Executive Compensation Schemes in the Banking Industry: A Comparative Study between a Developed Country and an Emerging Economy

INTRODUCTION This paper examines the executive compensation schemes and practices of banks operating in Canada (a developed country) and South Africa (an emerging economy). In both countries a relatively small number of large banks dominate the national market, making the banking sector a unique research context and an interesting first step in the comparison of compensation paid in each country. Using a population of eight major publicly-traded banks in Canada and the four main banks in South Africa, we investigate the structure and level of executive compensation, defined as the sum of salary, annual bonus, the values of executive stock options and long term incentive plans (LTIPs). We discriminate between banks operating in Canada and those operating in South Africa and use contingency theory of management accounting to explain the differences. The term developing countries has been defined in a variety of ways by different authors mainly based on: 1) geographical location and 2) economic development. For example, Perera (1989) defines developing countries as those countries in the so-called Third World. Third World refers to those countries that do not belong to the Western world centered in the U.S.A, or the Eastern world with the former USSR as a centre. Wallace (1990) defines developing countries as those in the mid-stream of development and refers to an amorphous and heterogeneous group of countries mostly found in Africa, Asia, Latin America, the Middle East and the Oceanic. South Africa is identified to represent developing countries since although classified so by the United Nations (2001) and the World Bank (2000), it lies on the upper income bracket of such countries. South Africa falls between both a developed and a third world country making it a good subject for examining the way in which compensation schemes are used in a developing country. South Africa is a developing country to the extent that it is an exporter of raw materials rather than finished goods; the economy is heavily tied to one raw material, namely gold. South Africa has accelerated its privatization program with up to $24 billion of government assets to be released for divestiture (ADB, 2000). The paper proceeds as follows; Section 2 describes the study theoretical framework. Section 3 describes the data and the methodology. Section 4 presents the results while section 5 discusses the results and presents a conclusion of the study. THEORETICAL FRAMEWORK Agency theory predicts that performance measures used for incentive purposes determine the direction of effort by the agent and that the incentive weight determines the amount of effort provided by the agent. The conventional theoretical framework for understanding reward contracts is in agency theory (Lambert 2001). Consequently the use of incentive contracts will lead to higher effort levels and increased performance on those dimensions that are being measured (Moers and Peek, 2000). The main prediction of the agency model is that pay should be sensitive to firm performance in order to induce managers to exert effort and thereby align the interests of the shareholders and managers (Jensen and Meckling 1976; Widener 2006). Agency theory focuses on the risk characteristics of the enterprise (including any information asymmetry issues) as prime determinants of the shape and nature of reward contracts (Stathopoulos et al 2004). Emerging economy stocks are the most risky firms in our study (due to information asymmetry) and the developed economy stocks are the least risky, and so we expect to see differences between the reward contracts of South African Banks and those of the Canadian banks in our study. We expect South African bank executives to prefer a higher proportion of their compensation in long term incentives since more risk would lead to higher option values (Black and Scholes, 1973). A similar argument could be made based on Smith and Watts (1992) who argue that a firm's growth opportunities will have an impact on its executive compensation policy. …

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