International Journal of HospitalityManagement

“An examination of executive compensation in the restaurant industry”

Presented by: M. Shafiq

Rashid Khan

Faiza Manzoor

Qandeel Khattak

Abstract

The purpose of this empirical study is to examine executive compensation in the restaurant industry. The effects of a set of accounting-based performance measures, market-based performance measures, and executive-related factors on the compensations of firm CEOs, other senior executive managers, and board members were examined.

Drawn from 16 consecutive years of data and a sample of over 2200 observations from restaurant companies, the findings revealed that determinants of equity based compensation vary by different types of executives. In addition, this study supports the notion that executive compensation in the restaurant industry is determined not only by firm performance measures but also by executive-related characteristics such as tenure.

Introduction

It has been widely recognized that top executives play a significant role in any organization’s success.

As an area of both research and practice, executive compensation regarded as an important motivating factor in the successful management of an organization.

The literature on corporate governance and agency theory suggests that when appropriately designed, compensation packages can be effective tools in inspiring senior executives to seek to maximize shareholders’ value rather than their personal benefits.

Different performance measures have been adopted in different studies, and consequently, without an established set of “best” performance measures, different results have been produced (e.g., Baysinger and Butler, 1985; Core et al., 1999; Finkelstein and Hambrick, 1989; Hermalin and Weisbach, 1991; Morck et al., 1988)..

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In addition, executive compensation has been reported to be associated with firm size and leverage.

According to the upper echelons theory, top executives act on the basis of their personal biases, experiences, values, and executive characteristic variables may serve as useful, although imprecise, proxies for the executives’ cognitions and values.

There has been little research conducted on executive compensation in the restaurant industry, of which the characteristics differ from those of other industries in many ways.

First, it was widely recognized that firms in the hospitality industry tend to have agency related problems stemming from ownership styles. Property ownership as well as management is a practice in the hospitality industry

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Second, the real estate component of the hospitality industryincreases the capital intensity of the hospitality firms. High capital intensity and relatively low level of operating inventories (De Franco and Lattin, 2006) stimulate the business risk and financial inflexibility

Reich (1994) suggested that because of the high ratio of short-rundecisions compared to long-run, the hospitality managers are under pressure in that short term production output can only be modified by changing the variable inputs such as payroll and relate expenses and rent or mortgage payments, while more modification can be done in the long-run.

Restaurant industry is considered to be highly labor intensive while less capital intensive compared to the lodging sector, and consequently restaurant managers tend to focus more on short-run decisions compared to the hotel executives (Reich, 1994).

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The objective of this research, therefore, is to complement existing research by studying executive compensation in the restaurant industry from a more comprehensive approach than have any previous studies.

This study address three research questions:

What are the primary factors that affect executive compensation in the restaurant industry?

Are the compensations of different types of executives, such as CEOs, other senior management team members, and board members, influenced by different factors?

In addition to financial variables, is an executive’s compensation related to his or her personal characteristics, such as age, gender, and tenure

Literature reviewCorporate governance and agency theory

Corporate governance is gaining more interest from governments, international associations, and the business world.

The term refers to the allocation of structures, principles, and processes used to direct and control companies (La Porta et al., 2000; Shleifer and Vishny, 1997; Cadbury, 1992).

In general terms, corporate governance refers to a combination of processes, customs, policies, laws, and institutions by which companies are directed, administrated, and controlled (La Porta et al., 2000; Shleifer and Vishny, 1997).

In the context of a company, corporate governance deals with balancing the interests of all parties in order to reach the maximum level of efficiency and profitability (Du Plessisetal.,2005)

Continu………..According to agency theory, corporate agency problems occur when goal incongruence exists between managers and stockholders (Jensen, 1986; Jensen and Meckling, 1976).

When conflicts of interest exist, it is challenging to create a sus-tainable and continuously profitable corporation if the interests of owners and managers are not aligned (Hansmann, 1996)

Jensen and Meckling (1976) suggested that companies should provide compensation packages that reflect managers’ performance, resulting in an increase in shareholders’ wealth.

Another way to avoid agency problems is by rewarding managers based on the financial returns to share- holders (Kerr and Bettis, 1987).

