Relationship between gray directors and executive compensation in Indian firms

Abstract

Purpose-The purpose of this paper is to examine the empirical relationship between gray directors (non-executive non-independent directors) and executive compensation among companies listed in India's National Stock Exchange (NSE). The paper also examines the possible interplay of relationships between controlling shareholder duality (controlling shareholder being the CEO), ownership category and executive compensation. Design/methodology/approach-A sample of 438 firms listed in the NSE of India was studied using data spanning five financial years, 2012-2013 to 2016-2017. Findings-Empirical evidence suggests that there is a positive association between the proportion of gray directors on the board and executive compensation. The sensitivity of executive compensation to gray directors is found to be higher among family controlled firms. This research has also found that CEOs who belong to controlling shareholder groups received higher pay than professional CEOs. The authors conjecture that these results suggest cronyism and may contribute to lower levels of corporate governance practices in the country. Research limitations/implications-The hybrid board structure, which India has adopted with the desire to bring the best of Anglo Saxon and Japanese board philosophies, has paradoxically led to self-serving boards. Exploration of alternative thinking to bring about changes in the regulatory framework is, therefore, necessary. Originality/value-Serious problems are identified with the philosophy behind board composition mandated by Listing Requirements for Indian firms with empirical evidence showing how the existing rules generate cronyism and unfairness to minority shareholders.

Full text

Relationship between gray
directors and executive
compensation in Indian firms
Krishna Prasad and K. Sankaran
Justice KS Hegde Institute of Management, Nitte, India, and
Nandan Prabhu
Manipal Institute of Management,
Manipal Academy of Higher Education, Manipal, India
Abstract
Purpose –The purpose of this paper is to examine the empirical relationship between gray directors
(non-executive non-independent directors) and executive compensation among companies listed in
India’s National Stock Exchange (NSE). The paper also examines the possible interplay of relationships
between controlling shareholder duality (controlling shareholder being the CEO), ownership category and
executive compensation.
Design/methodology/approach –A sample of 438 firms listed in the NSE of India was studied using data
spanning five financial years, 2012–2013 to 2016–2017.
Findings –Empirical evidence suggests that there is a positive association between the proportion of gray
directors on the board and executive compensation. The sensitivity of executive compensation to gray
directors is found to be higher among family controlled firms. This research has also found that CEOs who
belong to controlling shareholder groups received higher pay than professional CEOs. The authors
conjecture that these results suggest cronyism and may contribute to lower levels of corporate governance
practices in the country.
Research limitations/implications –The hybrid board structure, which India has adopted with the
desire to bring the best of Anglo Saxon and Japanese board philosophies, has paradoxically led to
self-serving boards. Exploration of alternative thinking to bring about changes in the regulatory
framework is, therefore, necessary.
Originality/value –Serious problems are identified with the philosophy behind board composition
mandated by Listing Requirements for Indian firms with empirical evidence showing how the existing rules
generate cronyism and unfairness to minority shareholders.
Keywords CEO pay, Controlling shareholder duality, Gray directors,
Non-executive non-independent directors
Paper type Research paper
Introduction
In India, corporate ownership is predominantly in the hands of domestic individuals and
families (Balasubramanian and Ramaswamy, 2013). However, institutions, governments
and foreign entities also hold their respective stakes in Indian companies. Against this
background, the salaries of CEOs of firms held by domestic individuals and families are found
to be higher than those of others. Studies have shown that the compensation of CEOs who are
European Journal of Management
and Business Economics
Emerald Publishing Limited
2444-8494
DOI 10.1108/EJMBE-11-2017-0038
Received 5 November 2017
Revised 23 May 2019
Accepted 30 May 2019
The current issue and full text archive of this journal is available on Emerald Insight at:
www.emeraldinsight.com/2444-8494.htm
© Krishna Prasad, K. Sankaran and Nandan Prabhu. Published in European Journal of Management
and Business Economics. Published by Emerald Publishing Limited. This article is published under the
Creative Commons Attribution (CC BY 4.0) licence. Anyone may reproduce, distribute, translate and
create derivative works of this article (for both commercial and non-commercial purposes), subject to
full attribution to the original publication and authors. The full terms of this licence may be seen at
http://creativecommons.org/licences/by/4.0/legalcode
The authors acknowledge and thank the financial support provided by Nitte Education Trust,
Mangaluru, India for completing this research. Authors are thankful to the anonymous reviewers for
their insightful comments.
