Compensation-Based Tax Shifting and Shareholder Expropriation

Annita Florou∗

Department of Accounting and Finance University of Macedonia

Current version: March 2007

∗ Corresponding author: Annita Florou, Department of Accounting and Finance, University of Macedonia, 156 Egnatia Street, 54006 Thessaloniki, Greece; Tel: +30 2310 891666; Fax: +30 2310 891278; e-mail: anflorou@uom.gr. I thank John Filos for helpful insights and background information. I also thank Antonis Kolivopoulos for his research assistance as well as Eftihis Sartzetakis and Kostas Karamanis for their comments. I am particularly indebted to Peter Pope for his invaluable guidance.

Compensation-Based Tax Shifting and Shareholder Expropriation

Abstract

Managers can expropriate shareholders by a variety of means. In this paper I examine a new expropriation mechanism that has not been considered in the prior literature, namely the possibility of managers to shift personal income taxes to shareholders. I examine a unique feature of the Greek tax system whereby corporate directors can receive cash compensation either in the form of taxable salary and bonus or in the form of tax-free profit distributions. Salary and bonus payments are deductible for corporate tax purposes whereas profit distributions are not, making a unit of profit distribution more costly to shareholders than a unit of salary/bonus. Ceteris paribus, rational directors prefer profit distribution to salary/bonus given that in the former case their personal taxes are paid by shareholders. Based on a sample of 235 companies I find that board members extract additional payment by shifting compensation-related taxes to shareholders. I also find that the degree of tax shifting reduces as board ownership increases, especially when family board ownership is involved. Finally, I document that board monitoring does not appear to be effective in curbing shareholder expropriation through compensation-based tax shifting.

Keywords: taxes, executive compensation, ownership structure, family control.

1

I. Introduction

The level of executive compensation is a controversial issue in the business press and has

been studied by an extensive academic literature based on the classic agency model (e.g.

see Jensen and Murphy 2004 for a recent review). However, this literature does not

address the role of taxes in compensation, probably because the tax treatment of various

forms of cash components is similar in most tax jurisdictions. In the current paper, I

exploit a unique feature of the Greek legislation, namely the differential tax treatment of

alternative cash compensation components, to examine whether managers expropriate

shareholder wealth by shifting their personal income taxes to outside shareholders. In

addition, I investigate the effect of managerial ownership and family control.

Cash payments to managers in Greece can be recognised as either an expense in

respect of salary/bonus (hereafter “salary”) or a profit distribution (i.e. a below the line

item). In the first case, salary compensation is taxed as personal income and is fully tax

deductible from corporate profits. In the second case, cash compensation entails no tax

burden for managers but is not tax deductible for the company. Effectively, when

managers receive profit distribution rather than salary their personal tax costs are shifted

to the owners of the firm. Put differently, with profit distribution shareholders pay the

managers’ compensation-related taxes. Rational managers have a strong preference for

profit distribution as opposed to salary if the rate of substitution between the two

compensation components does not fully reflect the tax benefit to managers. However,

the net benefit received because of tax shifting to shareholders will fall as managerial

ownership increases. In this case, managers who are also shareholders bear some of the

shifted tax costs.

2

I test whether there is shareholder expropriation via this tax shifting mechanism

by exploring the relationship between the level of total board cash compensation and the

proportion of profit distribution (i.e. the mix of pay). Based on a sample of 235 firms

listed in the Athens Stock Exchange (ASE) in 2004, I find that board total cash

compensation in gross terms is unrelated to the proportion of gross profit distribution.

This implies a one for one trade-off in pre-tax compensation components, consistent with

tax shifting. Moreover, net total cash compensation of the board is positively related to

the proportion of net profit distribution. These findings indicate that board directors

increase their net total cash payment by substituting profit distribution for salary and

therefore, reducing their personal taxes. Shareholders, on the other hand, incur the tax

costs as a consequence.

With respect to ownership, I find that the positive link between net total cash

compensation and net profit distribution is a decreasing function of board equity stake.

Consistent with the incentive alignment argument of ownership, this result suggests that

managerial ownership reduces agency costs. Similarly in terms of family control, I find

that the positive effect of higher profit distribution on the level of total cash compensation

is mitigated as family board ownership increases. Concentrated, undiversified family

board ownership, therefore, increases economic incentives to diminish agency conflicts.

Finally, I document that board monitoring does not mitigate shareholder expropriation

through higher profit sharing. Empirical findings are robust to the inclusion of standard

economic determinants of remuneration (e.g. firm performance, firm size etc.) and the

adoption of alternative compensation specifications (i.e. linear and log-linear).

The contribution of the paper is three-fold. First, it extends the compensation

3

literature by examining the role of taxes when different cash compensation components

are taxed differently. This setting enables the investigation of shareholder expropriation

via the mechanism of tax shifting. Second, it complements a limited number of prior

studies with mixed evidence on the link between remuneration and managerial ownership

(e.g. Core et al. 1999) by documenting the impact of managerial ownership on the

relation between the level of compensation and the proportion of profit distribution.

Finally, it adds to a growing literature examining the costs and benefits of family control

(e.g. Anderson and Reeb 2003) by providing findings regarding the impact of family

board ownership on the above association.

The remainder of the paper is organised as follows. The next section discusses in

detail the motivation of the paper, reviews prior related literature and elaborates on the

study’s research focus. Section III describes the sample and the empirical model

employed. Empirical findings are presented in Section IV and further results are

discussed in Section V. Section VI concludes.

II. Motivation

Literature Review

The role of taxes in managerial compensation is addressed primarily by the tax literature

that examines how taxes and changes in tax rules influence the compensation choices of

firms (see the reviews by Shevlin 1999; Shackelford and Shevlin 2001).

Several papers explore the role of taxes in the choice of firms between incentive

stock options (ISOs) and non-qualified stock options (NQOs) (Hite and Long 1982;

Matsunaga et al. 1992; Balsam et al. 1997; Austin, 1998); other papers focus on choices

4

regarding pension plans (e.g. Thomas 1988, 1989; Clinch and Sibano 1996). Similarly, a

number of papers investigate firm responses to the “million-dollar” provision enacted in

the US in 1993 (e.g. Johnson et al. 1999; Hall and Liebman 2000; Harris and Livingstone

2002). These studies adopt the “global contracting” framework of Scholes and Wolfson

(1992), according to which effective tax planning requires the researcher to consider all

parties involved in the transaction, all taxes and all costs. The global contracting

framework implicitly assumes that managers act in the interest of shareholders (i.e.

maximise the net cash flows to shareholders).

In contrast, to my knowledge, the role of taxes within a classic agency context,

where the separation of managers from outside investors involves an inherent conflict,

has not been explicitly addressed (see reviews of the academic literature on managerial

compensation by Murphy 1999; Bushman and Smith 2001; Jensen and Murphy 2004).

This is probably because in most tax regimes alternative cash compensation components

are treated symmetrically from the managers’ tax point of view. Moreover, there have

been relatively few studies of the relation between the level of compensation and

managerial ownership. Consistent with the incentive alignment argument relating to

managerial ownership, a number of studies find that CEO compensation is a decreasing

function of CEO’s ownership stake (Allen 1981; Lambert et al. 1993; Core et al. 1999;

Core 2000). This finding is not supported by Holderness and Sheeman (1988), who

document that managers owing at least half of the firm’s equity receive marginally higher

salaries than other officers.

