay-performance sensitivity on firm-specific variables and corporate governance variables. Following Conyon and Murphy (2000) we define stock-based pay-performance sensitivity as: (Shares held as % of firm shares) + (Options held as % of shares) × (option delta) + (LTIP shares as % of firm shares) × (LTIP delta), where option delta is calculated by using Black-Scholes formula, and LTIP delta = 1. Tobin's Q is measured as the sum of book value of assets plus market value of common stock minus book value of common stock divided by book value of total assets. The goodness-of-fit measures reported are either the R2 (OLS regression) or pseudo R2(median regression). All monetary variables are in 1999 constant British pounds. T-statistics are in parentheses and for OLS they are calculated using the Huber-White-Sandwich estimator which adjusts for correlation within a cluster (firm). ***, ** and * indicate that the coefficient is significant at the 1, 5 and 10% level, respectively. Table 6. Tobit analysis: CEO pay-performance sensitivity of option grants This table reports coefficients from the Tobit regression of the CEO compensation against the change and lagged change in shareholder's wealth(which is defined as rtVt−1, where rt is the rate of return on common stock realised in fiscal year t, and Vt−1 is the firm value at the end of the previous year., firm size (market capitalisation), Tobin's Q, board size, proportion of non-executive directors on the board, percentage of total institutional share ownership, percentage of four largest institutional share ownership, outside blockholders’ ownership. Tobin's Q is measured as the sum of book value of assets plus market value of common stock minus book value of common stock divided by book value of total assets. All monetary variables are in 1999 constant British pounds. The coefficient of intercept is not reported. Our sample consists of 390 firms and 2304 firm-year observations over the period from 1999 to 2005. T-statistics are provided in parenthesis. ***, ** and * indicate coefficient is significant at the 1, 5 and 10% level, respectively. All equations include time and industry dummies. Pay--Performance Sensitivity Of Stock Options In this section, researchers examine relation b/w corporate governance variables & pay--for--financial performance sensitivity of stock option granted during a year. Thus, researchers focus on flow measure of stock options granted to C.E.Os. As Core & Guay (2008) argue firms can use flow of equity incentives to reward past financial performance & to reoptimise incentives for future financial performance. One would also expect that large shareholders, mainly institutional shareholders in U.K, & board of directors would have direct control in influencing flow measure of C.E.O equity incentives. We use Yermack's (1996) methodology to compute option grant sensitivity. We calculate delta of every option grant, ∂C/∂P  (whereC is value of call option & Pis price of stock) using Black--Scholes model. We then multiply delta of options by number of options granted, & divide by number of shares outstanding at beginning of year. This number will be sensitivity of option grant per pound change in share value.  To analyse relation b/w option--grant sensitivity & corporate governance variables, researchers use a Tobit model. Some firms do not pay their C.E.Os with stock options, & even those firms that use options do not necessarily grant them every year. Thus, stock options data have a large number of zero--valued observations & have a truncated distribution, which would make Tobit approach appropriate.25 The regression model is as follows: The change in shareholder wealth, Δ(shareholder wealth)it, which is defined as rtVt−1, where rt  is rate of return on common stock realised in fiscal yeart, & Vt−1 is firm value at end of previous year. Control variables include corporate governance variables, that is, institutional ownership, directors’ ownership, board size & percentage of non--executive board members on board, & other firm--specific characteristics, that is, firm size (which can be measured by firm's market capitalisation)26 & growth opportunities (which can be measured by Tobin's Q). Industry--specific effects & time--effects are also included. The model is similar to Hartzell & Stark (2004), who focus on impact of institutional ownership on pay--financial performance sensitivity. However, different from their study researchers also control for impact of board structure & directors’ ownership, C.E.O age & tenure on option grant sensitivity. A positive coefficient estimate for institutional ownership would suggest that institutional shareholders provide monitoring in designing C.E.O remuneration packages in U.K firms. Additionally, a positive coefficient estimate for percentage of non--executive directors on board would be interpreted as non--executive directors’ active monitoring in determining structure of C.E.O remuneration packages. The results of tobit regressions, provided in Table 6, show that institutional share ownership is important in explaining option--grant pay--for--financial performance sensitivity. Columns (1) & (2) show that results hold whether concentration