Gray directors
and executive
compensation

controlling shareholders is generally higher than that of professional CEOs (Parthasarathy
et al., 2006; Ramaswamy et al., 2000). This phenomenon of excessive CEO compensation,
which appears to be dominant in family controlled firms, assumes importance because of
governance implications that warrant research attention. CEO compensation and agency
conflict have many implications that generate other agency costs.
The issue of excessive and unabashedly high CEO compensation has been a matter of
public debate especially in countries like the USA, and also in the corporate world in general
across the globe. Corporate governance requirements vis-à-vis board composition and norms
regarding the appointment of independent directors are expected to address the problem of
excessive CEO compensation. However, evidence of the effectiveness of such measures
remains mixed. In this paper, we posit that the factors that demonstrate the possible
relationship between the nature of board composition and CEO compensation are different in
the Indian context. Boards of Indian companies consist of a mix of independent directors,
executive directors and gray directors. This kind of board mixture is also often characterized
by the absence of within-board pressure and expression of the voice of dissent. However, in
general, appositive pressure of dissenting opinions and expressions of dissent within
corporate boards are missing in the Indian context. The absence of a purposeful voice of
dissent implies that something which is of great utility from the standpoint of maintaining
corporate governance standards, is absent. Therefore, it is necessary to investigate the
association between the characteristics of board composition and CEO compensation.
Accordingly, this paper examines two crucial issues related to the nature of boards in the
Indian context. First, it seeks to investigate whether the presence of gray directors on
the corporate board has any association with the magnitude of CEO compensation. Gray
directors are demarcated on the basis that they are neither executives nor independent
directors (Borokhovich et al., 2014; Hsu and Wu, 2014). We suspect that CEOs may collude
with gray directors in fixing CEO compensation leading to adverse corporate governance
and unfair treatment of minority shareholders.
Second, this paper investigates whether there would be any change in the relationship
between the presence of gray directors on corporate boards and CEO compensation across
different ownership categories. Accordingly, we investigate the association between board
composition that is characterized by the presence of gray directors and the magnitude of
CEO compensation among different ownership categories of Indian companies. It may be
noted that the majority of Indian firms are family owned and very few firms are controlled
by professional management. Therefore, investigation of the likely adverse impact of
ownership structure and board composition is also significant to protect the interest of
minority shareholders.
Though there are studies that have investigated the relationship between independent
directors and CEO compensation, the literature on the relationship between gray directors and
the CEO compensation is limited. This is evident from a close scrutiny of prior research on gray
directors that has investigated its association with variables such as firm value and
performance (Choi et al., 2007; Khan et al., 2012; Kumar and Singh, 2012; Srivastava, 2015;
Yammeesri and Herath, 2010; Zakaria et al., 2010), board composition and corporate governance
(Borokhovich et al., 2014; Carcello and Neal, 2000; Clifford and Evans, 2002; Core et al., 1999;
Raghunandan et al., 2001; Ryan and Wiggins, 2004; Sarkar, 2009; Sarpal, 2015; Shivdasani and
Yermack, 1999) and earnings management and fraud (Beasley, 1996; He et al., 2009; Houston
et al., 2016; Hsu and Wu, 2014). To the best of our knowledge, this is the first study of its kind in
the Indian context that has attempted to understand the relationship between gray directors
and excessive CEO compensation across different categories of board composition.
Exploring the relationship between the presence of gray directors and CEO
compensation is significant for several reasons. First, the presence of gray directors may
be causing excessive payments to CEOs incommensurate with their performance and
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industry standards. More generally, directors who are supposed to oversee the performance
of their firms may have to address the issue of a conflict of interest as the “overseer,”and
the “overseen”would be the same. Second, the presence of gray directors is likely to be a
cause of concern for investors and minority shareholders who might perceive the role of the
board to be unfavorable to them (Zhao and Brehm, 2011). Third, gray directors may be
“related”to their CEOs. Here, the insidious nature of the conflict of interest is evident.