The effect of family control is an area of growing interest. Anderson and Reeb

(2003) provide an excellent comprehensive review of the potential costs and benefits of

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family ownership. On one hand, concentrated ownership by families may encourage them

to engage in self-interested actions at the expense of firm performance and outside

shareholders (for related empirical studies see, for example, De Angelo and De Angelo

2000; Gomez-Mejia et al. 2001). On the other hand, when there is large concentrated

family ownership, family wealth depends more on the firm’s performance; consequently,

family members have both the incentive and the power to pursue firm-value maximizing

strategies (for related empirical studies see, for example, Anderson et al. 2003; Barontini

and Caprio 2006). There are very few papers examining the role of family ownership in

determining managerial compensation. Gomez-Mejia et al. (2003) find that family CEOs

are paid less as family ownership concentration increases. But, Haid and Yurtoglou

(2006) present evidence suggesting that managers of firms with more than 50% family

ownership receive a higher pay.

Tax Treatment of Cash Compensation in Greece

Greece has a differential cash compensation tax treatment, which moreover coincides

with the accounting treatment (Articles 23a & 24, Law 2190/1920; Article 54, Law

2238/1994; Alifantis 2003). Specifically, cash payments can be treated as either an

expense item (i.e. salary) or a profit distribution item (i.e. a below the line item). In the

first case, cash compensation received by managers is taxed at personal level as ordinary

income and is fully tax deductible from corporate profits. In the second case, cash

compensation is not taxed in the hands of managers because compensation comes out of

profits that have already been taxed at the firm level and allows no tax deduction at the

corporate level. In the latter case, managerial remuneration can be regarded as a “pseudo”

6

dividend, although it does not depend on stock ownership. Greek companies can

compensate managers through profit distribution only if profits after statutory reserves

and dividends (hereafter “net distributable” profits) are positive (Article 24, Law

2190/1920)1. Panel A of Table 1 summarises the tax treatment of cash payments

according to the Greek law.

Assuming the company pays gross total cash compensation P, with 100% salary

the manager is taxed at the ordinary personal tax rate Tp attracting a tax liability of P.Tp

and the firm receives a tax deduction of P.Tc where the corporate tax rate is Tc. With

100% profit distribution the tax cost of the manager P.Tp is partially or fully shifted to the

firm, which now loses its tax benefit P.Tc; in other words, in this case shareholders pay

the manager’s compensation taxes. The tax consequences to both the manager and the

firm (i.e. the shareholders) are summarised in panel B of Table 1.

[INSERT TABLE 1]

This differential tax treatment of alternative forms of cash compensation could

induce “self-interested” managers to expropriate from shareholders. That is, given the tax

“superiority” of profit distribution, relative to salary, managers have incentives to receive

their pay in the form of profit distribution and therefore increase their total net

remuneration at the expense of shareholders.

But, does this incentive change? So far, the analysis assumes that the manager

does not own any equity stake. Given that profit distribution implies shifting tax costs to

shareholders, an obvious case where managerial incentives for expropriation might be

reduced is where managers own shares; in this case, managers, who are now shareholders

themselves, incur some of the shifted tax costs. To illustrate the point let us continue the

7

previous analysis and assume that the manager holds a fraction of firm’s equity E and

hence, remaining shareholders own (1-E) of equity. With profit distribution the net

benefit to the manager-owner equals:

cp E.P.TP.TBenefitNet −= (1)

whereas, the remaining shareholders bear a cost equal to (1-E)*P.Tc.

Rearranging equation 1 gives:

( )cp TETPBenefitNet .* −= (2)

Let us now consider the extreme case where the firm is fully owned by the

manager, i.e. E equals one. Substituting for E in equation 2 we get:

( )cp TTPBenefitNet .* −= (3)

In this case, the choice between salary and profit distribution is determined by the

personal and company tax rates. Specifically: a) if the personal tax rate Tp is higher than

the corporate tax rate Tc then profit distribution is preferred because its net benefit to the

manager-owner is positive; b) if the personal tax rate Tp is the same as the corporate tax

rate Tc then the manager is indifferent between the two types of compensation, given that

the net benefit equals zero and; c) if the personal tax rate Tp is lower than the corporate

tax rate Tc then salary is preferred because the net benefit of profit distribution is

negative.

According to the 2004 Greek tax law (Law 3296/2004) the highest personal tax

rate, applicable to total annual income above €23,000 is 40%, whereas corporate tax rate

is 35%. Based on a survey by KPMG, mean total CEO compensation of Greek companies

in 2003 is €292,000. Moreover the finance, sales, marketing and human resources

director earns €117,159; €111,548; €119,470 and; €100,331 respectively. It is, therefore,

8

reasonable to assume that the personal tax rate applicable to a considerable - if not the

largest fraction - of the annual compensation of the directors of my sample is higher than

the corporate tax rate, which in turn implies that profit distribution is preferred against

salary even when the manager fully owns the firm2.

In the generic case where 0<E<1, the net benefit of profit distribution, as derived

from equation 1, is a decreasing function of the managerial equity E. In other words,

ceteris paribus, the higher the ownership share of the manager E the higher the corporate

tax cost E.P.Tc she incurs and hence, the lower the net benefit she realises. On the other

hand, the costs born by the remaining shareholders because of profit distribution are an

increasing function of managerial equity E; ceteris paribus, the higher the ownership

share of the manager E the lower the equity stake owned by outside shareholders (1-E)

and therefore, the lower their cost (1-E)*P.Tc.

Overall, the differential tax treatment of profit distribution provides managers

with a strong incentive to prefer this type of cash compensation in order to reduce their

personal taxes and therefore, extract additional payment at the expense of shareholders;

they, in turn, incur additional tax costs. This incentive, however, is moderated in the

presence of managerial ownership; in fact, managerial incentives for shareholder

expropriation diminish as managerial ownership increases.

Research Questions

The first research question I explore is whether higher profit distribution, defined as a

proportion of total cash compensation leads to higher total pay. By including the

proportion of profit distribution (i.e. the mix of pay) as an economic determinant of total

9

cash compensation, I examine whether managers extract additional payment due to the

tax advantage of profit distribution, after controlling for the trade-off between profit

distribution and salary.

Figures 1a and 2b illustrate the predictions of the study regarding the effect of the

proportion of profit distribution. Given that salary for directors in my sample is generally

taxed at 40%, the highest personal tax rate in Greece, and that profit distribution is non-

taxable, if there is a one to one trade-off between the two forms of cash payment in gross

terms then for every one Euro increase in net profit distribution net salary decreases by

sixty cents. Consequently, gross compensation does not change but net compensation

increases with higher profit distribution. In this case, as illustrated in figure 1a, there is

shareholder expropriation: net total cash compensation of managers is higher because of

tax shifting to shareholders.

[INSERT FIGURE 1a]

On the other hand, if there is a one to one trade-off between the two cash

components in net terms then for every one Euro increase in gross profit distribution

gross salary decreases by approximately one Euro and sixty seven cents. This means that

in gross terms an increase in the percentage of profit distribution is followed by a larger

decrease in the percentage of salary. Consequently, net total cash compensation does not

change but its gross value is negatively related to profit distribution. In this case, as

illustrated in figure 1b, there is no shareholder expropriation by managers.

[INSERT FIGURE 1b]

Overall, shareholder expropriation is expected if for every one Euro increase in

gross profit distribution the decrease in gross salary is equal to or greater than one Euro

10

but less than one Euro and sixty seven cents. Obviously, ceteris paribus, there is always

shareholder expropriation if for every one Euro increase in gross profit distribution gross

salary decreases by less than one Euro whereas there is never shareholder expropriation if

gross salary decreases by more than one Euro and sixty-seven cents.

The second research question I address is whether managerial ownership affects

the relation between the level of total cash compensation and the proportion of profit

distribution. Finally, I examine whether the moderating effect of managerial ownership

depends on whether it is related to family or non-family board members. As discussed

previously, managerial ownership increases the corporate tax costs incurred by the

manager-owner and hence, decreases the net benefit received through profit distribution.

