Institutional directors and board compensation: Spanish evidence

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www.elsevier.es/brq

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Business

Research

Quarterly

ARTICLE

Institutional

directors

and

board

compensation:

Spanish

evidence

夽

Felix

López-Iturriaga

a,b

_,

_Emma

_García-Meca

c,∗

_,

_Fernando

_{Tejerina-Gaite}

a,b

a_Accounting_and_Finance_Department,_University_of_Valladolid,_Spain

b_{International}_Laboratory_of_{Intangible-driven}_Economy,_NRU_Higher_School_of_Economics,_Russia c_Accounting_and_Finance_Department,_Technical_University_of_Cartagena,_Spain

Received14September2013;accepted24July2014 Availableonline23September2014

JEL CLASSIFICATION G23; G32; M12 KEYWORDS Corporate governance; Institutional investors; Boardofdirectors; Remuneration; Compensation

Abstract Weaddresstheinfluenceofdirectorswhorepresentinstitutionalinvestorsinthree aspectsofboardcompensationpolicies:levelofcompensation,composition,andperformance sensitivity.Wedifferentiatepressure-sensitivedirectors(i.e.,withbusinesslinks)and pressure-resistant directors (i.e., without business links). Our results show that pressure-resistant directorsdecreasetotalboardcompensationanditsfixedproportion,whereastheyincrease thevariableproportionoftotalremunerationandthepay-for-performancesensitivity.By con-trast,pressure-sensitivedirectorsoffertheoppositeresults.Thesefindingsareconsistentwith theviewthatinstitutionalinvestorsarenotahomogeneousgroupandthatpressure-resistant directorsfulfillamorethoroughmonitoringrole.

夽 _The_authors_are_grateful_to_Alisa_Larson,_Mónica_{López-Puertas} Lamy,KurtDesender,XoséH.Vázquez(associateeditor)and two anonymous referees for their commentson previous versions of the paper, and for the ﬁnancial support provided by the Span-ishMinistryofScienceandInnovation(ECO2011-29144-C03-01and ECO2011-29144-C03-02).Alltheremainingerrorsaretheauthors’ soleresponsibility.

∗_{Corresponding}_author.

E-mailaddresses:ﬂopez@eco.uva.es(F.López-Iturriaga), emma.garcia@upct.es(E.García-Meca),ftejerina@efc.uva.es (F.Tejerina-Gaite).

Introduction

Corporatecompensation schemeshave been a high prior-ityissue in the agenda of corporate governance reforms. In an attempt to improve corporate governance in pub-lic ﬁrms and to mitigate potential conﬂicts of interest, the European Commission recently issued several rec-ommendations (2009/384/EC; 2009/385/EC) to enhance appropriatecompensationpolicies,moredetaileddisclosure requirements, and a higher level of control for indepen-dent directors and shareholders within the pay setting process.

http://dx.doi.org/10.1016/j.brq.2014.07.003

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Inthisdebateregardingappropriatecompensation poli-cies, 90% of institutional investors believe thatcorporate executives areoverpaid (Brandes etal., 2008). This per-ceptionhasledsomeinstitutionalinvestorstogiveuptheir traditionalpassiveroleandbecomeactivelyengagedinthe compensation decisions at their portfolio firms (Bushman andSmith,2001;HartzellandStarks,2003).Asinstitutional investors have emerged as a significant group of share-holders withthe incentives and the capabilities tocheck managerialpower,theseinvestorsalsoexercisetheir influ-enceonthecompensationschemesoftheirinvestedfirms (Parrinoetal.,2003).

Theliteraturehasfoundthatinstitutionalinvestors influ-ence both the level and the structure of CEO pay in accordancewithshareholderinterests,whichmaybein con-flictwiththeinterestsofCEOs(Davidetal.,1998;Hartzell and Starks, 2003). But, although prior research provides significant insights on the relationship between institu-tional investors’ ownership and compensation, it has not yetaddressedtheeffectoftheseshareholdersasdirectors andtheimpactoftheir differentnatureoncompensation policies.

WiththenotableexceptionsofHempelandFay(1994), Boyd(1996)andCordeiroetal.(2000),mostprevious liter-aturefocusesonCEOandexecutivecompensation,solittle isknownaboutthedeterminantsofthepayofothersenior personnel.However,rapidgrowthindirectorcompensation hascausedabigcontroversy,sincedirectorsservingonthe compensationcommitteecandeterminethelevelandmix oftheirowncompensationpackages(Cordeiroetal.,2000). Thisfacthasledtopotentialconflictsofinterests, differ-ent tothe conflicts withmanagers, whodo not set their ownsalaries.Indeed,accordingtoDaltonandDaily(2001) the stock based compensation for directors is evenmore contentiousthansimilarpracticesforofficers.

The presence of directors appointed by institutional investorsontheboardisrisingacrosscountriesand, accord-ingly,theseinstitutionsarebecomingmoreinfluentialinthe corporate governance. Heidrick and Struggles (2011) find that,althoughdirectorsappointedbyinstitutionalinvestors only account for 2% of British firms directorships, they accountfor 40% of directorship in Spain, 35% in Belgium, and 22% in France. Moreover, due to an alleged lack of efficiencyofindependentdirectorsinEuropean countries, some authors highlight that the supervising role in these environmentsis actuallyplayed bydirectorsappointedby institutionalinvestors (SánchezBallesta andGarcía Meca, 2007). Given the widespread importance of institutional investors, a better understanding how their presence on boardsaffectstheir owncompensation schemes isclearly needed,especiallyincivil-lawcountrieswherethese direc-torsaretakingupanincreasinglyactiveroleintheirfirms’ corporategovernance.

We study the impact of institutional directors on two aspectsof remuneration policy:composition and sensitiv-ity. We also check whether institutional directors have a significantmoderatingeffectontherelationbetween per-formance and board remuneration. The literature shows thatinstitutionalinvestorsdonotactasamonolithicgroup in firm governance(Almazán et al.,2005; Cornett etal., 2007;Chenetal.,2007;Choietal.,2012).Accordingly,we propose that the type of business relation between firms

andinstitutionalinvestorsisthekeytodescribingtherole of institutional directors.We therefore study therelation betweenremunerationsandinstitutionaldirectors,making adistinctionbetweentheinstitutionalinvestorswhokeep business relations with the ﬁrm on whose board they sit andtheinstitutionalinvestorswhosebusinessactivityisnot relatedtothecompanyinwhichtheyholdadirectorship.

Weuse a sample of Spanish listed firms between 2004 and 2010. Spain is likely the best paradigm to study the effectivenessofinstitutionaldirectorsfortwomainreasons. First,SpainistheEuropeancountrywiththehighest pres-enceofinstitutionalinvestorsontheboardsoflargefirms (Bonaetal.,2011;Crespí andPascual, 2012).Second,the Spanishfinancialsystemisbankoriented.Banksplayan out-standingrolebothascreditorsandblockholders.Banksalso appointasignificantproportionofdirectorstotheboardsof theirclientfirms.

