SUMMARY OF THE TWO ARTICLE

PRINCIPAL-AGENT APPROACH TO ENERGY EXECUTIVE COMPENSATION

DESIGN
AND
URBAN SIZE AND SENIOR EXECUTIVE COMPENSATION: EVIDENCE FROM
CHINA

Compiled by:
Group 12
Topic: Executive Compensation
(01) Monika Yovita 1402190067
(02) Ary Noor Setyaningsih 1402194038
(03) Agma Aureole 1402194080
(04) Alifah Nurul Halizah L. 1402194217

ACCOUNTING STUDY PROGRAM

FACULTY OF ECONOMICS AND BUSINESS
TELKOM UNIVERSITY
2022
 ARTICLE 1
PRINCIPAL-AGENT APPROACH TO ENERGY EXECUTIVE COMPENSATION
DESIGN

Introduction
The principal–agent problem attracted attention from researchers 20 years ago in
connection with the bankruptcy of an energy trading and distribution company Enron
Corporation. This led to a reform of the regulation of the relationship between corporate
owners (principals) and their management (agents). Regulations have significantly changed
requirements for disclosure of information by companies in order to protect the interests of
owners and stakeholders. Nevertheless, there remains a “principal–agent” problem in the
compensation of energy executives. The competition of companies for highly qualified
executives causes the need to offer executives decent compensation. The study attempts to
resolve the “principal–agent” controversy by testing the “principal–agent” theory in the
settings of the energy executive compensation.

Prior Literature
Energy management and the principal–agent problem. Schepers and Gardberg study the
principal–agent problem, which led to the bankruptcy of an energy trading and distribution
company Enron Corporation in 2001. Mezger et al. argues that in the electricity markets in
the context of the Principal–agent theory (PAT), the consumer is a principal and the provider
is an agent. Anadon et al. argue that the “principal–agent problem” can arise at different
stages of renewable energy innovation if the decision making processes regarding innovation
are divided between different actors. Using the principal–agent theory, Chaney has identified
the inverted principal–agent relationship.
Energy and sustainability policy and the principal–agent problem. Kastrinos and Weber
[9] argue that technological uncertainties of research and development projects can be an
important source of principal–agent problems in European research and innovation policy.
Among other objectives, the policy should be positioned in the context of renewable energy
financing.
Energy efficiency and the principal–agent problem. Lee analyzes various barriers to
energy efficiency and singles out, among others, principal–agent relationships. Liang et al.
argue that the main reason for the inefficiency of incentive policies lies in the agency problem
between the authorities and the owners of the buildings. They compare policy scenarios and
conclude that the authorities should focus more on regulating energy prices.
Energy executive compensation and remuneration and the principal–agent problem.
Some studies argue that oil prices had a significant impact on the remuneration of executives
of oil and gas companies [15–18]. Shang et al. [18] empirically examine executive
compensation caused by luck events, which in turn are caused by rising oil prices. They
report a positive relationship between executive compensation and corporate performance in
125 Chinese energy companies. At the same time, this study has shown that in the opposite
situation (i.e. in the case of falling oil prices) executives are not punished. Srivastava [19]
studies the relationship between managers’ high rewards and their unique ability to forecast
corporate risks. Srivastava [19] reports that oil and gas industry executives are more likely to
have internal information that can allow them to predict corporate risks. Some companies link
management incentive systems to long-term sustainable development goals. The National
Grid plc applies the remuneration of top management, which takes into account the company
targets (greenhouse gas reduction) [20]. Condon [21] studies Shell’s current executive
remuneration policy and reports that the company provides remuneration for cuts in
emissions.

Hypothesis and Methodology

Hypothesis
H1 : The impact of disclosure on owners’ decisions regarding the size of the energy executive
compensation package.
H2 : The impact of disclosure on the acceptance (or rejection) of the compensation package
by the manager.
H3 : The impact of increasing the compensation package of energy executives on the efforts
of the manager.
H4 : The impact of disclosure on managers’ decisions regarding the level of their efforts.

The contribution in this study extends the analysis of the impact of information disclosure on
the terms of the energy executive contracts, and estimation of the executive efforts to the
terms of the contract.
Methodology

The study is carried out within the framework of behavioral game theory. Regression analysis
is also used extensively for estimates related to the principal–agent problem — regarding
energy executives’ extraordinary abilities [19], regarding electricity markets [2], regarding
tests on energy executives’ remuneration for their luck [15,18]. The experimental approach
eliminates the influence of factors that are not the subject of study, but which may affect the
response (corporate culture, regional characteristics, seasonal differences, cultural
characteristics).

Subjects of the experiment were undergraduates. At the beginning of the experiment, the
instructions were read aloud. After that, the subjects asked questions. Analysis of covariance
(ANCOVA) is used to analyze experimental data.