Consequently, as the ownership stake of managers increases the positive effect of net

profit distribution on net total cash compensation is predicted to decrease. Figure 1c

describes the case of shareholder expropriation in the presence of managerial ownership;

net total cash compensation increases with higher profit distribution but at a decreasing

rate.

[INSERT FIGURE 1c]

III. Research Design

Sample

I collected compensation data from the annual reports of companies listed in the Athens

Stock Exchange in 2004. I selected fiscal year 2004 for study because the accounting

treatment and disclosure of compensation items changed in 2005 with the mandatory

transition to International Financial Reporting Standards (IFRS). After excluding

11

companies for which no annual reports could be obtained the primary sample includes

251 companies (71.3% of all ASE firms), representing more than 90% of the total market

capitalisation of the Greek equity market as of the end of 20043. In addition, I excluded

three companies because information about their ownership structure was unavailable. I

also excluded investment trusts and companies voluntarily applying IFRS. The final

sample consists of 235 firms with 2004 fiscal year end in December (226 firms in total)

and June (9 firms in total). Details of the sampling procedure are summarised in Table 2.

[INSERT TABLE 2]

The study’s final sample represents 88% of the total market capitalisation of the

Greek equity market as of the end of 2004 and spans all the sectors of the Athens Stock

Exchange, with concentration in the construction, consumer goods, industrial

products/services and food industries.

Empirical Model and Measurement Issues

I test the following generic empirical model:

Compensationi = ionDistributiProfit1βα + κγΣ=

+5

1kikitDeterminanEconomic ε+ (1)

As mentioned Greek firms are required to disclose remuneration details only for

the entire board and not individual directors (e.g. CEO, Chairman, executive board

members etc.) Consequently, I model total board cash compensation. Moreover, I

perform two alternative specifications of model 1: linear and log-linear, using the natural

logarithm, to test both the euro value effect of profit distribution on board compensation

as well as the elasticity of this relation.

12

Based on the analysis in Section II, I use two measures of board compensation in

model 1: gross total cash compensation (GCOMP) and net total cash compensation

(NCOMP). Gross total cash compensation equals the sum of salary and profit

distribution. Net total cash compensation equals the sum of profit distribution and 60% of

salary. Similarly, I employ two measures of profit distribution: gross and net, calculated

as the proportion of gross and net total cash compensation, respectively4. As illustrated in

figure 1a if there is shareholder expropriation then total gross cash compensation remains

the same but net total cash compensation increases. Therefore, in the case of

expropriation model 1 predicts an insignificant sign of β1 under GCOMP and a positive

sign of β1 under NCOMP.

Following prior literature I include the following standard economic determinants

of executive compensation: a) firm size (Mkt. Cap.), measured by market capitalisation

(e.g. Larcker et al. 2005); b) firm investment opportunities measured by book-to-market,

calculated as the book value of common equity divided by the market value of common

equity (e.g. Conyon and Murphy 2000); c) firm performance measured by return on

assets (ROA), defined as earnings before interest and taxes divided by total assets at the

beginning of the year (e.g. Core et al. 1999), and stock returns (RET), calculated as log of

(RIt+1/RIt), where RI stands for Return Index on 1st January5 (e.g. Core et al. 1999;

Conyon and Murphy 2000; Larcker et al. 2005) and; d) firm risk (σRET), measured by

the standard deviation of monthly stock returns for the prior five years (e.g. Core et al.

1999; Larcker et al. 2005)6. In line with prior theoretical models and empirical work, the

level of pay is expected to be positively related with firm size, investment opportunities

and firm performance (e.g. Rosen 1982; Smith and Watts 1992) but compensation may

13

either increase or decrease with firm risk (e.g. Banker and Datar 1989). Stock returns are

obtained from Datastream and all other firm data is collected from Profile Analytics (a

Greek financial database). All economic determinants correspond to the year prior (i.e.

2003) to the year in which compensation is awarded (i.e. 2004). Compensation variables

as well as all control variables are winsorised at the extreme two percentiles. In the

empirical analysis, I also include a vector of industry dummies.

To test the incentive-alignment effect of ownership I test the following model:

Compensationi = +++ ii OwnershiponDistributiProfit 21 ββα

5

13 kiii tsDeterminanEconomic OwnershiponDistributiProfit κ

κ

γβ ∑=

+× (2)

In model 2 I employ four alternative measures of board ownership: a) total board

(CEO) ownership, defined as the percentage of shares owned by all board directors

(CEO); b) family board ownership, i.e. the proportion of shares owned by board members

that are relatives with each other, c) non-family board ownership, i.e. the proportion of

shares owned by board members that have no family relationship with each other and; d)

total family ownership, i.e. the proportion of shares owned by board directors and other

investors that belong to the same family. I identify family relationships among board

members and other investors based on the individual’s surname. Given that profit

distribution is decided by directors at the end of the financial year, I obtained ownership

information from ASE as at the end of the fiscal year 2004. Moreover, Greek firms have

to file ownership information with ASE only if equity stake is higher than 5%. As

illustrated in figure 1c, if board ownership increases the net benefit received by directors

because of higher profit distribution reduces. Hence, model 2 predicts a negative sign on

the interaction term between profit distribution and ownership.

14

Table 3 reports the frequency of the two forms of board cash compensation, salary

and profit distribution: 25.5% of sample firms compensate their board directors through

profit distribution (Panel A). However, only profitable firms are permitted to give profit

distributions to directors; the rate of profit distribution increases to 35% of firms with

positive net distributable earnings (Panel B). Moreover, 16 firms compensate directors

exclusively through profit distribution while 147 firms pay directors only salary; 38 firms

adopt both types of compensation and; 11 firms do not remunerate directors either

through salary or profit distribution7 (Panel C). I excluded this group of firms from the

analysis given that the study focuses on the link between total cash compensation and

profit distribution.

[INSERT TABLE 3]

Given the tax superiority of profit distribution, relative to salary, an obvious

question that arises is why don’t all directors take advantage of the former? A number of

reasons could explain this observation. First, there is a timing issue: in contrast to salary

that is routinely paid at the end of each month, profit distribution can only be paid at the

end of the year8. Second, profit distribution is riskier compared to salary because it can

be awarded only if the company has positive net distributable earnings. Third, and most

importantly, there are significant implications for redundancy and retirement

compensation. According to the Greek law (Law 3198/1955), employees are entitled to

compensation in the case of job termination or retirement; redundancy compensation is

almost twice that of retirement. In both cases, compensation depends on the most recent

salary as well as the years of work experience. However, profit distribution is not taken

into account when calculating redundancy or retirement pay (Article 3, Law 2112/1920;

15

Alifantis 2002). Consequently, in the most extreme case where a director is fully

compensated through profit distribution she is not entitled to any of the above payments

at all. For these reasons it is unlikely that profit distribution will dominate other forms of

compensation for all directors9.

Table 4 presents the descriptive statistics for all variables. Panel A refers to the

compensation variables. The mean value of total gross and net cash compensation of the

board is approximately €465,253 and €309,222 respectively. Mean gross (net) profit

distribution accounts for about 14% (16%) of total gross (net) compensation. Panel B

describes the ownership variables. Board ownership is about 45%, of which 37% is

owned by family board members and the remaining 8% is owned by non-family. The

mean value of CEO and total family ownership is approximately 41% and 34%

respectively. Moreover, panel C reports that in the majority of Greek companies (101 in

total) there is only family board ownership whereas in 28 firms equity is owned only by

non-family board members. The descriptive statistics in panels B and C illustrate the

dominance of family-controlled firms in Greece (see also PWC 2006). Panel D describes

the economic determinants of compensation. The mean value of market capitalisation is

€239m. Book-to-market is, on average, 0.794 whereas the mean firm reports accounting

and stock returns of 5.3% and 16.9% respectively.