Our results suggest that maintaining business ties betweenfirmsandinstitutionalinvestorsaffectstheroleof theinstitutionalinvestors.Directorsappointedby pressure-resistantinvestorsserveamonitoringrolethatmitigatesthe agencyproblembetweenshareholdersandmanager. Coher-entwiththeirdisciplinaryrole,pressure-resistantdirectors increasetherelativeweightofthevariablecompensation, decreasetheproportionoffixedcompensation,andinduce compensation packages sensitive to performance. These findingsareconsistentwiththeviewthatdifferencesexist between these twotypes of directors and that pressure-resistantdirectorsfulfillamorethoroughmonitoringrole.

Wemakeseveralcontributionstotheliterature.First,we providenewevidenceontheeffectsofdirectorsappointed by institutionalinvestors onremunerationpolicyin away thatisdifﬁcult tocapture intheUSorUK context,where this kind of director is less prevalent. Existing studies on theeffectsofinstitutionalinvestorsarecommonlybasedin theframeworkoftheconventionalUS/UKmodelof corpo-ratecontrolandtherefore,ingeneral,focusoninstitutional investors solelyas shareholders. Second, we provide new evidence on the effect of board composition ondirector remuneration.Althoughmanagerialcompensationhasbeen oftenanalyzed,directors’payhasonlyrecentlysparkedan intensedebateinEurope.Thewaveof corporatescandals hasrenewedconcernsabouttheeffectivenessofboard mon-itoringandthehighcompensationsthatdirectors’receive. Finally,ourexaminationofwhetherinstitutionalinvestors’ presenceonboardsofdifferenttypesofinstitutions,such as banks or investment funds,leads toobservable differ-ences in remunerationpolicycan provide newinsights on the heterogeneity in monitoring costs across institutional investors,which,inturn,hasimportantimplicationsforthe debateovertheproperdegreeofinstitutionalinvolvement incorporategovernance.

Theoretical

foundations

and

hypotheses

development

Theoreticalbackground

Although small shareholders can vote with their feet if they do not agree with the performance or actions of managers, institutionalinvestorsfindit difficulttooffload

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their substantial investments without negatively impact-ing stock prices. Given the cost and difficulty of selling their shareholdings, institutions are motivated to pres-sure management intotaking actionsthat benefit outside shareholders. Institutional investorsthen provide astrong incentivetopromotecompanyactivitiesthatincrease the firm’s value and thus the value of their own investments (JensenandWarner,1988).Twosuchactionsmaymoderate excessivepay and encourage pay-for-performancereward systems.HartzellandStarks(2003)reportthatinstitutional ownership concentration is positively related to the pay-for-performancesensitivityofexecutivecompensationand negativelyrelatedtothelevelofcompensation,evenafter controllingforfirmsize,industry,investmentopportunities, andperformance.

The concentrated ownership structure of European countries, as Spain, may lead result in other conflictsof interestssuchasotheso-calledprincipal---principalagency conflicts(HartzellandStarks,2003;Huddart,1993;Shleifer andVishny,1986;Youngetal.,2008).Accordingtothis self-servingperspective,institutionalinvestors,actingeitheras directorsorincollusionwithmanagers,mayengagein tun-neling activities and in the expropriation of wealth from minority shareholders (Johnson et al., 2000; Renders and Gaeremynck,2012;Shan,2013).Thus,insteadofimposing an efficientcontrol onmanagerial discretion,institutional shareholdersmayabusetheirpositionofdominantcontrol at the expense of the other stakeholders to expropriate rentsfromthenoncontrollingshareholders(HarrisandRaviv, 1988;ShleiferandVishny,1997).

From the agency theory perspective, the board of directors can work as an information system for external stakeholders to monitor insiders behavior. In this con-text,directorscompensationisthenanimportantincentive mechanismsthatshapedirectorbehavior.AccordingtoDavis and Stobaugh (1995) director compensation should fulfill severalgoals:(a)motivatethemtoaligntheirinterestswith shareholders;(b) coverresponsibility andliabilityrisk;(c) be consistent withtransparency in director compensation setting.Akeyissuethereforeiswhetherdirectorsarebeing compensatedinawaythatmotivatesthemtoputeffortand makedecisionsthatmaximizethereturnoftheshareholders theyrepresent to(Cordeiro etal., 2000). Then,although nonexecutive directors and, specifically, those appointed by institutional investors are charged with looking after the interests of shareholders, there are reasons to ques-tiontheireffectiveness.Conflictsofinterestsappearwhere directors serving on the compensation committee deter-minethelevelandmixoftheirowncompensationpackages (Cordeiroetal.,2000).Inexchangeforexcessive compensa-tion,directorsmaybemorelaxindischargingtheirassigned monitoringandoversightfunctionsleadingthemto expro-priation activities. Accordingto Chenet al.(2013), these potential conflicts of interest and related outcomes may ultimatelyservetoerodeanyanticipatedbenefitsof direc-torcompensation.

Whenanalyzingtheconsequencesofdirectorsappointed by institutional investors, we must not consider them as ahomogeneousgroup.Thedifferencesacrossinstitutional investors are not only legal or regulatory but also vary in terms of investment strategy and the incentives and resourcestogatherinformationandtoengageincorporate

governance(Bennettetal.,2003).Almazán etal.(2005), Borokhovichetal.(2006),Bushee(1998),FerreiraandMatos (2008) and Ramalingegowda and Yu (2012) have shown that certain types of, but not all, institutional investors havean asymmetricinﬂuence oncorporateissuessuch as antitakeoveramendments,R&Dinvestmentdecisions, pro-ﬁtability,andearningsconservatism.

Along thisline, two main groups of institutional direc-torscan be differentiated:pressure-sensitive institutional investors who maintain business with the ﬁrm in which they invest --- basically, banks and insurance compa-nies --- and pressure-resistant institutional investors with no potential business links --- basically, investment funds and pension funds. According to Almazán et al. (2005), the costs of monitoring differ across both groups, with the potentially active group (i.e., the pressure-resistant investors)havinglowercosts.Consistentwiththis classiﬁca-tion,wedifferentiatebetweenpressure-sensitivedirectors (i.e.,representingpressure-sensitiveinstitutionalinvestors) and pressure-resistant directors (appointed by pressure-resistantinstitutionalinvestors).

Hypothesesdevelopment

Banks and insurancecompanies face different regulatory, legal,andcompetitiveenvironmentsthaninvestmentfunds. Davidetal.,1998,Almazánetal.,2005andShinandSeo (2011)suggestthatinstitutionalinvestors’fiduciary respon-sibilities,conflictsofinterest,andasymmetricinformation interact with each other to determine jointly the influ-enceofinstitutionalinvestorsonremuneration.Theyargue thatpressure-resistantinstitutionalinvestorsarelesslikely to suffer from conflicts of interest arising from business relationshipsand, thus, more likely toengage actively in monitoring.Consequently,directorswhorepresent institu-tionswithoutbusinessrelationscanusetheirvotepowerto opposepreferencesformoregenerouscompensation. Nev-ertheless,sincecompensationschemesareusuallyviewed asanincentivemechanism,onecouldassumethatmore gen-erouscompensationpackages couldappeal moretalented directors.Asaconsequence,thequestionabouttherelation betweenthe differenttypes of institutional directorsand thecompensationlevel arises.Weaddress thisissuein an exploratoryapproachandrunpreliminaryanalysestocheck whetherpressure-resistantorsensitivedirectorsarerelated tohigherorlowerdirectorcompensation.