An experimental approach based on principal– agent theory was applied:

1. to design a fixed and variable component of the compensation contract,

2. to assess the impact of information disclosure on the terms of the contract,
3. and to estimate the response of the manager’s efforts to the terms of the contract.

Finding

In both treatments, owners are generally not inclined to offer a variable payment of
more than half (0.5) of total income. Variable payment is most often set by owners at the rate
of 0.15–0.35 (treatment without disclosure (DWO) of information about previous results), as
well as in the amount of 0.25–0.4 (treatment with disclosure (DW) of information about
previous results). A fixed payment is most often set by owners at the rate of 400–500 units
(treatment with disclosure (DW) of information about previous results), as well as at the rate
of 200–400 units (treatment without disclosure (DWO) of information about previous
results).

The impact of disclosure on owners’ decisions regarding the size of the energy
executive compensation package The zero-hypothesis is as follows: H0 — disclosure does
not affect the decision-making of owners. However, the F-value of 1.82 (p-value = 0.1805)
implies that the model is not significant. Table 1 provides an assessment of the significance of
the impact of the factor (D “Disclosure”) characterizing the level of the compensation
package, depending on the disclosure (DW) or non-disclosure (DWO) of previous results.
 The impact of disclosure on the acceptance (or rejection) of the compensation
package by the manager The zero-hypothesis is as follows: H0 — Acceptance and rejection
of the compensation package by the manager does not depend on disclosure. Table 2 shows
the parameter estimates. The impact of the factor characterizing the disclosure of information
is not significant. The zero-hypothesis cannot be rejected: the nature of the disclosure does
not have a significant effect on the acceptance (or rejection) of the compensation package by
the manager.

The impact of increasing the compensation package of energy executives on the

efforts of the manager The zero-hypothesis is as follows: H0 — The increase of the
compensation package does not affect the manager efforts. As a response, manager effort
levels are used. The impact of the factor characterizing the level of the compensation package
(FVP “Fixed and variable payment”) is significant (Table 4). The zero-hypothesis (the
increase of the compensation package does not affect the manager efforts) is rejected. Thus,
such behavior of managers can be described as rational.

The impact of disclosure on managers’ decisions regarding the level of their efforts
The zero-hypothesis is as follows: H0 — Disclosure does not affect managers’
decision-making. To test this hypothesis, the linear model described in the previous
subsection is used. Table 3 shows the parameter estimates. The impact of the D
(“Disclosure”) factor is not significant (Table 4). The zero-hypothesis cannot be rejected, as
the differences in decisions taken are statistically insignificant.

Conclusion

1. The impact of disclosure on owners’ decisions regarding the size of the energy
executive compensation package. The zero-hypothesis is not rejected: disclosure does
not affect the decision-making of owners regarding the size of the offer of the energy
executive compensation package.
2. The impact of disclosure on the acceptance (or rejection) of the energy executive
compensation package. The zero-hypothesis cannot be rejected: the nature of the
disclosure does not have a significant effect on the acceptance (or rejection) of the
energy executive compensation package.
3. The impact of increasing the compensation package of energy executives on the
efforts of the manager. The zero-hypothesis is rejected. Accordingly, an increase of
 the compensation package has an impact on the increase of the manager's efforts. This
confirms the rational behavior of managers.
4. The impact of disclosure on managers’ decisions regarding the level of their efforts.
The zero-hypothesis cannot be rejected. Disclosure does not affect managers’
decisions regarding the level of their efforts.
Research Strength

This study explains in detail the results of hypothesis testing using sentences that are
easy for readers to understand, researchers also provide images to show the results of
executive compensation offers. Research conducted with the opposite situation in the case of
oil prices falling but executives not being punished, this became an interesting discussion
when previous studies reported a positive relationship between executive compensation and
company performance.

Research Weakness

In this study, researchers did not know if there was competition for financial interests
or personal relationships that could have influenced the results in this journal.
 ARTICLE 2
URBAN SIZE AND SENIOR EXECUTIVE COMPENSATION: EVIDENCE FROM
CHINA

Introduction
The level of executive compensation is closely related to many factors, such as
corporate performance, difficulty in corporate management, executive human capital, market
salary, corporate governance structure, internal and external supervision intensity, personal
characteristics, enterprise characteristics, business environment and so on . Research on the
relationship between senior executive compensation and corporate performance is based on
the optimal contract theory, which means that compensation is set by the client in order to
encourage the agent to maximize their interests .
So the shareholding ratio of senior executives has a certain impact on their
compensation. Secondly, we can analyze the relationship between wage premium and urban
agglomeration under the premise that the labor force can migrate freely because senior
executives are considered to be highly mobile due to low migration costs compared with
ordinary workers. Thirdly, introducing spatial location factors into the corporate governance
theory expands the original framework of optimal contract theory.