Finally, there is also the issue of controlling shareholder duality, i.e., CEO being a controlling
shareholder of the firm, which may hurt other shareholders (Chakrabarti et al., 2012). As
such, we also examine the effect of controlling shareholder duality and CEO compensation
across different ownership categories.
Prior research (e.g. Chauhan et al., 2016) has found that Indian family controlled firms
exhibit a lower degree of board independence in comparison with management-controlled
firms (MCF). The relationship between lower board independence and excessive CEO
compensation may not become such a matter of concern if executive compensation is
commensurate with profits earned by the company in question. However, this is not so in
the Indian context (Ghosh, 2006; Narayanan and Dubey, 2015). Specifically for family
owned companies, Raithatha and Komera (2016) have shown that executive compensation
has no association the performance of family controlled firms. In contrast to this, non-
family firms, run by professional managers place more emphasize on pay-for-performance
(Saravanan et al., 2017).
There are several contributions that this paper makes to the literature on executive
compensation. First, it is revealed that there exists a significant association between the
presence of gray directors and CEO pay in family controlled firms. In this connection, we also
investigate whether and how the presence of gray directors in Indian companies is associated
with CEO compensation across different ownership categories. This is accomplished by
dividing Indian corporate firms into different groups based on firm ownership.
Second, we show empirical evidence of the positive association between the presence of
gray directors and executive compensation. This paper situates the research discourse on
gray directors on the theoretical rationale of psychological contract theory while explaining
why several theories of executive compensation fail to account for the relationship between
gray directors and unduly excessive executive compensation. In this respect, this paper goes
beyond agency theory, stewardship theory, and a broad spectrum of theories of executive
compensation to theoretically explain the phenomenon of excessive executive compensation
using psychological contract theory. At last, this paper extends the research conversation
on gray directors by going beyond the prior research areas of: association between gray
directors and firm value/performance; association between gray directors; board
composition and corporate governance; and association between gray directors, earnings
management and corporate fraud.
The remainder of the paper is organized into six sections. In the second section, we review
the literature and provide the theoretical underpinnings for further empirical treatment of the
topic. In doing so, we examine prior empirical evidence on board and ownership structure,
CEO compensation and firm performance. Furthermore, we analyze different theories of
executive compensation. In this context, we show why these theoretical explanations of
executive compensation and the broader approaches, which categorize the theoretical
narratives of executive compensation, fail to account for the relationship between gray
directors and the magnitude of executive compensation. We also discuss the appropriate
theoretical perspectives that explain the hypothesized association between gray directors and
executive compensation. Also, we discuss the implications of prior research on gray directors
while showing how this paper extends the research conversation on gray directors. In the
third section, we develop hypotheses and state the constructs of this study as also the control
variables that we use. We describe the selection of variables and sampling issues in the fifth
Gray directors
and executive
compensation

section. In the sixth section, we document the empirical results of the association between the
level of compensation and explanatory variables. And the final section provides a summary,
conclusions, contributions to the literature and policy implications.
Literature review and theoretical underpinnings
Findings of prior research are noteworthy in the context of the relationship between gray
directors and executive compensation. For example, Core et al. (1999) examine the effect of
gray directors on standards of corporate governance, CEO compensation and firm
performance. For this purpose, their study used a sample of 495 firms in the USA with
findings suggesting that the presence of gray directors reduces the standard of corporate
governance. Therefore, they call for improving the quality of corporate governance by
eliminating gray directors. Clifford and Evans (2002) show that the combination of inside
directors and gray directors constitutes the majority of boards of a sample of Australian
firms. Those authors conclude that the presence of gray directors would compromise the
objectivity and effectiveness of corporate boards. In the South Korean context, Choi et al.
(2007) indicate that the presence of independent directors maximizes firm performance in
stock markets while the presence of gray directors does not lead to higher firm performance.
Srivastava (2015) shows that the presence of gray directors in no way corresponds to higher
firm performance in the Indian context. The absence of a positive association between the
presence of gray directors and higher firm performance is also evident among Malaysian
(Zakaria et al., 2010) and Thai (Yammeesri and Herath, 2010) firms.