Critics have voicedconcerns thatdirectors’ compensa-tionpackageshavenotbeencloselytiedtofirmperformance (Bebchuk and Fried, 2004). As an example, Bebchuk and Grinstein (2005) argue that executive pay has increased farbeyond levelsthat canbe explainedby thegrowth in firmsizeandtheperformanceobservedoverthe1993---2003 period. Joining compensation to performance helps align board interests with shareholder interests. Explicit ties betweendirectors’wealthandthefirm’sstockpriceprovide directors with a strong incentive to increase firm value. Consequently,directors’remunerationshouldbepositively relatedtofirmperformance.However,duetotheconflicts ofinterests,wepositthatdirectorsappointedby pressure-resistantinstitutional investorswillbemore motivated to strengthen the relation between performance and board

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payments than directors appointed by pressure-sensitive institutional investors. The higher costs of monitoring of pressure-sensitivedirectors,relatedtodifferencesintheir legal,regulatoryandcompetitive environmentsaswell as thelikelihoodofcurrentorfuturebusinessdealingwiththe ﬁrmstheyown,mayweakentherelationshipbetweenﬁrm performanceandboardcompensation.

This intuition is consistent withAlmazánet al.(2005), whoﬁndthat thelinkbetweenperformanceand manage-rialcompensationincreaseswiththeconcentrationofactive institutions’ownership(pressureresistant)butisnot signif-icantlyrelatedtotheconcentrationofpassiveinstitutions’ ownership(pressuresensitive).Accordingly,wehypothesize thatasimilarrelationshouldholdforinstitutional director-ships:

H1. Pressure resistant (pressure-sensitive) institutional directorspositively(negatively)moderate therelationship betweenﬁrmperformanceandboardremunerations.

Giventhisdiscussion,pressure-resistantdirectorsshould beabletocounteract managerial dominance andtoalign compensation schemes with shareholders’ preferences. Directors’remunerationpackageshaveseveralcomponents and vary widely across ﬁrms.Some companies reimburse directors’expenses for attendingmeetingsbutprovide no additionalcompensation. Other companies pay a uniform annual cash retainer plus per-meeting fees. Besides cash compensation,ﬁrmsmayproviderestrictedstocksorstock optionstocommitteemembers.

Weconsidershort-termincentivesincludingbasesalary and long-term incentives including stock options, long-term incentive plans, and additional benefits. A number of good reasons exist to explain why long-term incen-tivesarean effective paycomponent (Bryanetal.,2000; GoergenandRenneboog,2011).First,theyprovidethemost directlinkbetweenfirm performanceandpay. Therefore, theymay incentivizedirectors towork hard and tomake shareholder-oriented decisions. Second, long-term incen-tivesmayenablethefirm tobringvaluablehumancapital tothe board and toensure the loyalty of the incumbent directors.However,accordingtotheEuropeanCommission variable pay schemes have become increasingly complex andhave ledtoexcessiveremunerationandmanipulation (EUCGF, 2009). This finding suggests that board-incentive payisatwo-edgedsword:ontheonehand,itcanalignthe interestsof controlling andminority shareholders; onthe otherhand,it caninduceundesirablebehaviorandoverly generousboardpay(ShinandSeo,2011).

Wepositthattheincentivesofinstitutionaldirectorsto monitorcompositionboard paydepend ontheconflictsof interest that the institutional directors face. These con-flictsaremorepronouncedwheninstitutionalinvestorshave business ties with the firm. Due to the lower conflicts of interests and their interest in aligning board inter-ests with shareholder interests, we posit that directors appointedbypressure-resistant institutionalinvestorswill preferlong-termincentiveplansthandirectorsappointedby pressure-sensitiveones.Alargestock-basedcomponentthat tiesboard paytofirmperformanceisbelieved toincrease board pay risk and help alignthe directors’ interest with those of shareholders. Accordingly, we hypothesize that

pressure-sensitivedirectorswillprefertoretaincontrolover theirpaybyreceivingahigherproportionofﬁxed compensa-tionandalowerproportionofvariablecompensation.The higherconﬂictsof interests,their riskaversion aslenders andtheirincentivestominimizetheprobabilityofdefault mayexplaintheseexpectations.Consequently, oursecond hypothesisisstatedasfollows:

H2. Directorsrepresentingpressure-resistantinstitutional investors are negatively related to board’ ﬁxed salary (short-termcompensation)andpositivelyrelatedwiththeir variablecompensation(long-termincentives),comparedto directorsrepresentingpressure-sensitiveinvestors.

One of the most often used mechanisms to tie the incentivesofinsiderstoshareholders’interestsis pay-for-performanceschemes(JensenandMurphy,1990).Although there are not any evidence in this context regarding board remuneration as a whole, David et al. (1998) and Almazán et al. (2005) find that pressure-resistant insti-tutional investors are more likely than pressure-sensitive institutional investorstoinfluence CEO payin accordance withshareholder preferences.More specifically,the stake oftheseinstitutionalinvestorsisnegativelyassociatedwith thelevelofCEOpaybutpositivelyassociatedwith pay-for-performancesensitivity.

We suggest that directors appointed by banks and insurancecompanieswillhave morepronouncedconflicts, leadingthemtocompromisetheirroleinmonitoringdirector pay.Thus,pressure-sensitivedirectorswillbelessinterested in tying directors’ pay to firm performance. Conversely, pressure-resistant directorshavemore abilitytouse their position todiscipline other directorspreferencesand will thereforebemorepronetolinkthecompensationpackages tothefirm’sperformance.

H3. Directorsrepresentingpressure-resistantinstitutional investorswillincreaseboardremunerationsensitivitymore thandirectorsrepresentingpressure-sensitiveinvestors.

Empirical

design

Sample

Oursample is drawnfrom thepopulation of Spanish non-financialfirmslisted ontheSpanishStock Exchangeduring 2004---2010. We excludefinancial companiesboth because theyareunderspecialscrutinybyfinancialauthoritiesthat constrain theroleof theirboard ofdirectorsandbecause of their special accountingpractices. We obtain our data fromtwodatabases.Financialinformationandfirms’ mar-ket value come from the Amadeus database.1 _Corporate governance informationis collectedfrom the annual cor-porate governancereports that all listed companies must publishsince2003.Thesecorporategovernancereportsdo notprovide individualizedinformationabout the compen-sationof eachdirectorbutdoprovidethetotalaggregate

1_Amadeus _is _a _product_of _Bureau _van_Dijk _Electronic Publish-ingandprovidescomparablestandardizedﬁnancialinformationfor companiesacrossEurope.