of institutional shareholdings is measured by total institutional share ownership or top four institutional share ownership. The finding of significant relation b/w C.E.O remuneration structure & institutional share ownership concentration supports hypothesis that institutional ownership can serve as a monitoring device that influences structure of C.E.O remuneration. Additionally, columns (3) & (4) show results for block--holder share ownership & number of block holders. The evidence of significant & positive impact of block--holder ownership & number of block--holders on option--grant sensitivity suggests that block--holders provide monitoring for structure of C.E.O remuneration. This is ironic because, inside of firms, it often seems to be cost that gets lion's share of attention. Cappelli & Neumark (2002) observe this same omission in much of broader literature on effectiveness of Human Resources systems. Indeed, they interpret their findings as indicating that high road Human Resources systems ‘raise labor costs … but net effect on overall profitability is unclear’ (p. 766). For example, roughly one--half of publicly traded firms on 100 Best Firms to Work For list offer shares options to all or nearly all employees (Fortune, 1999: 126). Third area of fit, internal alignment, has been least studied. work of Gomez--Mejia & Balkin (1993) has sought to identify overarching remuneration strategies, but more work is needed to document which aspects of pay tend to cluster together in firms & whether certain clusters are more effective &/or what contingency factors are most important. In any event, modest evidence that exists concerning degree of actual alignment b/w pay & other Human Resources strategy dimensions suggests that there is less alignment than one might wish (Wright et al., 2002). Finally, although fit is typically seen as an important goal, this should perhaps be tempered by possibility that fit can be a double--edged sword when it comes to remuneration & Human Resources systems. Gerhart et al. (1996) pointed out that system (& resulting workforce) that fits current business strategy might quickly become a poor fit if business strategy changes. A less tightly aligned set of Human Resources practices, where bets were hedged, might make a successful adaptation more likely. As Boxall & Purcell (2004: 56) put it: ‘In a changing environment, there is always a strategic tension b/w performing in present context & preparing for future.’ Perhaps in recognition of limitations of static vertical fit, some recent work on Human Resources systems emphasizes importance of agility in Human Resources systems & strategy (Dyer & Shafer, 1999) & relatedly, of flexibility (Wright & Snell, 1998), or what might be seen as a capability for achieving dynamic fit. As a key part of an Human Resources system, remuneration must then be evaluated on an ongoing basis to consider its contribution to flexibility. Some examples of remuneration programs that are seen as promoting flexibility are skill--based & competency--based pay, as well as broadbands (in place of more detailed pay grades). Many people argue that poor C.E.O remuneration plans were one of key elements that contributed to bringing about recession. Despite extensive literature on remuneration, there still remain many unanswered questions, including how to best incentivize C.E.Os. Some argue that it is through higher pay sensitivity, which is created by awarding bonuses, shares awards, & options to C.E.Os. In theory, higher pay sensitivity would create greater incentives for C.E.Os to do what is best for their firm, because C.E.O’s wealth is more closely tied to changes in firm financial performance. In other words, better firm performs, higher value of C.E.O’s wealth gets. On other hand, this type of remuneration creates a payoff asymmetry as C.E.Os face unlimited gains but limited losses (this is further explained below). This phenomenon might lead C.E.Os to take on excessive risk as their remuneration sensitivity increases (Bebchuk & Spamann, 2009). Scholars also debate who must be responsible for setting these incentives: must shareholders have more influence in setting remuneration structures, or must government regulate them' As stated previously, some economists state that shareholders might incentivize C.E.Os to take on excessive risk (Cheng, Hong, & Scheinkmann, 2009), which implies that shareholders must have less influence on C.E.O remuneration. Others argue that closer alignment of shareholder interests & executive remuneration drives firm success, & shareholders must therefore have more control on C.E.O remuneration. In fact, many activist investors attempt to reinforce shareholder interest & C.E.O incentive alignment in portfolio firms. These findings might seem surprising, but there exist logical theories that help explain these results. Fahlenbrach & Stulz suggest that C.E.Os with more tightly aligned incentives took risks that other C.E.Os did not. These risks were taken because C.E.Os were incentivized by their remuneration structure to take them. Pre--crisis, these risks looked very profitable for C.E.Os & shareholders. As it turns out, risks lead to disastrous consequences