[INSERT TABLE 4]

The correlations between the study’s independent variables, reported in Table 5,

are generally small in absolute value and mostly insignificant; the largest correlation,

between net profit distribution and accounting returns, equals 0.222.

[INSERT TABLE 5]

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IV. Results

This section contains the main empirical findings of the study. First, I explore the relation

between board total cash compensation and profit distribution. Then, I discuss the impact

of board ownership on the above association and finally I investigate further the effect of

equity ownership by distinguishing between family and non family.

Total Cash Compensation and Profit Distribution

Table 6 presents regression models relating total cash compensation to profit distribution.

Panels A and B refer to gross and net total cash compensation respectively. In model 1 of

both panels I examine only the effect of the standard economic determinants. Consistent

with prior research, cash compensation is increasing with firm size and stock

performance (e.g. Core et al. 1999; Conyon and Murphy 2000; Larcker et al. 2005). The

model is able to explain almost 33% and 32% of the cross-sectional variation in gross and

net total cash payment respectively. Empirical results regarding the standard economic

determinants remain boadly unchanged throughout the analysis.

As reported in Table 6, the coefficient on gross profit distribution is statistically

insignificant (Panel A). In contrast, the coefficient on net profit distribution (Panel B) is

positive (1,764.8) and significant at conventional levels (p-value of 0.047). These

findings suggest that the trade-off between gross cash components is not different from

one to one, implying tax shifting. Moreover, if cash pay through net profit distribution

increases by one percent the value of net total cash compensation increases by

approximately €1,765. These findings are consistent with the predictions of tax-based

shareholder expropriation illustrated in figure 1a and the empirical specification 1.

17

Model 3 of panels A and B presents the log-linear specification of compensation.

Similarly to prior research (e.g. Core et al., 1999) I transform total compensation and

market capitalisation via the natural logarithm but continue to define the remaining

variables as previously. Inferences regarding the association between total cash

compensation and the proportion of profit distribution both in gross and net terms remain

unchanged. The coefficient estimate on gross profit distribution is statistically

insignificant (Panel A); the coefficient of net profit distribution, albeit less significant, is

still positive (Panel B). Compared to the linear model of compensation the log-linear

specification has lower explanatory power; the adjusted R2 of model 3 is 0.215 (as

opposed to 0.322 of model 2) and 0.253 (as opposed to 0.339 of model 2) in panels A and

B respectively.

[INSERT TABLE 6]

Overall, the findings in Table 6 suggest that managers increase the net value of

their total cash remuneration by tax shifting through higher profit distribution.

Shareholders, on the other hand, incur the above tax costs.

The Impact of Board Ownership

Having established a positive link between net total cash compensation and the

proportion of net profit distribution, Table 7 explores the role of board ownership in

determining the relation between total cash compensation and profit distribution. Panel A

reports Euro value of net total cash compensation regression results. Models 1 and 2

refer to total board ownership. In both models I include the total board ownership

measure and its interaction term with the net profit distribution variable. Because of the

18

filling requirements of ASE, according to which ownership information must be provided

only if it is higher than 5%, in model 1 I add an indicator variable equal to one if board

ownership information is not disclosed and zero otherwise as well as the interaction

between this dummy variable and the measure of net profit distribution. Model 1,

therefore, presents regression results for the full sample (i.e. 146 observations). Model 2,

presents regression results only for a sub-sample of firms, for which information for all

variables, including board ownership, is available. As reported, the sample size in model

2 is reduced by approximately 37%.

The main variable of interest in Table 7 is the interaction term between net profit

distribution and total board ownership. Consistent with the predictions of figure 1c and

the empirical specification 2, I find that the coefficient of the interaction term is -147 in

model 1 and -129.8 in model 2; in both cases, the estimate is significant at the 1% level.

Moreover, the coefficient on the main effect of net profit distribution is still positive

(9,427.3 and 8,620.4 in models 1 and 2 respectively) and highly significant (p-value is

0.000). In other words, the impact of net profit distribution on the level of total cash

compensation becomes less positive as board equity stake increases. For example, in

model 1 when board ownership increases from zero to one percent the marginal impact of

one unit change in net profit distribution on total cash compensation falls from 9,427.3 to

9,280.3 euros (i.e. 9,427.3 – 147). In line with the incentive alignment argument of

managerial ownership, the findings reveal that managers extract less net cash

compensation as their equity ownership increases. It is worth noting that the main effect

of total board ownership is positive but insignificant in model 1 and marginally

significant in model 2 (p-value is 0.086). This finding weakly supports prior evidence of

19

Holderness and Sheeman (1988), who document that majority-shareholder managers

receive marginally higher salaries than other officers.

Arguably, the CEO is a very – if not the most – important and influential

decision-maker of a firm. Accordingly, in models 3 and 4 I repeat the previous analysis

by focusing on the impact of CEO ownership. Similar to model 2, sample size reduces

significantly in model 4. In line with the previous results, I find that the coefficient of the

interaction term between net profit distribution and CEO ownership is negative and

highly significant in both models (e.g -122.9 with a p-value of 0.000 in model 3) whereas

the coefficient on the main effect of net profit distribution is still positive and highly

significant (e.g. 6,432.4 with a p-value of 0.000 in model 3). Moreover, the coefficient on

the main effect of CEO ownership is insignificant in both models 3 and 4. Panel B of

Table 7 reports the regression results under the log-linear specification. All the above

findings remain qualitatively unchanged.

[INSERT TABLE 7]

Collectively, the regression results indicate that board ownership increases tax

costs incurred by managers and therefore, moderates their incentives for shareholder

expropriation through higher profit distribution. This finding is consistent with the

explanation of managerial ownership reducing agency costs.

The Effect of Family Control

Table 8 completes the empirical analysis by exploring further the role of board ownership

on the relation between cash compensation and profit distribution. Panel A reports results

using the value of net total cash compensation as the dependent variable. In models 1 and

20

2 I incorporate two ownership variables, family and non-family, as well as their

interaction with net profit distribution. Similar to Table 7, model 1 presents regression

results for the full sample (i.e. 146 observations) while model 2 presents regression

results only for the sub-sample, for which information for all variables, including board

ownership, is available.

Results reveal that the negative effect of board ownership is attributed primarily

to family control. Specifically, the main effect of net profit distribution is positive and

highly significant (8,622.4 and 8,039.7 in models 1 and 2 respectively with a p-value in

both cases of 0.001) whereas the coefficient on its interaction term with family board

ownership is negative and highly significant (-136.9 and -124 in models 1 and 2

respectively with a p-value in both cases of 0.001). Therefore, the effect of net profit

distribution on the level of total cash compensation is less positive as family board equity

stake increases. For example, in model 1 when board ownership increases from zero to

one percent the marginal impact of one unit change in net profit distribution on total cash

compensation falls from 8,622.4 to 8,485.5 euros (i.e. 8,622.4-136.9). In contrast, the

coefficient on the interaction term between non-family ownership and net profit

distribution has the predicted negative sign but is not significant at conventional levels.

In models 3 and 4 I repeat the above analysis by employing an alternative

measure of family ownership. Specifically, in these models I include the total family

ownership variable to examine the impact of equity owned not only by family board

members but also non-board family members related to directors. Findings regarding the

effect of family control on the relationship between net total cash compensation and net

profit distribution persist. The coefficient on the interaction term of total family

21

ownership with net profit distribution is negative and highly significant (e.g. -117.4 with

a p-value of 0.006 in model 3) whereas the coefficient on the equivalent interaction term

of non-family ownership remains statistically insignificant.

Panel B of Table 8 reports the regression results under the log-linear specification.