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compensation of the board members and its distribution amongthedifferentcomponents.

Webuildanunbalancedpanelof627firm-year observa-tionsfrom162firms.Roughly,oursampleaccountsformore than95%ofthecapitalizationofSpanishnonfinancialfirms. The panel is unbalanced because duringthis periodsome firmsbecomepublicandotherfirmsdelistasaconsequence ofmergersandacquisitions.Nevertheless,theestimations basedonunbalancedpanelsareasreliableasthosebased onbalancedpanels(Arellano,2003).

Variables

We define four dependent variables that are consistent with each one of our hypotheses. RETRIB is the average annualcompensationofeachdirector,definedasthetotal compensation of the whole board of directorsdivided by the number of directors.FIXCOMP is the fixed proportion ofthecompensation,definedasthequotientbetweenthe totalfixedcompensationandthetotalcompensationofthe whole board of directors. VARCOMP is the variable com-ponentof the compensation,defined astheratioof total variable compensation to the total compensation of all the board members.2 _SENSITIVITY _is _the_sensitivity _of _the average compensation of the directorsto changesin firm performance,whichisoperationalizedasthevariationinthe compensationoftheboardrelativetothevariationofreturn onassets(ROA)betweenthepreviousandthecurrentyear. We define three main independent variables related to the presence of institutional investorsin the board of directors.To begin,wedefine INSTITastheproportionof directorsappointedbyinstitutionalinvestors.Wethenmake the distinction between pressure-sensitive and pressure-resistantdirectors.Thus,wedefineSENSITastheproportion ofboardmemberswhorepresentpressure-sensitive institu-tionalinvestors(i.e.,banks andinsurancecompanies) and RESISTasthe proportion ofthe board members who rep-resent pressure-resistant institutional investors (primarily mutualfundsand pensionfunds). Wealsointeract INSTIT, SENSIT,andRESISTwiththepreviousyear’sROAtocompute INSTITROA,SENSITROA,andRESISTROA,respectively.These threevariablesintroducethemoderatingeffectoftheboard compositionconditionalontheperformanceofthefirm.

Wecontrolforanumberoffactorsthatcanpotentially affectretributionsandthatmakeourresearchcomparable topreviousstudies(Almazánetal.,2005;Davidetal.,1998; Doucouliagosetal.,2007;FernándezMéndezetal.,2012; SánchezMarínetal.,2013).SIZEisthelogof totalassets andisameasureoffirmsize.LEVisthefinancialleverage variable,measured asthe ratio of book value of debt to totalassets.MTBistheequitymarket-to-bookvalue,which proxiesbothgrowthopportunitiesandmarketexpectations aboutthefirm.WealsocontrolforROA.Appendixprovides asummaryofallthevariables.

2_Although _FIXCOMP_and_VARCOMP _may_be _in_opposition,_these variablesarenottheonlycomponentstoconsider.Totalretribution mayalsoincludemeetings attendancefees,stocks, options,and otherwaysofcompensation.

Empiricalmethod

Weﬁrstreportadescriptiveanalysistoshowthemain char-acteristics of our sample. This step provides preliminary evidenceaboutthepossibleeffectofinstitutionaldirectors onthecompensationofthedirectorsandaboutpossible dif-ferencesbetweenthetypesofinstitutionaldirectors.Next, weperformanexplanatoryanalysistotestourhypotheses. Werunthefollowingbaselinemodel:

COMPENSATit =˛+ˇ1·LEVit−1+ˇ2·MTBit+ˇ3·SIZEit

+ˇ4·ROAit+

ˇj·BOARDit

+ˇj·BOARDROAit+i+t+εit, where COMPENSAT represents the variables of directors compensationaspreviouslydeﬁned;BOARDitrepresentsthe variables of institutional directorships; BOARDROAit rep-resents the interaction between ROA and the variables of institutional directorships; i represents the individual effect;irepresentsthetimeeffect;andεitrepresentsthe stochastic error. The time effect includes the macroeco-nomicfactorsthataffectalltheﬁrmsinthesameperiod.

Ourdatabasecombinestime-series withcross-sectional data, allowing for the formation of panel data, which weestimatewiththeappropriatepaneldatamethodology (Arellano,2003).Intheestimationofourmodel,two prob-lems can arise: constant and unobservable heterogeneity andendogeneity.Constantandunobservableheterogeneity referstospecific characteristics of each firm thatremain constantovertimeasrepresentedbythefixed-effectsterm

i. Because they are unobservable, they become part of

therandomcomponentintheestimatedmodel.Paneldata methodology enhances the control of this constant and unobservableheterogeneityintroducedbytheﬁxed-effects term.

The endogeneity problem may appear because lagged directors’ compensation can affect the structure of the boardofdirectors(DemsetzandVillalonga,2001;Hermalin andWeisbach,1998;VillalongaandAmit,2006).Toaddress this problem, Blundell and Bond (1998) and Bond (2002) suggesttheuseofthepaneldatasystemestimator.This pro-cedure is an improved version of thegeneralized method of moments, given the possibility that weak instruments caninducepoor asymptoticprecision (Alonso-Borregoand Arellano,1999).This method providesefﬁcient estimates whose consistency depends critically on the absence of second-orderserialautocorrelationintheresidualsandon thevalidityof theinstruments(ArellanoandBond,1991). Accordingly,wereportthem2test. Totest thevalidityof theinstruments,weusetheHansentestofoveridentifying restrictions,whichallowsustotestthe absenceof a cor-relationbetweentheinstrumentsandtheerrortermand, therefore,tocheckthevalidityoftheselectedinstruments. Asanalternativewaytoaddresstheendogeneityissues andtochecktheconsistencyofourresults,wealsoestimate ourmodel usingthe instrumental variablesmethod. More speciﬁcally, we implement the two-stages least squares methodtoinstrumentthecorporategovernancevariables.

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Table1 Maindescriptivestatistics.

Variable Mean Std.dev. Q25 Q50 Q75 RETRIB 468.59 22.085 134.58 284.44 545.24 FIXCOMP 0.452 0.271 0.234 0.432 0.623 VARCOMP 0.391 0.291 0.151 0.371 0.638 SENSITIVITY 0.029 1.757 −0.025 0.001 0.038 INSTIT 0.207 0.181 0.000 0.182 0.313 SENSIT 0.072 0.11 0.000 0.000 0.125 RESIST 0.137 0.182 0.000 0.083 0.200 SIZE 13.592 2.021 12.192 13.471 14.862 LEV 0.593 0.183 0.483 0.611 0.729 MTB 2.656 2.529 1.31 1.984 3.117 ROA 0.041 0.076 0.013 0.041 0.077

Thistableprovidesthemean,standarddeviation,andquartiles ofthemainvariables.SeeAppendixforvariabledeﬁnitions.