Board of directors are expected to act as representatives of shareholders to minimize
agency costs (Fama and Jensen, 1983). Accordingly, regulators in countries like the USA
have mandated that public companies should constitute boards in such a manner that the
majority of directors should meet requirements of the notion of independence[1]. However,
there is an alternative view. According to this, independent board composition is likely to be
problematic from the standpoint of what independent directors can offer to corporate value
maximization in terms of their expertise. In line with such an argument, Miwa and
Ramseyer (2005) observe that “What outsiders offer in independence, they sacrifice in
expertise. The more independent they are, the less they know about the firm”(p. 300).
Insufficient expertise of independent directors is the premise on which Japanese companies
constitute their boards. In Japan, boards largely consist of insiders or top executives as
members of the board. Even a cursory look at board compositions of American and
Japanese firms shows that independent directors dominate the American model whilst
inside director-executives play a prominent role in Japanese corporate boards. While agency
theory is the foundational premise of the USA model, what drives Japanese board
composition is stewardship theory (Ueda, 2015).
Though both these theories have noteworthy limitations, their relevance is undeniable.
Empirical studies have shown that both models add value to firms ( Jensen and Meckling,
1976; Miwa and Ramseyer, 2005) in their unique ways. Accordingly, there have been
attempts to integrate the governance implications of both these theories to address the
problem of agency conflicts. For example, the Indian model of board composition appears to
be an amalgam of both these models.
The Securities and Exchange Board of India (SEBI) requires that all listed firms should
have a corporate board with an optimum combination of inside and outside directors. SEBI’s
regulations stipulate that the percentage of outside directors should not be less than
50 percent of the total number of directors on a corporate board and the chairman of the
board should be an outsider. Furthermore, the number of independent directors should not
be less than 30 percent of the total number of directors if the chairman of the board is an
outsider. The role of non-executive independent directors is meant to reduce agency costs
while the function of the executive (inside) directors is to provide intellectual assistance in
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taking strategic decisions. SEBI effected these changes in its related statutes (Clause 49 of
the Listing Agreement) in the wake of the submission of a report in 1999 by a high-powered
committee set up by the government. The objective of these regulations is, understandably,
to institutionalize the notion of “independence”in the board structure itself.
While there are clear guidelines on who could be the outside directors (independent
directors), there are no restrictions on the remaining 50/70 percent of directors. Accordingly,
these could all be executives or a mix of executives and non-executives. This ambiguous
mandate regarding non-independent directors has given rise to another class of individual
directors, i.e., non-executive, non-independent directors (Quadrant 4 in Table I).
Theoretically, Quadrant 1 cannot exist at all since no executive can be “independent.”
The definition of the independent director as per Clause 49 of Listing Agreement states that
“independent director’means a non-executive director of the company […]”(Sarkar, 2009).
A director becomes truly independent if he/she is free from any conflict of interest in his/her
dealings with the company. Accordingly, the person should be able to express the voice of
dissent, if necessary, in a free manner. Therefore, we have categorized Quadrant 1 as not
applicable (na).
If the corporate board is dominated by an “objective outsider,”as indicated in
Quadrant 2, the underlying assumption is that those directors provide a control function.
In this case, we can draw underlying theoretical premises from agency theory. As opposed
to this, domination by “benevolent insiders”(Quadrant 3) presupposes underlying support
from stewardship theory. Maassen (1999) points out this distinction, mentioned above, as
the underlying theoretical inspiration to draw a line of demarcation among directors. It is
interesting to note that there are board structures which are available to provide for both
control and expertise functions as in the case of Chinese companies. For example, Chinese
law allows for a two-tier board system consisting of an advisory board of directors and a
supervisory board (Conyon and He, 2011), the former providing the advisory function and
the latter, the expertise function.
“Gray directors”appear in Quadrant 4 because there is no explanation in the literature
regarding the nature of their role and Hsu and Wu (2014) define these actors as the
non-executive directors who are not independent directors. Anderson and Reeb (2004)
define gray directors as those directors with existing or potential ties to the firm.