All the above findings remain qualitatively the same with only one exception; i.e. the

negative effect of the interaction term of total family ownership with net profit

distribution is not statistically significant in model 4. With regards to the main effects of

ownership, contrary to previous studies (e.g. Gomez-Mejia et al. 2003) I find that family

ownership has no explanatory power for the level of compensation; the coefficients of

family board and total family ownership are insignificant under all models in both panels.

Moreover, in the case of non-family ownership the coefficient is positive and statistically

significant but not consistently under all models in panels A and B.

[INSERT TABLE 8]

In sum, the evidence in Table 8 suggests that equity ownership by board directors,

who are members of the same family, is advantageous for the remaining outside

shareholders. Concentrated, undiversified family board ownership increases economic

incentives to diminish agency conflicts; the positive effect of higher profit distribution on

the level of total cash compensation because of tax shifting lessens as family board

ownership increases.

V. Further Analysis

So far, the empirical analysis ignores the role of boards in determining managerial

behaviour and actions. Arguably, firms with weaker board structures have greater agency

22

problems and therefore, managers of these firms are more likely to engage in self-

interested actions. In this section, I examine whether the quality of board monitoring

affects the degree of shareholder expropriation via higher profit distribution.

Prior literature has identified a number of characteristics that potentially proxy for

board monitoring quality. First, the composition of the board, i.e. the proportion of

outside members that are independent of inside directors and have reputational concerns,

may enhance quality (Fama and Jensen 1983; Peasnell et al.2000; Klein 2002). But,

several scholars argue that outsiders do not perform any substantial monitoring role

because they lack the necessary time and expertise or are unwilling to exercise their

authority and “take tough decisions” (Crystal 1991; Hart 1995; Core et al. 1999; Conyon

and Florou 2006). Moreover, in the current case, outside directors themselves may

expropriate shareholders by receiving profit distribution. Second, the existence of an

independent chairperson may also improve the quality of board monitoring. The primary

benefit of separating the CEO/chairman titles is to facilitate an independent control of the

behaviour of the CEO and other directors (Jensen 1993; Yermack 1996; Core et al. 1999).

Yet, separating the roles does not necessarily improve governance effectiveness (Larcker

et al. 2004; Conyon and Florou 2006) or may even introduce other agency costs (Brickley

et al. 1997). Finally, the extent to which boards perform their duties may depend on their

size. Although boards’ capacities for monitoring increase with size, larger boards are

slower in decision-making and hence, less effective (Lipton and Lorsch 1992; Yermack

1996).

Following the extensive literature on board effectiveness (see, for example, Dahya

and McConnell 2003, for a comprehensive review) my board quality variables include

23

board size, defined as the total number of board members, the proportion of outside and

independent outside board directors as reported by the firm and, an indicator variable set

equal to one if the roles of CEO and board chairman are separated and zero otherwise10. I

manually collected information regarding board variables from the 2003 annual reports.

To test whether board structure variables affect the relationship between the level

of total cash compensation and the proportion of profit distribution, in model 1 of Section

III I include the main effects of all the board variables as well as their interaction with the

net profit distribution measure. Again, I test both the linear and log-linear specifications

of the above model. In the absence of a clear theoretical basis for distinguishing between

the above competing views on board effectiveness, I argue that smaller boards with

separate CEO/chairman positions and a higher fraction of outside or independent outside

board members enhance board monitoring and hence, mitigate shareholder expropriation

through compensation-based tax shifting. Consequently, the coefficients on the above

interaction terms are expected to be negative for outsiders and the separation of the

CEO/chairman roles and positive for board size. In untabulated results, I find that neither

the main effects nor the interaction terms of the board variables are significant at

conventional levels. Hence, there seems to be no evidence that board monitoring

moderates shareholder expropriation via the tax shifting mechanism.

VI. Conclusions

This study exploits a unique feature of Greece, namely the differential tax treatment of

alternative forms of cash compensation (i.e. profit distribution and salary), and

documents that taxes play a significant role in determining the level of managerial

24

compensation. Using a sample of 235 firms listed on the Athens Stock Exchange in 2004,

I find that net total cash compensation of board directors increases with profit

distribution, after controlling for reductions in salary and the standard economic

determinants of the remuneration level as well as testing for alternative compensation

specifications. This finding suggests that board directors enhance their after-tax

remuneration by shifting their personal taxes to the firm’s shareholders.

Moreover, I find that the benefit obtained by directors because of tax shifting

reduces as board ownership increases. This is particularly evident in the case of family

board ownership. The results indicate that managerial ownership as well as family control

is advantageous for the firm’s shareholders by reducing the inherent conflicts between the

latter and the firm’s officers. Finally, further analysis suggests that the quality of board

monitoring proxied by a number of variables (e.g. the proportion of outside members on

the board) does not curb shareholder expropriation through compensation-based tax

shifting.

The results of the current study have potentially important implications for

financial statement transparency in the context of IFRS. Contrary to the Greek accounting

rules that reflect the tax code, managerial compensation under IFRS can be treated only

as an expense item. Consequently, IFRS profits reported to shareholders may differ from

taxable profits. In addition, IFRS do not require detailed disclosure of director

remuneration (with the exception of stock options). Accordingly, it may be the case that

directors of Greek companies that now have to prepare their financial reports according

to IFRS, will continue to be compensated through profit distribution. This, however, may

not be visible to shareholders. This issue presents a case where IFRS may adversely

25

affect transparency of financial reporting at the expense of shareholders.

26

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29

Table 1 The Tax Implications of Different Forms of Cash Compensation

Panel A: Tax Treatment of Cash Compensation Components

Cash Component Taxation at Personal Level

Taxation at Corporate Level

Salary Taxed as ordinary income Fully tax deductible Profit Distribution Fully tax-free No corporate tax deduction

Panel B: Tax Consequences to the Manager and the Shareholders Cash Component Manager Shareholders Salary Tax cost = PTp Tax benefit = PTcProfit Distribution Tax cost = 0 Tax benefit = 0 NOTES: P is gross total cash compensation. Tp and Tc denote personal and corporate tax rates respectively.

30

Table2 Sample Selection Process

Total Number of Firms listed in ASE during 2004 352 Not available annual reports (101) Primary sample 251 Missing information on ownership structure (3) Investment trusts (12) Voluntary adoption of IFRS (1) Final Sample 235

NOTES: ASE denotes Athens Stock Exchange

31

Table 3 Incidence of Profit Distribution and Salary

Panel A: Profit Distribution – Full Sample Incidence Number of Companies (%) Yes 60 (25.5%) No 175 (74.5%) Total 235 Panel B: Profit Distribution – Sample with Net Distributable Earnings>0 Incidence Number of Companies (%) Yes 60 (35%) No 111 (65%) Total 171 Panel C: Incidence of Board Cash Compensation by Form Form of Cash Compensation

Profit Distribution Yes

Profit Distribution No

Salary – Yes 38 147 Salary – No 16 11

NOTES: The sample consists of 235 firms listed in the Athens Stock Exchange during 2004. Net distributable earnings are earnings after statutory reserve and dividends. There are 23 firms for which, information on salary is not available (Panel C).

32

Table 4 Descriptive Statistics for Board Compensation and its Hypothesised Determinants

Panel A: Board Cash Compensation Variable Obs. Mean Median Std. Dev. GCOMP 201 465,252.9 288,000.0 482,670.6 NCOMP 201 309,221.6 193,193.6 327,009.7 Gross Profit Distribution % 201 14.31 0.00 30.16

Net Profit Distribution % 201 16.01 0.00 31.75

Panel B: Board Ownership Variable Obs. Mean Median Std. Dev. Total Board Ownership % 146 45.26 47.05 22.27

Family Board Ownership % 146 36.88 41.05 26.94

Non-Family Board Ownership % 146 8.38 0.00 15.85

Total Family Ownership % 146 41.34 48.36 28.06

CEO Ownership % 139 33.74 31.81 20.08 Panel C: Incidence of Board Ownership by Family Status

Type of Board Ownership

Non-Family Board Ownership

Yes

Non-Family Board Ownership

No Family Board Ownership Yes 17 101

Family Board Ownership No 28 78

33

Panel D: Economic Determinants Variable Obs. Mean Median Std. Dev. Mkt. Cap. (millions of euros) 202 239.1m. 55.24m. 634.9m.