Results

Descriptivestatistics

Table1 presents themean value, thestandard error, and thequartilesofthemainvariables.Therepresentativesof institutionalinvestorsaccountfor around21%of director-ships,withpressure-resistantdirectorstwiceasimportant aspressure-sensitive directors. Consistent withthe inter-nationaltrend toincrease the importanceof institutional investors (Li et al., 2006), the proportion of directors appointedbyinstitutionalinvestorsinoursampleincreases from19.6%in2004to21.7%in2010.

Table2reports thecorrelationmatrix amongthe varia-bles. With the exception of some relations among the variablesofcorporategovernance,allofthempresentlow correlationcoefficients,sothatmulticollinearityshouldnot beaconcern.Inaddition,thepossibilityofmulticollinearity canberuledoutonthebasisoftwofacts.First,ourmodel isaparsimoniousone,sothevariablesofcorporate gover-nance(INSTIT,SENSIT, andRESIST) arenot simultaneously includedinthemodel.Second,wealsoprovideavariance inflationfactor(VIF).OurVIFscoresarebelow3,andthus weconfirmthatmulticollinearitydoesnotskewourresults (Belsleyetal.,2004;Kutneretal.,2005).

For an exploratory analysis, we divide the sam-ple into two groups depending on the proportion of institutional investors (pressure-sensitive investors and pressure-resistantinvestors)intheboardroom:thegroupof firmswiththeproportionofinstitutionaldirectorsoverthe INSTIT medianvalue and thegroup offirmswiththe pro-portionof institutional directorsunderthe INSTIT median value. The same pattern applies to SENSIT and RESIST variables. Then, we conduct a test of means comparison to explore whether compensation schemes are different betweenbothgroups.Table3reportstheresults.Although not conclusive, the findings suggest that gray directors appointed by institutional investors are relatedto differ-encesin directors’compensation.Whereas theproportion ofinstitutionaldirectorsdoesnotseemtoinducesignificant differences, pressure-sensitive directors have asymmetric effects, compared to pressure-resistant directors. More specifically,directorsrepresentingpressure-resistant insti-tutional investors are positively related to the variable componentandnegativelyrelatedtothefixed partofthe compensation. Conversely,pressure-sensitivedirectorsare relatedtoahigherfixedpartandtoalowervariable com-ponentofdirectors’compensation.

Explanatoryanalysis

Table 4 provides the estimates related to total compen-sation. We test the effects of all institutional directors, pressure-sensitive institutional directors, and pressure-resistant institutional directors on the average compen-sation of directors (RETRIB). Column (1) shows that all institutionaldirectors(INSTIT)haveadirectnegative rela-tiononRETRIB.Thisresultisinlinewithsomeotherstudies that focusonAnglo-Saxon countriesin which institutional ownershipmake someappreciabledifferencesinthelevel ofpolicypay(CoshandHughes,2007).

Moreinteresting,columns (2)and(3)showthatRESIST does not have a signiﬁcant impact on the total compen-sation of each director, whereas SENSIT has a signiﬁcant negativeeffect.Theseresultsdosuggestthattheonlytype of institutional directors effectively affecting the whole board compensation is the pressure-sensitive one. These results can be understood at the light of the different

Table2 Correlationmatrix.

RETRIB FIXCOMP VARCOMP SENSITIVITY INSTIT SENSIT RESIST SIZE LEV MTB FIXCOMP −0.248 VARCOMP 0.228 −0.739 SENSITIVITY −0.106 −0.013 −0.013 INSTIT −0.058 0.126 −0.114 −0.063 SENSIT 0.036 0.135 ₋0.184 ₋0.066 0.394 RESIST −0.081 0.048 −0.004 −0.025 0.811 −0.218 SIZE 0.554 ₋0.160 0.187 ₋0.052 0.060 0.229 ₋0.082 LEV 0.178 −0.048 0.009 −0.073 0.171 0.068 0.138 0.434 MTB 0.050 −0.054 0.077 −0.030 −0.094 −0.069 −0.055 0.095 0.082 ROA 0.158 −0.055 0.200 −0.054 −0.180 −0.077 −0.142 0.132 −0.335 0.353 VIF 1.560 1.470 1.430 1.360 1.260 1.130

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T able 3 Test of means comparison. RETRIB FIXCOMP V ARCOMP SENSITIVITY High level Low level p -V alue High level Low level p -V alue High level Low level p -V alue High level Low level p -V alue INSTIT 498.02 439.83 0.97 0.443 0.461 0.49 0.410 0.373 0.19 0.132 0.065 0.27 SENSIT 381.50 563.08 0.00 0.481 0.433 0.06 0.320 0.438 0.00 0.087 0.057 0.43 RESIST 429.71 493.17 0.39 0. 429 0. 474 0.08 0.415 0. 368 0.09 0.104 0.038 0.43 This table provides the median value of board fixed compensation (RETRIB), fixed component (FIXCOMP), variable component of total compensation (V ARCOMP) and sensitivity conditional on the high or low level of institutional directors (INSTIT), pressure-sensitive (SENSIT) and pressure-resistant directors (RESIST). p -V alue is the significance level to accept the null hypothesis of equality of means between groups.

Table4 Generalizedmethodofmomentsestimatesofthe baselinemodel(totalcompensation).

(1) (2) (3) INSTIT −1.063*** (0.162) RESIST −2.715 (25.32) SENSIT −257.2*** (26.68) SIZE 144.2*** _145.5*** _144.0*** (4.007) (4.629) (6.721) LEV 119.2*** _94.56*** _170.9*** (8.480) (13.13) (29.11) MTB 4.925*** _5.348*** _11.44*** (1.327) (1.073) (1.868) ROA −1.062*** ₋_0.823*** ₋_2.927*** (0.235) (0.235) (0.439) Observations 433 433 433 m2 1.01 1.00 0.97 Hansentest(d.f.) 63.14(72) 69.02(72) 68.25(72)

Thistableprovidestheestimatedcoefﬁcients(t-stats)through thegeneralized methodofmoments. Thedependentvariable is RETRIB.SeeAppendix for variabledeﬁnitions. m2is atest ofsecondorderserialautocorrelation.Hansentestisatestof overidentifyingrestrictions,whichdistributesas2_(degrees_of freedom).

*** _Conﬁdence_at_99%_level.

incentives that pressure-resistant and pressure-sensitive directorsface.Sincepressure-resistantones aresupposed to provide a more independent managerial oversight, thehighercompensationofboardswithpressure-resistant directorscan be due to the compensation package work-ingasanincentiveforbettercorporateperformancewhen directorsareinterestedinprovidingsuchoversight.

ConsistentwithAlmazánetal.(2005),Khanetal.(2005) andShinandSeo(2011),theestimatesofourcontrol varia-blesshow thatdirectorsof the largerfirms(SIZE)receive higher fixed compensation. Directorsof larger companies areexpectedtobepaidmorethandirectorsofsmallfirms duetothehigherdegreeofcomplexityoftasks,the poten-tially greater value placed on directors’ decisions, and, hence,thegreaterrewardfrommakingthem(Doucouliagos etal.,2007).Inthesamevein,directorsofmoreleveraged firmsandfirmswithmoregrowthopportunitieshaveahigher compensation.