For instance, those board members who may have been functioning as gray directors might
be former employees of the company, relatives of controlling shareholders, investment
bankers and so on (Sarkar et al., 2012). Consequently, gray directors are non-independent,
non-executive directors who are not “independent.”In the regulatory filings of companies,
ordinarily, directors are classified as either independent or non-independent directors. This
classification disguises the presence of gray directors. In this connection, Houston et al.
(2017) find that the boards of 51 percent of the SP 500 firms of USA had gray directors
during 2000–2012. The percentage representation of gray directors is increasing in India
over time (Sarkar, 2009). However, prior studies have not explored their influence on
corporate boards’functioning. Nor have they investigated the nature and degree of control
that gray directors exercise over the functioning of corporate boards. Table II presents a
summary of the findings of prior research on gray directors.
Whether executive or non-executive
Whether independent or not Executive Non-executive
Independent 1. na 2. Objective outsider
Non-independent 3. Benevolent insider 4. Gray directors
Table I.
Cross classifying the
two dimensions
Gray directors
and executive
compensation

Prior research reveals several interesting implications of the presence of gray directors on
corporate boards. First, there is a strong possibility of a conflict of interest. Suchconflict might
arise because gray directors are likely to demonstrate their “obligation”to CEOs as their CEO
might have taken the initiative in appointing them (Shivdasani and Yermack, 1999). Second,
Themes Country Sample Findings
Association between gray directors and firm value/performance
Choi et al. (2007) South Korea 457 Gray directors exercise an insignificant effect on firm performance
Yammeesri and
Herath (2010)
Thailand 245 Presence of gray directors is not a significant determinant of firm
value
Zakaria et al. (2010) Malaysia 277 There is an inverse relationship between the performance of firms
and the number of gray directors
Kumar and
Singh (2012)
India 157 The proportion of gray directors is negatively associated with
firm value
Khan et al. (2012) Australia 188 There is no statistically significant association between firm’s
performance and the proportion of gray directors on corporate
boards
Srivastava (2015) India 164 Presence of gray directors is negatively associated with firm’s
financial performance
Association between gray directors, board composition and corporate governance
Core et al. (1999) USA 495 There is a negative relationship between the presence of gray
directors on corporate boards and standards of corporate
governance. Accordingly, reduction in standards of corporate
governance is associated with the presence of gray directors on
corporate boards
Shivdasani and
Yermack (1999)
USA 341 The degree of involvement of CEOs is found to be high in the
process of appointment of gray directors
Carcello and
Neal (2000)
USA 223 There is a negative association between the proportion of gray
directors and receipt of going concern report
Raghunandan
et al. (2001)
USA The audit committee is likely to perform better in the absence of
gray directors than with their presence
Clifford and Evans
(2002)
Australia 47 Findings revealed that 35 percent of non-executive directors were
gray directors. The combination of insider and gray directors
constituted a majority of corporate boards
Ryan and
Wiggins (2004)
USA 1,018 Independent directors on the board dominated by inside and gray
directors are less incentivized to monitor
Sarkar (2009) India 186 The proportion of gray directors in India increased during the study
period
Osi (2009) USA Presence of gray directors may diminish the integrity of the board
Borokhovich
et al. (2014)
USA 370 Gray directors place their interests as shareholders first when a
replacement decision is likely to weaken their business ties with
the firm
Sarpal (2015) India 114 CEO duality improves the level of board independence by limiting
the proportion of gray directors on the board
Association between gray directors, earnings management and corporate fraud
Beasley (1996) USA 150 The negative association between the likelihood of fraud and the
percentage of gray directors
He et al. (2009) Australia 231 Positive association between earnings management and share
ownership of gray directors
Hsu and Wu (2014) UK 158 The higher the number of gray directors on the board, the lower
would be the probability of corporate failure
Houston et al.
(2016)
USA 339 There is likely to be an increase in corporate fraud when former
employees serve as gray directors
Source: Summary of literature review
Table II.