Ln (Mkt. Cap.) 202 17.98 17.82 1.427 Book-to-Market 202 0.794 0.673 0.681 ROA 188 0.053 0.033 0.081 RET 206 0.169 0.174 0.361 σ(RET) 200 0.192 0.190 0.053

NOTES: The sample consists of 224 firms listed in the Athens Stock Exchange during 2004. GCOMP is gross total cash compensation defined as the sum of salary and profit distribution. NCOMP is net total cash compensation defined as the sum of profit distribution and 60% of salary. Gross (net) profit distribution % is calculated as profit distribution divided by gross (net) total cash compensation respectively. Total board (CEO) ownership % is defined as the percentage of shares owned by all board directors (CEO). Family board ownership % is the proportion of shares owned by board members that are relatives with each other. Non-family board ownership % is the proportion of shares owned by board members that have no family relationship with each other. Total family ownership % is the proportion of shares owned by board directors and other investors that belong to the same family. Mkt. Cap is market value of common equity. Book-to-market is calculated as the book value of common equity divided by the market value of common equity. ROA (return on assets) is calculated as earnings before interest and taxes divided by total assets at the beginning of the year. RET (stock returns) is calculated as log of (RIt+1/RIt), where RI stands for Return Index on 1st January. A company's return index shows the growth in the share value and the value of the dividends. The relevant formula is: RI = RIt * (Pt + Dt)/Pt-1, where Pt = price on ex-date (i.e. the day dividend payments become certain), Pt-1 = price on previous day and Dt = dividend payment associated with ex-date t. σ(RET) is the standard deviation of monthly stock returns for the prior five years.

34

Table 5 Correlations Between Selected Independent Variables

Panel A: Net Profit Distribution

Variable

Total Board

Owner- ship %

CEO Owner- ship %

Mkt. Cap.

Book-to-

Market ROA RET σ(RET)

Net Profit Distribution %

0.003 (0.965)

-0.016 (0.857)

0.164 (0.027)

-0.112 (0.134)

0.220 (0.003)

0.085 (0.247)

-0.063 (0.398)

Panel B: Total Board Ownership Variable Mkt. Cap. Book-to-

Market ROA RET σ(RET)

Total Board

Ownership %

-0.102 (0.244)

-0.058 (0.506)

0.137 (0.137)

0.041 (0.641)

-0.131 (0.142)

Panel C: CEO Ownership Variable Mkt. Cap. Book-to-

Market ROA RET σ(RET)

CEO Ownership

%

-0.055 (0.534)

-0.065 (0.469)

0.049 (0.602)

0.068 (0.451)

-0.126 ().170)

NOTES: The sample consists of 224 firms listed in the Athens Stock Exchange during 2004. Net profit distribution % is calculated as profit distribution divided by net total cash compensation. Total board (CEO) ownership % is defined as the percentage of shares owned by all board directors (CEO). Mkt. Cap is market value of common equity. Book-to-market is calculated as the book value of common equity divided by the market value of common equity. ROA (return on assets) is calculated as earnings before interest and taxes divided by total assets at the beginning of the year. RET (stock returns) is calculated as log of (RIt+1/RIt), where RI stands for Return Index on 1st January. A company's return index shows the growth in the share value and the value of the dividends. The relevant formula is: RI = RIt * (Pt + Dt)/Pt-1, where Pt = price on ex-date (i.e. the day dividend payments become certain), Pt-1 = price on previous day and Dt = dividend payment associated with ex-date t. σ(RET) is the standard deviation of monthly stock returns for the prior five years.

35

Table 6 Total Cash Compensation and Profit Distribution

Panel A: Gross Total Cash Compensation and Gross Profit Distribution Dependent Variable: GCOMP Model 1 Model 2 Model 3

Gross Profit Distribution % - -31.7 (0.978)

-0.000 (0.806)

Mkt. Cap. 0.000 (0.000)***

0.000 (0.000)*** -

Ln (Mkt. Cap.) - - 0.280 (0.001)***

Book-to-Market -24,658.5 (0.666)

-24,709.9 (0.668)

0.017 (0.907)

ROA -282,752.2 (0.597)

-280,219.2 (0.616)

-0.065 (0.956)

RET 151,0807.4 (0.048)**

152,006.9 (0.046)**

0.445 (0.060)*

σ(RET) -905,090.7 (0.254)

-903,374.5 (0.256)

-0.717 (0.715)

Intercept 716,011.9 (0.001)**

715,668.3 (0.001)***

7.728 (0.000)***

No. Observations 146 146 146 Adj. R2 32.7% 32.2% 21.5% Panel B: Net Total Cash Compensation and Net Profit Distribution Dependent Variable: NCOMP Model 1 Model 2 Model 3

Net Profit Distribution % - 1,764.8 (0.047)**

0.005 (0.086)*

Mkt. Cap. 0.000 (0.000)***

0.000 (0.000)*** -

Ln (Mkt. Cap.) - - 0.279 (0.001)***

Book-to-Market -16,079.9 (0.679)

-12,257.7 (0.744)

0.020 (0.891)

ROA -36,561.0 (0.916)

-178,451.9 (0.624)

-0.158 (0.894)

RET 99,897.9 (0.053)*

86,985.8 (0.073)*

0.439 (0.061)*

σ(RET) -373,006.8 (0.465)

-463,774.4 (0.366)

-0.808 (0.678)

Intercept 424,056.9 (0.005)***

440,543.6 (0.003)***

7.273.0 (0.000)***

No. Observations 146 146 146 Adj. R2 32.0% 33.9% 25.3%

36

NOTES: The sample consists of 224 firms listed in the Athens Stock Exchange during 2004. GCOMP is gross total cash compensation defined as the sum of salary and profit distribution. NCOMP is net total cash compensation defined as the sum of profit distribution and 60% of salary. Gross (net) profit distribution % is calculated as profit distribution divided by gross (net) total cash compensation respectively. Mkt. Cap is market value of common equity. Book-to-market is calculated as the book value of common equity divided by the market value of common equity. ROA (return on assets) is calculated as earnings before interest and taxes divided by total assets at the beginning of the year. RET (stock returns) is calculated as log of (RIt+1/RIt), where RI stands for Return Index on 1st January. A company's return index shows the growth in the share value and the value of the dividends. The relevant formula is: RI = RIt * (Pt + Dt)/Pt-1, where Pt = price on ex-date (i.e. the day dividend payments become certain), Pt-1 = price on previous day and Dt = dividend payment associated with ex-date t. σ(RET) is the standard deviation of monthly stock returns for the prior five years. Models (1) and (2) present the linear specification of total cash compensation. Model (3) presents the log-linear specification, where total cash compensation and market capitalisation are transformed via the natural logarithm but the remaining variables are defined as previously. Industry dummies are included in all models. p-values in parentheses. ***, **, * denote statistical significance at 1%, 5% and 10% level respectively.