We nowtest hypothesis H1and the wayin which ROA affectsdirectors’compensation depending onthe typeof institutionalinvestors(Table5).InColumn1wereportthe broadeffectofinstitutionaldirectorship:while,consistent withTable 4, INSTIT have a negative effect on directors compensation,theinteractionwithROAhasapositiveand significanteffect.Itmeansthat,although the representa-tionofinstitutionalinvestorsintheboard ofdirectorscan reduce the average total compensation, it also ties it to the performance of the firm or the board. Furthermore, whensplitting thiseffectinto theinfluence ofboth kinds of institutional investors,we findasymmetric effects. On theonehand,thepositivecoefficientofRESIST·ROAimplies

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Table5 Generalizedmethodofmomentsestimatesofthe baselinemodel(totalcompensation).

(1) (2) (3) INSTIT −1.316*** (0.147) INSTIT·ROA 0.201*** (0.0133) RESIST 13.96 (26.82) RESIST_·ROA 4.019** (1.592) SENSIT ₋267.8*** (57.69) SENSIT·ROA −0.0443 (5.115) SIZE 150.2*** _146.8*** _149.3*** (5.347) (5.099) (7.582) LEV 219.2*** _119.3*** _167.0*** (16.93) (20.20) (34.90) MTB 2.990*** _4.598*** _10.89*** (0.863) (1.137) (1.954) ROA −2.777*** ₋_1.205*** ₋_3.011*** (0.362) (0.358) (0.448) Observations 433 433 433 m2 1.01 0.97 0.94 Hansentest(d.f.) 67.67(72) 66.39(72) 63.55(72)

Thistableprovidestheestimatedcoefﬁcients(t-stats)through thegeneralized methodofmoments. Thedependentvariable isRETRIB.SeeAppendix for variabledeﬁnitions. m2is atest ofsecondorderserialautocorrelation.Hansentestisatestof overidentifyingrestrictions,whichdistributesas2_(degrees_of freedom).

**_Conﬁdence_at_95%_level. *** _Conﬁdence_at_99%_level.

thatpressureresistantdirectorstietheboardcompensation totheperformance ofthe board.On the other hand,the non-signiﬁcant coefﬁcient of SENSIT·ROA suggests a less disciplinaryroleforthiskindofinvestorssincethe compen-sationandincentivesoftheboardarenotsocloselytiedto itsperformance. The resultsofthis empiricalanalysisare consistentwiththeimplicationsofourmodelthat pressure-resistantdirectorscanprovidemoreintensemonitoringof corporatemanagement.

Wenowaddressthequestionaboutwhetherthe compo-sitionofthecompensationpackagedependsonthetypeof directorsrepresentinginstitutional investors(H2).Table6 reports the results of the estimations in which FIXCOMP (the ﬁxed proportion) is the dependent variable. Column (1)showsthatthebroadeffectofallinstitutionaldirectors (INSTIT)isalowerbasesalary.

Table 6 shows the results for the different types of institutional directors and different patterns for propor-tion of fixed compensation. The negative coefficient of RESISTinColumn(2)suggeststhatpressure-resistant direc-tors tend to reduce the fixed proportion of the salary. Conversely, Column (3) shows that directors represent-ing pressure-sensitive institutional investors increase the fixedcomponentofthecompensation,which confirmsH2.

Table6 Generalizedmethodofmomentsestimatesofthe baselinemodel(proportionofﬁxedcompensation).

(1) (2) (3) INSTIT −0.132*** (0.0245) RESIST −19.04*** (3.456) SENSIT 22.96*** (4.342) SIZE ₋5.152*** ₋_5.283*** ₋_5.441*** (0.406) (0.419) (0.393) LEV 32.93*** _33.08*** _17.17*** (2.053) (2.197) (3.994) MTB −3.237*** ₋_3.220*** ₋_2.214*** (0.142) (0.143) (0.214) ROA 0.258*** _0.350*** _0.214*** (0.0756) (0.0615) (0.0536) Observations 434 434 434 m2 −0.32 −0.27 0.22 Hansentest 70.88(72) 69.97(72) 69.42(72)

Thistableprovidestheestimatedcoefﬁcients(t-stats)through thegeneralizedmethodofmoments.Thedependent variable isFIXCOMP.SeeAppendixforvariabledeﬁnitions.m2isatest ofsecondorderserialautocorrelation.Hansentestisatestof overidentifyingrestrictions,whichdistributesas2_(degrees_of freedom).

*** _Conﬁdence_at_99%_level.

According to these results, the directors appointed by institutional investors have a completely different effect on the ﬁxed component of the compensation conditional on the nature of the institutional investor. This result can be understood in terms of the ability to monitor of each groupof institutionalinvestors.Sincepressure resis-tantinvestorshavelowerimpliedcosts ofmonitoring,our resultsareconsistentwithAlmazánetal.(2005),whoﬁnd that directors representing active institutional investors (pressure-resistant directors)facelowercosts of monitor-ing than the directors appointed by passive institutions (pressure-sensitivedirectors).

Table 7 reports consistent results when we estimate the determinants of thevariablecomponent of directors’ compensation(VARCOMP).Column(1)showsthatdirectors representing institutional investors increase the variable component. Nevertheless, the influence of institutional directorson thevariablecomponent of thecompensation is not homogeneous. Coherent with a more disciplinary role, RESIST exhibits a positive impact, so that pressure-resistant directors increase the relative weight of the variable compensation. On the contrary, consistent with the view that pressure-sensitive investors are more tran-sient, the proportion of these directors (SENSIT) has a negative influence. Due to the lower conflicts of inter-ests and their interest in aligning board interests with shareholderinterests,weconfirmthatdirectorsappointed by pressure-resistant institutional investors will prefer long-term incentive plans than directors appointed by pressure-sensitiveinstitutionalinvestors.

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Table7 Generalizedmethodofmomentsestimatesofthe baselinemodel(variableproportionofboardcompensation).

(1) (2) (3) INSTIT 0.141*** (0.0386) RESIST 17.79*** (2.337) SENSIT −45.94*** (7.607) SIZE 3.949*** _3.669*** _4.189*** (0.391) (0.296) (0.391) LEV ₋13.44*** ₋_12.72*** ₋_9.101** (2.774) (2.547) (3.486) MTB 0.632*** _0.495*** _0.330* (0.140) (0.146) (0.170) ROA 0.179*** _0.178*** _0.0279 (0.0454) (0.0502) (0.0312) Observations 414 414 414 m2 −1.61 −1.18 −1.25 Hansentest(d.f) 62.53(72) 57.10(72) 60.32(72)

Thistableprovidestheestimatedcoefﬁcients(t-stats)through thegeneralizedmethodofmoments.Thedependentvariableis VARCOMP.SeeAppendixfordeﬁnitionofvariables.m2isatest ofsecondorderserialautocorrelation.Hansentestisatestof overidentifyingrestrictions,whichdistributesas2_(degrees_of freedom).

