Effects of executive compensation on firm risk and performance after successful mergers and acquisitions deals

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2018

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Amewu, Godfred

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Abstract

The global financial system has experienced tumoil over the past decade due to the devastating effects of the 2007-2009 financial crisis. While controversies remain concerning the precise cause(s) of the crisis, some identified explanations have been linked to the culture of excessive risk-taking influenced by reward systems (executive compensation). There has been suggestions of closer monitoring and linking executive compensations to performance as the best way to align the interest of executives to that of shareholders. However, available empirical evidence on the relationship between compensation schemes and the performance of firm or risk remains unclear. At the same time, the influence of markets and executive self-induced decisions such as Mergers and Acquisitions (M&A) on incentives and how these incentives subsequently encourage excessive risk-taking, most especially in emerging markets like Africa, is underexplored. Knowledge on this subject is not only essential in addressing the various corporate governance issues relating to executives and firm value creation, but also critical for regulating the financial system. Using company data across 14 different African countries from 2000 to 2016, we extend literature by exploring the significance of deal, firm and corporate governance factors as drivers of pay-performance and risk. This thesis consists of four stand-alone empirical essays, each examining specific gap within the executive compensation, Mergers and Acquisitions (M&A), firm performance and risk context. The first essay provides evidence of positive abnormal returns earned by shareholders of acquirers upon mergers and acquisitions announcements on African markets. We observed significant cumulative abnormal returns for wider windows up to 25 days before and after M&A announcements. Confidentiality about pending merger announcements are poorly held resulting in significant information leakage occurring up to six trading days. Further, we establish that firm industry, mode of payment and nature of acquisition significantly influence abnormal returns. We also found strong positive effect of firm-specific factors (firm size and return on equity) on investor’s investment decisions following a merger announcement. The second essay examines the impact of mergers and acquisition deals on various executive pay schemes and factors that drive these pay increase. We find that executives and board of directors of African acquiring firms are rewarded significantly for carrying out successful M&A deals in the year of merger, both for our total sample, South Africa and Other Africa sub-samples. Besides, pay rise is strongly impacted by size of the deal across all the various forms of executive pay. We show that pay increases are high for executives who acquire private targets but no evidence was found to support the impact of domestic acquisitions. South African executives are rewarded more based on market perception of the deal quality. Increase in compensation is not affected by industry classification, diversification and international operations, cross-listing and mode of payment, although there is evidence of the influence of equity mode of payment for the South African market. Further, we distinctively examine the impact of corporate governance factors on pay rise and observe that firms with larger outside board of directors’ representation negatively determine executive total pay and there is no evidence that CEO’s age and gender influence executive pay. However, the experience of the CEO has a very high positive influence on the level of compensation for South Africa. We conclude that board of director’s total reward is also higher in the year of deal completion and is influenced, to a large extent, by size of M&A deal. The third essay examines the impact of executive compensation on performance measures after successful mergers and acquisitions. We find that executive compensation induced by M&A in Africa negatively affect the performance of listed firms. There is also evidence to support the impact of firm size, deal size, target destination, foreign ownership, diversification, outside board representation and executive ownership on the pay-performance nexus. Individual pay types, some control variables and market location, tend to affect performance differently. In the final essay, we examine the impact of various executive compensation types on the post-merger risk-taking by firm’s executives. Integrating the influence of deal, firm and corporate governance factors within the Agency Theory framework, we provide a deeper insight on executive pay and how it influences risk appetite. In general, we find that executive pay influences firm risk differently depending on compensation type and risk measure. Specifically, we find that rewarding executives with cash compensation reduces the total post-merger risk of acquirers. However, managers are motivated to increase systematic risk when they are rewarded with stock-based incentives. Besides, based on the argument that managerial compensation portfolio might impact systematic and unsystematic risk differently, our findings show no evidence of the impact of executive pay on unsystematic risk. Finally, by using accounting risk measures, we find no evidence of firms being financially distressed after mergers.

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Doctoral thesis submitted in fulfillment of the requirement for the award of Doctor of Philosophy The Graduate School of Business Administration, Wits Business School University of the Witwatersrand July 2018

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