Summary of research
findings on
gray directors
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this will necessarily lead to a decrease in the standard of corporate governance (Core et al.,
1999). Third, the incentive for gray directors to be a part of the monitoring mechanism is
almost non-existent (Ryan and Wiggins, 2004). Fourth, gray directors are likely to act in their
capacity as shareholders rather than as representatives of other shareholders especially in
those circumstances in which their self-interest is at stake (Borokhovich et al.,2014).Fifth,the
extent of board independence is likely to increase if there is a reduction in the proportion of
gray directors on boards (Sarpal, 2015). Sixth, corporate fraud is probable (Houston et al., 2016)
in the presence of gray directors though the evidence on the same remains mixed (Beasley,
1996). Seventh, the tendency to engage in practices related to earnings management would
increase if the proportion of shareholdings of gray directors is on the rise (He et al., 2009). At
last, there is overwhelming evidence to show that the presence of gray directors on corporate
boards does not increase corporate value or financial performance (Choi et al., 2007).
Despite the presence of compelling evidence against the utility of gray directors in
maximizing corporate value, the proportion of gray directors has nevertheless increased the
world over (Clifford and Evans, 2002).Therefore, it is theoretically useful to understand
the underpinnings of this phenomenon. Earlier, we pointed out that we cannot understand
the implications of gray directors without using agency theory or stewardship theory. While
recognizing this, it is also imperative to look for other specific theories for a precise
understanding of the underlying process that builds linkages between gray directors and
excessive CEO compensation. Knowing these interlinkages would also help us to appreciate
how this relationship becomes operational, specifically in those firms that have a dominant
presence of controlling shareholders who owe their appointment on corporate boards
especially in family controlled firms.
There are intellectually illuminating narratives that explain the phenomenon of executive
compensation. Scholars have grouped these theories in terms of their focus. Accordingly,
there are three approaches with which we can classify prior research on compensation. These
are the agency approach, value approach and symbolic approach (Otten, 2007).
Under the agency approach fall complete contract theory, prospect theory, managerial
theory, and, class hegemony theory (Bebchuk et al., 2002; Fama, 1980; Fama and Jensen,
1983; Gomez-Mejia and Wiseman, 1997; Kahneman and Tversky, 1979; Jensen and
Meckling, 1976). These theories explain executive compensation even as they address the
issues of agency problem and agency costs. These theories aim at “legitimizations of pay
levels and structures […] (that) […] are based on arguments of market forces and
conceptions of executive pay at risk”(Otten, 2007). These theories assume that managers
are fundamentally individualistic and rational. Accordingly, these theories articulate that it
is self-interest that drives actors. Therefore, the essential argument is that the source of
motivation of managers is higher levels of executive compensation. The objective of higher
levels of CEO compensation is to incentivize them to act in the interests of shareholders.
However, this explanation is limited to its relevance to the issue of monitoring the behavior
of executives. Accordingly, these theories do not provide a convincing elucidation of the
complicit behavior of gray directors in fixing excessive executive compensation.
Next, the value approach subsumes other theories such as marginal productivity theory,
efficiency wage theory, human capital theory, opportunity cost theory and superstar theory
(Carpenter et al., 2001; Prendergast, 1999; Roberts, 1956; Rosen, 1981). These theories
emphasize how much to pay based on the value brought in by the person receiving the pay.
In this regard, Otten (2007) argues that “executive pay is legitimized here by arguing that
pay is set by market forces and pay is mainly regarded as the market value of executive
services”(p. 6). The value approach to executive compensation does not explain gray
directors’propensity to remain as mute spectators even while they sacrifice their designated
role which demands exercising their independence on matters related to fixation of
executive compensation.
Gray directors
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Finally, under the rubric of the symbolic approach are theories such as tournament
theory, figurehead theory, stewardship theory, crowding-out theory, implicit/psychological
contract theory, socially enacted proportionality theory and social comparison theory
(Baker et al., 2002; Davis et al., 1997; Donaldson and Davis, 1991; Frey, 1997; Kidder and
Buchholtz, 2002; Lazear and Rosen, 1981; O’Reilly et al., 1988; Ungson and Steers, 1984).