* _Confidence_at_90%_level. ** _Confidence_at_95%_level. *** _Confidence_at_99%_level.

These results are in line withDavid et al. (1998) and Almazánetal.(2005),whoﬁndthatpressure-resistant insti-tutional investors are more likely than pressure-sensitive institutional investors to align pay policy to shareholder preferences.

In any case, the variableremuneration canhave some effects onrisk. The European Commission hasfound that theincentives created byvariablepay schemesmayhave resultedinexcessiverisktakingandinever-increasing lev-elsofremuneration(EUCGF,2009).Fromthispointofview, our results may shedsome light onthe relation between institutionalinvestorsandcorporaterisktaking(Crespíand Pascual,2012;ShinandSeo,2011).

A comparison of Tables 6 and 7 provides interesting insightsregardingthecontrolvariables.SIZEandMTBhave anegativeinfluenceonthefixedcomponentandapositive influenceonthevariablecomponent.Thesefindingsmean that largercompaniesandfirmswithmore growth oppor-tunitiestendtorelymoreonthevariablecomponentthan onthebasesalary.Conversely,financialleverageshowsthe oppositeeffect:ithasapositiveeffectonfixed compensa-tionandanegativeeffectonvariablecompensation.

Finally,Table8providestheresultsrelatedtoH3, con-cerning the sensitivity of compensation to performance. Column(1)showsthatinstitutionaldirectorshaveapositive influenceonpay-performancesensitivity.Nevertheless, sig-nificantdifferencesexistbetweenbothtypesofinstitutional investors,asshownincolumns(2)and(3).Thecoefficientof RESISTispositiveincomparisontothenegativecoefficient

Table 8 Generalized method of moments estimates of the baseline model (sensitivity of compensation to performance). (1) (2) (3) INSTIT 0.00849*** (0.00284) RESIST 1.095* (0.649) SENSIT −1.338*** (0.336) SIZE 1.402*** ₋_0.163 ₋_0.200 (0.0636) (0.146) (0.136) LEV −3.167*** ₋_3.820*** ₋_4.417*** (0.242) (0.384) (0.437) MTB 0.0141*** ₋_0.0353*** ₋_0.0314*** (0.00347) (0.00353) (0.00378) ROA ₋0.00241** _0.0270*** _0.0255*** (0.00120) (0.00433) (0.00433) Observations 401 401 401 m2 1.02 0.83 0.83 Hansentest 73.49(66) 70.69(66) 73.43(66)

Thistableprovidestheestimatedcoefﬁcients(t-stats)through thegeneralizedmethodofmoments.Thedependentvariableis SENSITIVITY.SeeAppendixfordeﬁnitionofvariables.m2isatest ofsecondorderserialautocorrelation.Hansentestisatestof overidentifyingrestrictions,whichdistributesas2_(degrees_of freedom).

* _Confidence_at_90%_levels. **_Confidence_at_95%_level. *** _Confidence_at_99%_level.

of SENSIT, which suggests that the directors representing pressure-resistantinvestorsinducecompensation packages sensitivetoperformancewhereaspressure-sensitive direc-torsdo not.Again, thisresult is consistent withtheview thatthedifferenttypesofdirectorstakeondifferentroles andthatpressure-resistantdirectorsundertakeamore thor-oughmonitoring role. In line with John etal. (2010) and JohnandQian (2003),thepay-for-performancesensitivity of board compensation decreases with the leverageratio andincreaseswithﬁrmsizeatthe1%level.

As previously noted,we present some furtheranalysis tocheckthesensitivity ofourresultstodifferent estima-tionmethodstoaddresstheendogeneityproblem.Werun newestimatesusingthetwo-stagesleastsquaresmethod. Table 9 reports the estimates for the models in which totalcompensation(RETRIB)is thedependentvariable:in Columns(1)---(3)weexploretheeffectofinstitutional direc-torsontheboardcompensationandinColumns(4)---(6)we testourﬁrsthypothesis aboutthe differentialmoderating effectofeachkind ofdirectors.Table10reportsthe esti-matesforthemodelsinwhichtheﬁxedcomponentofthe compensation(FIXCOMP)--- Columns(1)---(3)---the variable component (VARCOMP) --- Columns (4)---(6) --- and the pay-for-performance sensitivity --- Columns (7)---(9) --- are the dependent variables. Both tables corroborate the results previouslyreported.

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Table9 Two-stageleastsquaresestimatesofthebaselinemodels. (1) (2) (3) (4) (6) (5) INSTIT ₋0.921** ₋_4.812*** (0.442) (1.243) INSTIT·ROA 0.195** (0.0868) RESIST 16.94 −100.4*** (48.59) (36.18) RESIST·ROA 58.99*** (22.39) SENSIT −328.2*** ₋_301.9*** (76.46) (80.57) SENSIT·ROA −12.57 (12.29) SIZE 88.20*** _87.54*** _91.56*** _90.49*** _82.33*** _91.88*** (5.086) (5.103) (5.084) (5.499) (7.133) (5.088) LEV ₋50.78 ₋75.04 ₋65.61 42.91 125.1 ₋72.76 (52.52) (52.79) (50.78) (62.94) (99.35) (51.20) MTB 2.143 2.725 2.205 0.753 ₋0.821 1.872 (1.986) (1.991) (1.943) (2.174) (2.959) (1.967) ROA 0.112 0.182 −0.156 −2.116 −3.910* _0.131 (0.977) (0.981) (0.964) (1.398) (2.056) (1.003) Observations 433 433 433 433 433 433 R-squared 0.508 0.503 0.524 0.434 0.367 0.525

Thistableprovidestheestimatedcoefﬁcients(t-stats)throughthetwoleastsquaresmodel.ThedependentvariableisRETRIB.See Appendixforvariabledeﬁnitions.

* _Confidence_at_90%_level. **_Confidence_at_95%_level. *** _Confidence_at_99%_level.

Table10 Two-stageleastsquaresestimates.

(1) (2) (3) (4) (5) (6) (7) (8) (9)

FIXCOMP FIXCOMP FIXCOMP VARCOMP VARCOMP VARCOMP SENSITIVITY SENSITIVITY SENSITIVITY

INSTIT 0.536*** ₋_0.205 _0.0101 (0.175) (0.128) (0.0219) RESIST −63.04** _43.61** ₋_0.586 (24.59) (18.00) (0.436) SENSIT 40.32*** ₋_56.61*** ₋_2.220* (12.87) (9.719) (1.330) SIZE −3.508*** ₋_3.327*** ₋_3.401*** _1.777*** _1.194* _1.212* _0.00954 _0.00380 ₋_0.00368 (0.862) (0.941) (0.876) (0.636) (0.699) (0.646) (0.0377) (0.0418) (0.0477) LEV 11.49 25.21** _0.175 _4.397 ₋_3.808 _8.885 ₋_0.489 ₋_0.987* ₋_1.303* (8.594) (10.74) (9.622) (6.325) (7.944) (6.897) (0.354) (0.452) (0.637) MTB ₋0.759** ₋_1.079*** ₋_0.514 ₋_0.0304 _0.190 ₋_0.0755 ₋_0.00981 ₋_0.00899 ₋_0.000906 (0.327) (0.375) (0.348) (0.237) (0.273) (0.249) (0.0127) (0.0161) (0.0203) ROA 0.00792 ₋0.0193 0.00901 0.188 0.274* _0.233* ₋_0.00271 ₋_0.0166* ₋_0.0152 (0.163) (0.179) (0.166) (0.129) (0.143) (0.132) (0.00625) (0.00764) (0.00824) Observations 428 428 428 428 428 428 416 416 416 R-squared 0.116 0.195 0.075 0.142 0.181 0.107 0.234 0.163 0.118

Thistableprovidestheestimatedcoefﬁcients(t-stats)throughthetwoleastsquaresmodel.ThedependentvariablesareFIXCOMP, VARCOMPandSENSITIVITY.SeeAppendixforvariabledeﬁnitions.