The literature suggests, therefore, that performance-based compensation provides viable solutions to agency problems

Continu………..Executive compensation

Executive compensation refers to all company benefits paid to executives, including basic salary, short-term and long-term incentives, bonuses, shares options, and other forms of compensation.

According to Jensen and Meckling (1976), the best way to minimize agency problems is to compensate executives for their managerial performance.

It is argued in the literature that, ideally, the purpose of both the management and the board is to maximize the economic value of the shareholder’s interest, and consequently it is logical to expect that shareholder returns are good indicators for executive compensation decisions (i.e. Rappaport, 1981; Kerr and Bettis, 1987).

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Compared to executives in other industries, those in the hospitality industry have relatively low income levels (Sturman, 2001). Moreover, in the hospitality industry, executives working in the restaurant and hotel industries are paid less than are their peers in the casino industry (Kefgen and Mahoney, 2009).

According to Kim and Gu (2005), pay-for-performance compensation is only partially practiced in the restaurant industry. They suggested that the restaurant industry should consider profitability and stock performance in order to enhance company value and to minimize agency problems.

The results showed that a positive relationship exists among CEO compensation, gross revenue, net income, and stock price. They also found that stock price is a significant predictor of CEO compensation.

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Factors that affect executive compensation

Firm size: Executives may prefer compensation linked to firm size rather than performance-based benefits because firm size is less unpredictable than is firm performance, and thus executive benefits are more secure (McKnight and Tomkins, 2004). Kim and Gu (2005) found that firm size is the dominant factor in restaurant CEO cash compensation and that CEOs of large restaurant firms receive higher cash compensation than do CEOs of small ones

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Leverage (Debt): Jensen (1986) argued that leverage in a firm’s capital structure helps minimize agency costs related to free cash flow. Two perspectives exist regarding the relationship between leverage and executive compensation.

The first perspective suggests that an increase in financial leverage may cause agency problems, therefore lowering pay-for-performance compensation. Firm swith higher leverage ratios may decrease their levels of executive cash compensation (Gu and Choi, 2004).

The second perspective suggests that leverage can help align the objectives of executive management with those of owners, motivating management to improve firm performance in order to meet creditors’ payments, which are required to be made in cash.

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Firm performance: Literature on the relationship between executive compensation and firm performance has produced mixed results, many studies (Carr, 1997; Elston and Goldberg, 2003; Finkelstein and Hambrick, 1989; Jensen and Murphy, 1990; Baber et al., 1996; Kren and Kerr, 1997) have reported a positive relationship between firm performance and executive compensation.

In previous research, firm performance has been measured by accounting-based mea- sures such as profitability ratios, return on equity, and return on assets (Kim and Gu, 2005; Nourayi, 2006) and by market-based measures such as stock-price, stock return, and total shareholder return (Nourayi, 2006). Tobin’sQis an alternate market-based mea- sure of business performance (Chen and Lee, 1995). Tobin’s Q ratio, defined as a firm’s market value divided by the book value of its total assets .

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According to several previous studies (Coughlan and Schmidt, 1985; Rich and Larson, 1984; Murphy, 1985; Conyon et al., 2000), executive compensation is related more to market-based performance measures than to accounting-based ones. Alternatively, several researchers (Lewellen and Huntsman, 1970; Sloan, 1993; Carpenter and Sanders, 2002; Kerr and Bettis, 1987) have found some strong relationships between accounting-based measures and executive compensation.

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Executive characteristics

a) Gender: Agarwal (1981), Finkelstein and Hambrick (1989), and Santerre and Thomas (1993) reported that male executives are paid significantly more than are female executives. Bertrand and Hallock (2001) found that female executives are paid 45% less than male executives. According to a study (Adams et al., 2007) on gender differences in CEO compensation, women are not as highly compensated as men before being promoted to CEO posi-tions.

b) Age: An executive’s human capital – measured by expe- rience, knowledge, or other characteristics – should make a difference in compensation (Gray and Benson, 2003), but the liter- ature has not revealed the presence of such an impact (Finkelstein and Hambrick, 1996)