According to Otten (2007), “the legitimizing arguments (of the symbolic approach) are based
on social (or socio-economical), constructed beliefs about executive roles and how pay ought
to reflect this”(p. 14). These theories of executive pay, which prior research classifies under
the symbolic approach, focus on what ought to be paid to executives. We argue that it is
possible to explain the complicit behavior of gray directors, from the standpoint of the
symbolic approach, during the process of fixing and maintaining unduly high executive
compensation in family controlled domestic firms in India.
We can invoke the symbolic approach (or more particularly psychological contract
theory) to understand the relationship between gray directors and executive compensation
through two strands of analyses. The first strand of analysis is “negative”in the sense that
it helps us understand why the agency and value approaches are not relevant for
understanding the behavior of gray directors. The second strand helps us understand why
the symbolic approach is more appropriate than the other two approaches. The agency and
value approaches consider the impact of market forces as foundational premises based on
which determination of executive compensation can be understood. Invoking value and
agency approaches to explain the linkages between gray directors and excessive executive
compensation is acceptable in those situations that are marked by complete
professionalization of corporate management and, consequently, there is indeed a
separation of ownership from management in letter and spirit. However, the agency and
value approaches both fail to explain in entirety why executive compensation is excessive in
the absence of the conditions mentioned above. Though it is possible to explain excessive
compensation using both agency and value approaches, they do not provide us with an
acceptable explanation to make sense of the complicit behavior of gray directors.
Furthermore, these theories become relevant only in the pronounced presence of agency
conflict. However, as regards the role of gray directors, the issue of conflict is not between
shareholders and managers. It is, in fact, between controlling shareholders and minority
shareholders. Therefore, it is not possible to explain the issue of gray directors’complicity in
aligning themselves with the executives of family controlled firms from the perspective of
agency conflict.
Earlier we discussed how agency theory and stewardship theory direct the board
structure in American and Japanese companies, and conversely, how the behavior of board
members is explained (at least to a great extent) by these theories in their respective
geographies. However, these theories seem to be inadequate to explain the Indian situation,
and even more generally, the behavior of gray directors.
Even if agency theory may be used to explain the behaviors of CEOs and other directors
including independent directors who are expected to act in the best interests of
shareholders, the theory does not provide an adequate explanation of the behavior of gray
directors. The irrelevance of the agency theory about gray directors’behavior while fixing
executive compensation arises because of two reasons. First, prior research does not classify
gray directors as “independent”directors. Therefore, the very nature of the position of gray
directors does not inspire them to execute the moral responsibility of exhibiting true
“independence”in their conduct. Second, scholars define gray directors as those directors
with either existing or potential ties with their firms. This definition implies that they are
more likely to act in the interests of their benefactors than in the interests of shareholders.
A similar problem emerges if we attempt to invoke stewardship theory to explain the
behavior of gray directors. According to this theory, “principal satisfaction”is more important
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than executive pay as the source of motivation for top management executives. However, this
argument becomes untenable in the context of gray directors because their notion of
“principal satisfaction”is unlikely to go beyond the satisfaction of their benefactors within the
board itself. Accordingly, they may not consider shareholders as their true “principals.”It is
against this theoretical background that directors in Quadrant 3 are fundamentally different
from directors included in Quadrant 4. Therefore, just as agency theory fails to explain the
relationship between gray directors and excessive executive compensation, stewardship
theory also does not capture the complexity of this relationship. Otten (2007) argues that
“Stewardship theory does not provide clear hypotheses about pay levels or pay structures and
could, therefore, be questioned as a useful theory to legitimize executive pay”(p. 16).
Accordingly, Otten (2007) narrates the viewpoint of Donaldson (1995) while he states that
“stewardship theory sees subordinates as collectivists, pro-organizational and trustworthy as
opposed to, e.g., agency theory, which assumes subordinates to be individualistic,
opportunistic, and self-serving”(p. 16). Thus, stewardship theory articulates that executives
are supposed to take their decisions in the interests of their “principal.”From this point of
view, excessive executive compensation does not act as the source of executive motivation.
Given these propositions of stewardship theory, it also fails to account for the complicit
behavior of gray directors in fixing excessive executive compensation.
How do we make sense of the adverse role of “gray”directors in executive compensation?