that no one, including C.E.Os that took these risks, really saw coming. fact that C.E.Os did not sell their shares & also suffered enormous losses during downturn further strengthens this argument. If consistent, results of reserach would lead one to question government’s current actions in implementing programs like say--on--pay, which aim to reinforce shareholder influence on C.E.O remuneration in order to better align C.E.O incentives with shareholder interests. Better financial performance, on other hand, was correlated with banks that had “more restrictions on their activities, stronger oversight of bank capital, & a more independent supervisory authority.”3 Cheng, Hong, & Scheinkmann (2009) also argue that C.E.O risk--taking behavior is generally caused by incentives which are set by overoptimistic shareholders who buy shares & want to sell as soon as they have made a satisfying profit. Their results “suggest that reforms designed to strengthen influence of shareholders in remuneration decisions might exacerbate short--term risk--taking at expense of taxpayers by encouraging risk--taking during speculative periods.”4 issue is that when C.E.Os are paid in form of shares & shares options, their mentality resembles that of sharesholders. Sharesholders & C.E.Os then fully benefit from gains, but are “insulated from effects of any increase in level of losses.” core problem, in other words, is one of payoff asymmetry. In conclusion, executive remuneration is used in a variety of different ways to not only create wealth for their executives but also to create a since of accomplishment & a since of security for their executives. Organizations are almost required to provide these incentives to their executives because of what they do for their organizations. Executives are one of most important parts of any organization because they help organization to achieve their goals while at same time helping organization to create a profit so that they can pay their employees & themselves. C.E.Os will be in middle of this long running debate for a while. Conclusion This research ends up providing added pragmatic substantiation on the relation b/w C.E.O remuneration & financial performance controlling a comprehensive set of corporate governance mechanisms for a sample of 390 U.K non--financial firms from FTSE Allshare index for period 1999–2005. The empirical results indicate that pay--financial performance elasticity for U.K C.E.Os is 0.075 (0.095) for cash remuneration (total direct remuneration), indicating that a ten percentage points increase in shareholder return corresponds to an increase of 0.75% (0.095%) in C.E.O cash remuneration (total direct remuneration). In comparison to previous findings for U.S C.E.Os, pay--financial performance elasticity for U.K C.E.Os seems to be lower. Our findings on link b/w C.E.O wealth & firm financial performance show that both median share holdings & stock--based pay--financial performance sensitivity (which is calculated based on aggregate C.E.O share holdings, option holdings & L--T--I--P holdings) are lower for U.K C.E.Os than those reported by Conyon & Murphy (2000) & Aggarwal & Samwick (2004) for U.S C.E.Os. Thus, recent corporate governance reports emphasising link b/w C.E.O pay & corporate financial performance do not seem to be totally effective in practice. The findings also suggest that larger firms pay their C.E.Os higher remuneration, which one can interpret as reflecting their demand for higher quality C.E.O talent. Additionally, firms with larger board size pay their C.E.Os higher levels of total remuneration. Our findings also indicate that firms with a higher proportion of non--executive directors on board pay their C.E.Os more. These findings show that non--executive directors do not seem to provide monitoring in determining C.E.O remuneration. However, researchers also find that non--executive directors’ share ownership has a negative & significant impact on C.E.O remuneration level suggesting that ownership can provide incentives for non--executive directors to be more active in monitoring C.E.O remuneration packages. Many people argue that poor C.E.O remuneration plans were one of key elements that contributed to bringing about recession. Despite extensive literature on remuneration, there still remain many unanswered questions, including how to best incentivize C.E.Os. Some argue that it is through higher pay sensitivity, which is created by awarding bonuses, shares awards, & options to C.E.Os. In theory, higher pay sensitivity would create greater incentives for C.E.Os to do what is best for their firm, because C.E.O’s wealth is more closely tied to changes in firm financial performance. In other words, better firm performs, higher value of C.E.O’s wealth gets. On other hand, this type of remuneration creates a payoff asymmetry as C.E.Os face unlimited gains but limited losses (this is further explained below). This phenomenon might lead C.E.Os to take on excessive risk as their remuneration sensitivity increases (Bebchuk & Spamann, 2009). Scholars also debate who must be responsible for setting these incentives: must shareholders have more influence in setting remuneration structures, or