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Executive age can be expected to be positively related to executive compensation because human capital is accumulated through years of work, and older executives have more time to gain trust and influence with the board of directors

c) Tenure: An executive’s tenure refers to the number of years he or she has held the same position. Executive tenure has been expected to be positively linked to compensation, but tenure’s effect on compensation has differed in many studies.

d) Duality : Alongside these arguments, the compensation literature suggests that equity-based compensation provides an incentive for CEOs or boards of directors to pursue shareholders’ interests. According to Mehran (1995), firms with more outsiders on their boards make greater use of equity-based compensation for CEOs, and equity-based compensation for CEOs is positively

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related to firm performance.

Ryan and Wiggins (2004) found that firms with more outsiders on their boards award both CEOs and directors more equity-based compensation. In contrast, when a CEO’s power over a board increases, compensation provides weaker incentive to monitor.

A CEO’s power over a board increases, usually as a result of the combining of the roles of CEO and chairperson, which is called CEO duality. CEO duality creates a dominant CEO (Daily and Dalton, 1993; Jensen, 1993) that affects the independence of the board (Finkelstein and D’Aveni, 1994) and provides a wider power and locus of control (Hambrick and Finkelstein, 1987).

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Contributions of the study

Executive compensation is affected by many factors, and owners and managers tend to act in their own interests, resulting in conflicting goals (Levinthal, 1988).

As discussed, different performance measures are used to determine organizational per- formance, which is also multidimensional in nature (Chakravarthy, 1986). Therefore, executive compensation is indeed a comprehen- sive topic to study. Although the studies of Barber et al. (2006) and Kim and Gu (2005) have made considerable contributions to the hospitality literature, several issues potentially confound their findings.

This study’s purpose is to reconcile and improve on previ- ousstudies of executive compensation in the restaurant industry

Continu………..Data and methodology:

Compustat’s executive compensation (ExecuComp) database was used to retrieve data on executives’ age, years of employment in their company, gender, and position, in addition to the compensation data. Executives included in this database are not limited to CEOs’. ExecuComp collects data on up to nine executives from each company in its dataset, though most companies only report information on five. Compensation data was collected from ExecuComp. Balance sheets and income-statement-related data were retrieved from the Compustat database.

Stock-price-related data for the restaurant firms were collected from CRSP using a 10-digit central index key (CIK) for each company. In this study, equity based compensation includes total value of restricted stock grants, long-term incentive payouts, others, and value of options exercised.

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Findings:???????????????????????

Discussions:

The purpose of this article is to improve our understanding of executive compensation in the restaurant industry by developing four models using executive-related and market-based variables as executive compensation determinants to capture the relationship between these variables and executive compensation.

Following the finance and hospitality literature, 7 variables were selected to represent executive-related and market-based variables that might influence executives’ equity based compensation in the restaurant industry.

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Conclusions and recommendations for future studies :

Kim and Gu (2005, p. 352) recommended that, in order “to make the research in this area more comprehensive and thus more powerful, non-finance dimensions such as age, gender, and education of CEOs may be considered in future studies.”

To our best knowledge, this is also the first study within the restaurant industry that considers executive-related dimensions in addition to performance indicators. This research provides new evidence that executive compensation should be tied to market-based performance measures.

An important empirical implication of this study is to suggest that an approach built on market-based performance measures would be appropriate to compensate the executives in the restaurant industry.

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Limitation of the study

Some of the factors that were not captured in this research, such as education level, leadership practice, past performance and reputation, may also influence executive compensation.

Another limitation is related to the use of equity based compensation in the study. By using equity based compensation, this study does not include short- term incentive compensation in the form of salary and bonuses. Future research can address this limitation by examining the determinants of cash-based, equity-based and total compensation.

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In addition, this study focuses exclusively on the restaurant industry, and consequently its results should not be applied to the other sectors in the hospitality industry

An examination of the determinants of CEO, SEO, and board member compensation in the hotel and casino industries is recommended for future research in order to provide a even more complete picture on the whole hospitality industry and to explore whether determinants of cash based and equity based compensation change for different types of executives in other sectors of the hospitality industry .

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THANKS FOR BEARING……. :-p