Prior Literature
Carpenter and Sanders found that there is a significant positive relationship between
CEO compensation and corporate performance for companies when senior executive
compensation is proportional to their complexity. Palia uses a synchronous model that shows
that there is a weak positive relationship between management pay and corporate
performance when taking internal factors into account.

Methodology

The paper uses two models to test the effect of urban agglomerations on senior
executive compensation and analyze the relationship between senior executive compensation
and housing prices and municipal amenity prices. This paper uses the CEO's total annual
compensation to measure senior executive compensation. Researchers use the listed
company's net profit to refresh the industry's average net profit and industry-weighted net
profit and select the remainder as the senior executive skill level. Researchers used the
shareholding ratio of the largest shareholders to measure ownership.
Finding
We define CEO as the dependent variable to estimate the effect of city scale on
compensation, and results are as shown in Table 2. In addition, there is a ladder-like effect of
different city scales on senior executive compensation. Mega-cities have the greatest impact
on compensation, followed by large cities and big cities, and finally medium-sized cities. To
determine whether big cities pay high-skilled labor higher compensation due to accumulation
of human capital by learning and imitating, the column introduces tenure and four city scales
as cross items to capture the influence of tenure on compensation.
The results show that executives in mega-cities are paid 7.4% more compensation for
every additional tenure compared to small cities. The cross items of tenure and mega-cities,
large cities and medium-sized cities have a positive but not significant impact on
compensation. Our results are consistent with Glaeser and Gottlieb , that is, city scale is
complementary with high-skilled labor, big cities themselves are unable to produce
knowledge but can promote the circulation of information, so high-skilled labor can
accumulate human capital by imitating and communicating frequently. We want to analyze
the impact of skill, tenure and corporate performance on compensation for different city
scales.
The coefficient of skill has a significant impact on compensation in mega-cities, large
and medium sized cities at the 1% level, that is, different cities pay the same compensation to
different skilled labor. This illustrates firstly that there is no skill-sorting, secondly, the higher
compensation is not due to skill level in big cities, and finally there is no upward bias in
columns and . The coefficient of tenure in mega-cities and large cities are 0.072 and 0.049
respectively and are both significant at the 1% level, but are not significant in big and
medium-sized cities. The positive impact of productivity on compensation in big cities has
nothing to do with the amount of time spent living in a city but instead the impact depends on
whether executives move in or out of mega-cities, which we consider as the «horizontal
effect».
The results of the sub-sample also confirm why there is a significant wage premium in
mega-cities and large cities but not in other city scales. This impact comes from high
productivity in big cities which provide better learning opportunities for high-skilled labor,
which we represent as the «horizontal and growth effect». Column in Table 2 analyzes the
relationship between housing price, city amenity and compensation in the whole sample.
Housing price has a positive impact on compensation and is significant at the 1% level and its
coefficient is 13.6%.
City amenity measured by sulfur dioxide emissions has a positive effect on
compensation and is significant at the 10% level and its coefficient is 0.1%. In propositions,
higher wages in large cities may be due to compensating for higher housing prices and worse
city amenity, that is, the cost of living in big cities is higher.
We use the top three senior executives compensation and the top three chairman,
supervisors and executives compensation to substitute executives compensation, and remove
the age and tenure because it is difficult to measure tenure and age of this group. We use unit
housing price to measure housing price and use per capital area of green land to measure city
amenity, we expect the higher the per capital area of greenland the higher the compensation.
In addition, columns show that higher housing prices have a positive impact on wages and the
improvement of per capital area of green land leads to a decrease in compensation.

Conclusion
Relying on data of Chinese listed companies and 287 prefecture-level cities during
2005–2010 and classifying mega-cities, big cities, large cities, medium-sized and small cities
according to districts under city non-agricultural population in 2005, we find that big cities
pay more compensation to senior executives and there is a ladder-like effect of different city
scales on senior executive compensation. Tenure and corporate performance have a positive
effect on compensation in mega-cities and large cities, and results of our sub-sample indicate
that there is no “ability-sorting” in different city scales, so we can exclude the upward bias. In
addition, housing prices have a positive impact on compensation and lower wages may be a
compensating factor for better city amenity. As a real reflection of living cost in different
cities, the higher senior executive compensation in big cities is due to the higher living cost.
By introducing different classification methods and different variables to measure
compensation, housing price and city amenity, the above results are still robust.

Research Strength

In this study, researchers selected senior executives from listed companies to represent
high-skilled labor on the grounds, senior executives represented high-skilled labor,
researchers analyzed the relationship between wage premiums and urban agglomerations
under the premise that work force can immigrate freely because senior executives are
considered highly mobile due to low migration costs compared to ordinary workers.
Researchers introduce spatial location factors into corporate governance theory extending the
optimal original framework

Research Weakness
This article does not explain the hypothesis.