37

Table 7 Net Total Cash Compensation, Net Profit Distribution and Board Ownership

Panel A: Euro Value of Net Total Cash Compensation Dependent Variable: NCOMP Model 1 Model 2 Model 3 Model 4

Net Profit Distribution % 9,427.3 (0.000)***

8,620.4 (0.000)***

6,432.4 (0.000)***

5,812.2 (0.001)***

Undisclosed Ownership 90,545.5 (0.156) - 92,518.6

(0.108) -

Total Board Ownership % 983.4 (0.294)

1,589.5 (0.086)* - -

Net Profit Distribution %* Total Board Ownership %

-147.0 (0.002)***

-129.8 (0.001)*** - -

CEO Ownership % - - 1,413.6 (0.216)

1,519.2 (0.165)

Net Profit Distribution %* CEO Ownership % - - -122.9

(0.000)*** -103.8

(0.004)***Net Profit Distribution %* Undisclosed Ownership

-7,415.2 (0.017)** - -4,432.0

(0.049)** -

Mkt. Cap. 0.000 (0.000)***

0.000 (0.054)*

0.000 (0.000)***

0.000 (0.112)

Book-to-Market -23,144.5 (0.525)

-164.3 (0.996)

-21,315.0 (0.568)

968.7 (0.979)

ROA -293,266.9 (0.423)

-854,219.0 (0.063)*

-280,428.9 (0.432)

-811,869.7 (0.079)*

RET 85,683.8 (0.088)*

86,271.7 (0.121)

92,552.1 (0.071)*

95,519.5 (0.125)

σ(RET) -477,053.6 (0.350)

289,993.2 (0.541)

-629,857.3 (0.217)

50,095.4 (0.918)

Intercept 382,031.4 (0.041)**

32,479.6 (0.818)

402,935.1 (0.008)***

176,325.5 (0.119)

No. Observations 146 92 146 88 Adj. R2 36.7% 35.3% 36.8% 32.4%

38

Panel B: Natural Logarithm of Net Total Cash Compensation Dependent Variable: ln(NCOMP) Model 1 Model 2 Model 3 Model 4

Net Profit Distribution % 0.025 (0.003)***

0.024 (0.003)***

0.019 (0.000)***

0.019 (0.001)***

Undisclosed Ownership 0.515 (0.136) - 0.329

(0.249) -

Total Board Ownership % 0.008 (0.157)

0.010 (0.096)* - -

Net Profit Distribution %* Total Board Ownership %

-0.000 (0.013)**

-0.000 (0.018)** - -

CEO Ownership % - - 0.005 (0.389)

0.006 (0.316)

Net Profit Distribution %* CEO Ownership % - - -0.000

(0.004)*** -0.000

(0.018)** Net Profit Distribution %* Undisclosed Ownership

-0.020 (0.066)* - -0.014

(0.096)* -

Mkt. Cap. 0.245 (0.006)***

0.345 (0.001)***

0.207 (0.018)**

0.288 (0.010)**

Book-to-Market -0.010 (0.945)

0.159 (0.271)

-0.021 (0.883)

0.135 (0.359)

ROA -0.447 (0.702)

-1.631 (0.325)

-0.377 (0.748)

-1.496 (0.394)

RET 0.485 (0.054)*

0.453 (0.145)

0.534 (0.032)**

0.525 (0.109)

σ(RET) -0.875 (0.663)

1.000 (0.628)

-1.860 (0.368)

0.471 (0.833)

Intercept 7.479 (0.000)***

4.848 (0.028)**

8.565 (0.000)***

7.201 (0.001)***

No. Observations 146 92 146 88 Adj. R2 25.8% 27.6% 26.3% 24.8% NOTES: The sample consists of 224 firms listed in the Athens Stock Exchange during 2004. NCOMP is net total cash compensation defined as the sum of profit distribution and 60% of salary. Net profit distribution % is calculated as profit distribution divided by net total cash compensation. Total board (CEO) ownership % is defined as the percentage of shares owned by all board directors (CEO). Undisclosed ownership is a dummy variable equal to one if information on total board/CEO ownership is not filed with ASE because it is less than 5% and zero otherwise. Mkt. Cap is market value of common equity. Book-to-market is calculated as the book value of common equity divided by the market value of common equity. ROA (return on assets) is calculated as earnings before interest and taxes divided by total assets at the beginning of the year. RET (stock returns) is calculated as log of (RIt+1/RIt), where RI stands for Return Index on 1st January. A company's return index shows the growth in the share value and the value of the dividends. The relevant formula is: RI = RIt * (Pt + Dt)/Pt-1, where Pt = price on ex-date (i.e. the day dividend payments become certain), Pt-1 = price on previous day and Dt =

39

dividend payment associated with ex-date t. σ(RET) is the standard deviation of monthly stock returns for the prior five years. Models 1 and 3 present regression results for the full sample. Models 2 and 4 present regression results only for a sub-sample of firms, for which information on all variables, including board/CEO ownership, is available. Industry dummies are included in all models. p-values in parentheses. ***, **, * denote statistical significance at 1%, 5% and 10% level respectively.

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Table 8 Net Total Cash Compensation, Net Profit Distribution and Family/Non-Family

Ownership

Panel A: Euro Value of Net Total Cash Compensation Dependent Variable: NCOMP Model 1 Model 2 Model 3 Model 4

Net Profit Distribution % 8,622.4 (0.001)***

8,039.7 (0.001)***

7,927.4 (0.004)***

6,721.3 (0.003)***

Undisclosed Ownership 116,494.8 (0.065)* - 85,765.4

(0.242) -

Family Board Ownership % 981.2 (0.286)

1,429.8 (0.116) - -

Non-Family Board Ownership %

3,845.4 (0.040)**

3,186.8 (0.129)

3,247.1 (0.102)

2,544.3 (0.237)

Total Family Ownership % - - 296.5 (0.764)

573.5 (0.532)

Net Profit Distribution %* Family Board Ownership %

-136.9 (0.001)***

-124.0 (0.001)*** - -

Net Profit Distribution %* Non-Family Board Ownership %

-55.9 (0..497)

-42.9 (0.611)

-46.2 (0.580)

-18.4 (0.817)

Net Profit Distribution %* Total Family Ownership % - - -117.4

(0.006)*** -93.9

(0.008)***Net Profit Distribution %* Undisclosed Ownership

-6,574.5 (0.029)** - -5,886.7

(0.060)* -

Mkt. Cap. 0.000 (0.000)***

0.000 (0.088)*

0.000 (0.000)***

0.000 (0.108)

Book-to-Market -14,791.4 (0.675)

4,315.5 (0.900)

-14,264.7 (0.686)

6,636.1 (0.848)

ROA -259,629.4 (0.466)

-755,186.2 (0.080)*

-223,293.9 (0.532)

-669.587.0 (0.134)

RET 82,223.1 (0.095)*

88,777.2 (0.091)*

74,789.9 (0.138)

80,747.7 (0.147)

σ(RET) -596,804.2 (0.243)

88,578.8 (0.847)

-630,027.4 (0.209)

18,841.3 (0.966)

Intercept 359,893.8 (0.026)**

64,907.3 (0.629)

397,435.4 (0.014)**

114,088.8 (0.408)

No. Observations 146 92 146 92 Adj. R2 38.0% 37.1% 37.2% 33.6%

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Panel B: Natural Logarithm of Net Total Cash Compensation Dependent Variable: ln(NCOMP) Model 1 Model 2 Model 3 Model 4

Net Profit Distribution % 0.024 (0.004)***

0.024 (0.004)***

0.017 (0.025)**

0.016 (0.028)**

Undisclosed Ownership 0.625 (0.078)* - 0.286

(0.358) -

Family Board Ownership % 0.008 (0.161)

0.009 (0.112) - -

Non-Family Board Ownership %

0.018 (0.033)**

0.018 (0.055)*

0.011 (0.131)

0.011 (0.173)

Total Family Ownership % - - 0.001 (0.839)

0.001 (0.694)

Net Profit Distribution %* Family Board Ownership %

-0.000 (0.012)**

-0.000 (0.016)** - -

Net Profit Distribution %* Non-Family Board Ownership %

-0.000 (0.410)