* _Confidence_at_90%_level. **_Confidence_at_95%_level. *** _Confidence_at_99%_level.

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Concluding

remarks

Directorremuneration hasbeen thefocus ofconsiderable attentionfromthe public,media,academia,andthe pol-icymakersinrecent years.The debatecanbeapproached fromvarious angles:asoptimal pay structure for aligning paywithperformancetoreduceagencycosts;asa regula-toryissuewiththeobjectiveofremedyinganysystemﬂaws; andasapublicpolicyconcern.

Althoughpriorresearchhasprovidedsignificantinsights on the relation between institutional investors and man-agerial compensation, little is still know about the board memberscompensation.Itisarelevanttopicsince,unlike managers,directorsaresupposedtosettheirown compen-sation, which gives rise to new incentives and conflicts of interests. Thus, the contributions of our research are twofold:first,westudytheeffectofinstitutionalinvestors ondirectors’compensationratherthanmanagerial compen-sation. Second, we focus on the effect of institutional investorsasdirectorsratherthanowners.Bothissueshave notbeenaddressedbypreviousresearch.

Weanalyzetheroleofinstitutionaldirectorsin compen-sation policies of Spanish listed ﬁrms during the period 2004---2010.HeidrickandStruggles(2011)ﬁndthatSpainis theEuropeancountrywiththehighestproportionof direc-torsrepresentinginstitutionalinvestors.Thus,theSpanish caseprovidesnewinsightstotheinternationalgovernance literature (Baixauli-Soler and Sánchez-Marín, 2011; Firth etal.,2007)andallowscapturingtherelationbetween insti-tutionalinvestorsandcompensationpoliciesbetterthanina USorUKsetting,wheredirectorsappointedbyinstitutional investorsarelesscommon.

Our research corroborates the view that institutional investorsarefarfrombeingamonolithicgroupand under-line the differences among different types of directors regarding objectives, stability, scrutiny, and visibility. We make a distinction between those directors appointedby institutionalinvestorswhomaintainbusinessrelationswith thefirmonwhoseboardtheysit(pressure-sensitive direc-tors)and thoseappointedby institutionalinvestorswhose business activity is not related to the company in which theyholdadirectorship (pressure-resistant directors).We study theimpactof institutional directorsontwoaspects ofremunerationpolicy:compositionandsensitivity.Wealso checkwhetherinstitutionaldirectorshaveasignificant mod-erating effect on the relation between performance and boardremuneration.Specifically,wefindthatonlythe direc-torsappointedbypressure-resistantinstitutionalinvestors, compared to pressure-sensitive institutional investors, effectively reduce the fixed component of board remu-nerationandincreasethe pay-for-performancesensitivity. Conversely, the pressure-sensitive directors decrease the total board compensation and the variablecomponent of thecompensationpackage.

Taken together, these results suggest that directors appointedby pressure-resistant investorsserve asuperior monitoring role in mitigating the agency problems inside the firm by enhancing the role of the compensation as a mechanism of corporate governance and making the board compensation moretiedtothe firm’sperformance. Theseresultsconfirmthatinstitutionalinvestors’fiduciary

responsibilities,conﬂictsofinterest,andinformation asym-metry interact with each other to determine jointly the inﬂuenceofinstitutionalinvestorsonremuneration.Other theoreticalargumentstosupportourresultscanbefoundin thedifferentattitudetowardriskbetweendifferenttypes ofdirectors.

Ourresearchhasinterestingacademicandpolicy implica-tionsforthedebateovertheproperdegreeofinstitutional involvementincorporategovernance. Whenanalysing the roleof institutional investors,researchers must take into accountinvestors’participationinothermechanismsof cor-porate control such as the board of directors and their differentagendasandincentivesforcorporategovernance. Inparticular,directorsappointedbyinstitutionalinvestors shouldnotbeconsideredasahomogenousgroup,especially inacontextinwhichthemainagencyconﬂictstemsfrom adivergence of interestsbetween dominantand minority shareholdersandwheretheroleofinstitutionaldirectorsis highlyrelevant.Theseﬁndingshaveimportantpublicpolicy implicationsandsuggestthatregulatoryorganizationscould revisittheirpolicies onlargeequity positions ofdirectors appointedbyinstitutionalinvestorsandtheabilityofgroups ofinstitutionalinvestorstohavemoretosayin compensa-tiongovernancepractices.

Ourpaperhassomelimitationsthatcouldbeaddressed infutureresearch.First,theinteractionbetweenbothways ofinstitutionalinvestorsinfluence(ownershipand director-ships)couldbeintroducedjointly.Itcouldenhancetesting whether there are substitute or complementary effects betweenthem.Anotheravenueforresearchisanalyzingthe presenceofinstitutionaldirectorsinthecompensation com-mitteeratherthaninthewholeboard ofdirectors.Third, oncealongertimeperiodwasavailable,theattentioncould bepaidtotheeffectofthefinancialcrisisandtheextent towhichtheallegedly newcompensationdesignis aright answertothenewfinancialscenario.

Appendix.

Variable

deﬁnitions

Variables Description

RETRIB Totalcompensationoftheboarddividedby thenumberofdirectors

FIXCOMP Fixedcomponentofthetotalcompensation oftheboard

VARCOMP Variablecomponentofthetotal compensationoftheboard

SENSITIVITY Variationinthecompensationoftheboard relativetothevariationofreturnonassets (ROA)betweenthepreviousandthe currentyear.

INSTIT Proportionofdirectorswhorepresent institutionalinvestors

SENSIT Proportionofthedirectorswhorepresent pressure-sensitiveinstitutionalinvestors RESIST Proportionofthedirectorswhorepresent

pressure-resistantinstitutionalinvestors SENSITROA InteractionofSENSITandROAvariables RESISTROA InteractionofRESISTandROAvariables INSTITROA InteractionofINSTITandROAvariables

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Variables Description

LEV Ratioofbookdebttototalassets MTB Equitymarkettobookratio SIZE Totalassets(log)

ROA Grossproﬁttototalassets

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