must government regulate them' As stated previously, some economists state that shareholders might incentivize C.E.Os to take on excessive risk (Cheng, Hong, & Scheinkmann, 2009), which implies that shareholders must have less influence on C.E.O remuneration. Others argue that closer alignment of shareholder interests & executive remuneration drives firm success, & shareholders must therefore have more control on C.E.O remuneration. In fact, many activist investors attempt to reinforce shareholder interest & C.E.O incentive alignment in portfolio firms. These findings might seem surprising, but there exist logical theories that help explain these results. Fahlenbrach & Stulz suggest that C.E.Os with more tightly aligned incentives took risks that other C.E.Os did not. These risks were taken because C.E.Os were incentivized by their remuneration structure to take them. Pre--crisis, these risks looked very profitable for C.E.Os & shareholders. As it turns out, risks lead to disastrous consequences that no one, including C.E.Os that took these risks, really saw coming. fact that C.E.Os did not sell their shares & also suffered enormous losses during downturn further strengthens this argument. If consistent, results of reserach would lead one to question government’s current actions in implementing programs like say--on--pay, which aim to reinforce shareholder influence on C.E.O remuneration in order to better align C.E.O incentives with shareholder interests. Better financial performance, on other hand, was correlated with banks that had “more restrictions on their activities, stronger oversight of bank capital, & a more independent supervisory authority.”3 Cheng, Hong, & Scheinkmann (2009) also argue that C.E.O risk--taking behavior is generally caused by incentives which are set by overoptimistic shareholders who buy shares & want to sell as soon as they have made a satisfying profit. Their results “suggest that reforms designed to strengthen influence of shareholders in remuneration decisions might exacerbate short--term risk--taking at expense of taxpayers by encouraging risk--taking during speculative periods.”4 issue is that when C.E.Os are paid in form of shares & shares options, their mentality resembles that of sharesholders. Sharesholders & C.E.Os then fully benefit from gains, but are “insulated from effects of any increase in level of losses.” core problem, in other words, is one of payoff asymmetry. Of these seven major components short--term & long--term bonuses are very popular & important. Short--term bonuses are used to balance out an executive’s base pay & they are also used in ways to promote motivation among their executives. Short--term bonuses come in many different forms & for executives length--of--Service/Seniority Reward bonus is popular because most executive are with an organization for many years & they deserve some type of bonus for that. Short--term bonuses are base on a one year or less period & they are “intended to pay executives a bonus each year in a relatively predictable amount” (Short--Term Incentive Remuneration). Long--term bonuses are used to create security for executives so that they know their future with organization is safe & also to know that when they retire they will be able to live a comfortable life. Long--term bonuses include many different retirement programs like 401K, KSOP’s, Pension Plans, & Roth IRA’s. Some other types of long--term bonuses that do no go along with retirement are employee stock ownership plans & profits sharing plans. These types of bonuses give executives extra cash at future times with their organization & also build a comfort level with them so that they will continue to contribute to organization. Short--term & long--term bonuses are used for same reasons but they are put into effect in different ways. Short--term bonuses help executives realize that they are needed & that they are being recognized for work that they are doing. In conclusion, executive remuneration is used in a variety of different ways to not only create wealth for their executives but also to create a since of accomplishment & a since of security for their executives. Organizations are almost required to provide these incentives to their executives because of what they do for their organizations. Executives are one of most important parts of any organization because they help organization to achieve their goals while at same time helping organization to create a profit so that they can pay their employees & themselves. C.E.Os will be in middle of this long running debate for a while. Additionally, researchers document that institutional & blockholder ownership have a significant & negative impact on level of total C.E.O & cash remuneration, which shows existence of active monitoring by block--holders & institutional shareholders. Furthermore, researchers find that institutional share ownership has a positive & significant impact on C.E.O pay--financial performance sensitivity of option grants. These findings provide empirical support for stories from financial press about institutional investors’ influence on C.E.O remuneration packages. 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