-0.000 (0.417)

-0.000 (0.816)

-0.000 (0.859)

Net Profit Distribution %* Total Family Ownership % - - -0.000

(0.086)* -0.000 (0.130)

Net Profit Distribution %* Undisclosed Ownership

-0.019 (0.081)* - -0.012

(0.237) -

Mkt. Cap. 0.208 (0.024)**

0.287 (0.012)**

0.198 (0.031)**

0.276 (0.017)**

Book-to-Market 0.010 (0.946)

0.178 (0.200)

0.011 (0.938)

0.183 (0.183)

ROA -0.312 (0.787)

-1.286 (0.428)

-0.120 (0.917)

-0.905 (0.587)

RET 0.510 (0.040)**

0.496 (0.106)

0.497 (0.041)**

0.477 (0.113)

σ(RET) -1.608 (0.433)

0.122 (0.953)

-1.976 (0.347)

-0.478 (0.832)

Intercept 8.144 (0.000)***

5.938 (0.011)**

8.732 (0.000)***

6.633 (0.004)***

No. Observations 146 92 146 92 Adj. R2 26.7% 27.8% 25.0% 24.2% NOTES: The sample consists of 224 firms listed in the Athens Stock Exchange during 2004. NCOMP is net total cash compensation defined as the sum of profit distribution and 60% of salary. Net profit distribution % is calculated as profit distribution divided by net total cash compensation. Family board ownership % is the proportion of shares owned by board members that are relatives with each other. Non-family board ownership % is the proportion of shares owned by board members that have no family relationship with each other. Total family ownership % is the proportion of shares owned by board directors and other investors that belong to the same family. Undisclosed ownership is a dummy variable equal to one if information on family/non-family/total family ownership

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is not filed with ASE because it is less than 5% and zero otherwise. Mkt. Cap is market value of common equity. Book-to-market is calculated as the book value of common equity divided by the market value of common equity. ROA (return on assets) is calculated as earnings before interest and taxes divided by total assets at the beginning of the year. RET (stock returns) is calculated as log of (RIt+1/RIt), where RI stands for Return Index on 1st January. A company's return index shows the growth in the share value and the value of the dividends. The relevant formula is: RI = RIt * (Pt + Dt)/Pt-1, where Pt = price on ex-date (i.e. the day dividend payments become certain), Pt-1 = price on previous day and Dt = dividend payment associated with ex-date t. σ(RET) is the standard deviation of monthly stock returns for the prior five years. Models 1 and 3 present regression results for the full sample. Models 2 and 4 present regression results only for a sub-sample of firms, for which information on all variables, including family/non-family/total family ownership, is available. Industry dummies are included in all models. p-values in parentheses. ***, **, * denote statistical significance at 1%, 5% and 10% level respectively.

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Figure 1 Theoretical Predictions on the Relationship between Total Cash Compensation and the Proportion of Profit Distribution

Figure 1a

Shareholder ExpropriationOne to One Trade-Off in Gross Terms

0

50,000

100,000

150,000

200,000

250,000

0% 20% 40% 60% 80% 100% 120%

Profit Distribution

Tota

l Cas

h Co

mpe

nsat

ion

(eur

os) Gross Total Cash

CompensationNet Total CashCompensation

Figure 1b

No Shareholder ExpropriationOne to One Trade-Off in Net Terms

0

50,000

100,000

150,000

200,000

250,000

0% 20% 40% 60% 80% 100% 120%

Profit Distribution

Tota

l Cas

h C

ompe

nsat

ion

(eur

os) Gross Total Cash

CompensationNet Total CashCompensation

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Figure 1c

Shareholder Expropriation in the Presence of Managerial Ownership

0

50,000

100,000

150,000

200,000

250,000

0% 20% 40% 60% 80% 100% 120%

Profit Distribution

Tota

l Cas

h C

ompe

nsat

ion

(eur

os)

Gross Total CashCompensation

Net Total CashCompensationManagerial Equity 0%

Net Total CashCompensationManagerial Equity 50%

Net Total CashCompensationManagerial Equity100%

NOTES: Figure 1a shows the trend in gross and net total cash compensation if there is a one to one trade-off between gross profit distribution and gross salary. Figure 1b shows the trend in gross and net total cash compensation if there is a one to one trade-off between net profit distribution and net salary. Figure 1c shows the trend in gross and net total cash compensation if there is a one to one trade-off between gross profit distribution and gross salary under different levels of managerial ownership.

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Footnotes

1 Greek companies are obliged by the law to pay dividends (Article 45, Law 2190/1920; Article 3, Law 2753/1999). 2 Greek firms are required to disclose information on salary and profit distribution, separately, but only for the entire board and not individual directors (Article 43, Law 2190/1920; Article 5, Law 3016/2002). Moreover, there is no disclosure requirement regarding stock options. Consequently, it is not feasible in the current study to repeat the analysis of KPMG. 3Given the absence of a relevant database, I obtained the financial reports through a tedious and time-consuming process that involved visiting corporate web sites, using the mail and contacting the Athens Stock Exchange. 4 There may be a concern that the proportion of profit distribution (i.e. the mix of cash compensation) is endogenous. In this case, the resulting ordinary least squares (OLS) estimates are inconsistent and therefore, a two-stage least squares (2SLS) estimation is preferable. However, as Larcker and Rusticus (2005) demonstrate, if the instrumental variables employed in the 2SLS estimation are weak (i.e. they explain only a small proportion of the variation in the endogenous variable) or are not completely exogenous (i.e. they are correlated with the error term in the structural model) then simple OLS estimates are more likely to lead to correct statistical inference than 2SLS estimates. In the current study, it is very difficult to find a set of instrumental variables that is able to explain a significant proportion in the cross-section variation of the fraction of profit distribution, is truly exogenous and, even more is correlated with the proportion of profit distribution but not with total cash compensation. 5 A company's return index shows the growth in the share value and the value of the dividends. The relevant formula is: RI = RIt * (Pt + Dt)/Pt-1, where Pt = price on ex-date (i.e. the day dividend payments become certain), Pt-1 = price on previous day and Dt = dividend payment associated with ex-date t. 6 Prior papers measure firm risk as the standard deviation of annual stock and accounting returns, usually over a three- or five-year period (e.g. Core et al. 1999; Larcker et al 2005). Due to missing information, however, this approach results in reducing the study’s sample by almost two thirds. Accordingly, I use monthly stock returns. 7 There are 23 firms for which, information on salary is not available. 8 Profit distribution has to be decided by the board of directors at the end of the financial year and approved by shareholders at the AGM, which must take place within six months following the end of the fiscal year. Upon approval, directors receive their payment (Alifantis 2003; Dimitrakas 2005, 2006; Papagiannis 2006). 9 Given the above, it could be argued that the proportion of profit distribution (i.e. the mix of pay) proxies for differences like timing and risk level, for example, rather than differential tax treatment of the two cash components. In this case, however, the relation between total cash compensation and profit distribution should not differ between gross and net terms. I am particularly indebted to John Filos (chartered accountant) for his very insightful guidance on this matter. 10 Independent outside directors are defined in ARTICLE 4, Law 3016/2002, as follows:“Independent outside board members should not hold more than 0.5% of the company’s ordinary shares and should not have any “dependency” relationship with the

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company or with affiliated members”. “Dependency” relationship exists when a board member: a) has a business relationship with the company or its subsidiaries/affiliated firms (e.g. important supplier or customer) or b) is the chairman/CEO of the company or is the chairman/CEO/executive director of a subsidiary/affiliated company or is an employee of the company or its subsidiaries/affiliated firms or c) is an immediate or more distant family member of an executive director, a senior manager or the largest shareholder of the company or its subsidiaries/affiliated firms.

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