To address this question, we argue that psychological contract theory (within the overall
rubric of the symbolic approach) provides us with a credible grasp of the complicit behavior of
gray directors that makes them give their silent acceptance to excessive executive
compensation. Otten (2007) states that a “psychological contract is an individual’spersonalset
of reciprocal expectations of his obligations and entitlements which do not necessarily have to
be mutually agreed upon between the contractors”(p. 17). Accordingly, it is reasonable to
argue that gray directors make their attempts to display reciprocity in their behavior while
fixing executive compensation. Therefore, in the absence of mutually agreed upon obligations
and entitlements, they act in the interests of executives whom they consider as their de facto
principals. Accordingly, the need to demonstrate reciprocity in the relationship makes them
accord their silent acceptance to decisions on executive compensation. Therefore, it becomes a
matter of reciprocal exchange that they need to recognize.
Against this background, it is interesting to note the argument of Rousseau (1998) that
there are two foundational features of psychological contracts that operate in such a manner
that one party feels obligated to the other party and, accordingly, acts by the expectations of
the other party. First, perceived mutual obligations play a critical role in making one party
behave according to the expectations of the other even while those expectations are unwritten
and they are only perceptual (Rousseau, 1998). These perceived mutual obligations create
perceptions regarding reliance losses and, therefore, benefitted actors would strive to maintain
the status quo in their relationship equations with their benefactors. Accordingly, beneficiaries
of a psychological contract try to live up to the expectations of their benefactors even in those
situations wherein organizational change is inevitable. Therefore, we argue that any corporate
board functioning process, which bases itself on rewards and incentives, fails to account for
the complicit behavior of gray directors.
Second, Rousseau (1998) argues that agency theory oversimplifies the “incentive
contract”that exists between an organization and its workers. Employees do not necessarily
attribute to their organization the incentives that they receive. Accordingly, they need not
endow their organization with the position of “giver”of incentives in their perceptual
mindspace. Instead, they might accord the status of benefactor to their immediate
supervisor or someone else whom they believe to be their benefactor.
In line with the above arguments, we argue that the phenomenon of psychological
contracts adequately explains the relationship between gray directors and excessive
Gray directors
and executive
compensation

CEO/executive compensation. The notion of psychological contracts helps provide us with
an explanation for the complicit behavior of gray directors because these directors are likely
to perceive mutual obligations toward their CEO, whom they might believe to be their
benefactor. Therefore, they are more likely to identify themselves with the CEO than with
their company or shareholders. This person-based identification, facilitated by a
psychological contract between gray directors and their CEO, is likely to make gray
directors behave differently from independent directors. As a result, gray directors are
expected to be favorable to the CEO of their company while fixing executive compensation.
Drawing on psychological contract theory, therefore, we argue that gray directors’implicit
psychological contracts with their CEOs will likely to make them feel that their silent
acceptance of the proposed executive compensation is a form of reciprocity that they need to
demonstrate for being the beneficiaries of their position on the corporate board.
Hypotheses development
Gray directors and executive compensation
There are various viewpoints regarding the payment of compensation to executives.
As pointed out by many scholars such as Bebchuk et al. (2010), speculative and excessive
executive compensation would exercise a negative impact on the process of compliance with
standards of corporate governance. Therefore, fixation of excessive executive compensation
promotes various forms of misadventures relating to corporate governance on account of
agency problems. Accordingly, it has also been argued in the literature that the issue of the
debate should not be on how much executive compensation is paid ( Jensen and Murphy,
1990a). Instead, it should be on how it is paid especially about the legitimacy of the process
of fixation of CEO compensation ( Jensen and Murphy, 1990a). However, this is not to deny
the importance of paying adequate compensation to top executives for the talent that they
bring and the risks that they assume.
Though the individual profiles of directors on boards (independent, affiliated or
controlling shareholder) match firms’ownership (institutional, corporate parent and family
entrepreneur control) configurations (Sur et al., 2013), it is nevertheless relevant to study
implications of the presence of gray directors. This is because the presence of gray directors
has been on the rise, especially on the boards of Indian companies. This is intriguing
because it raises the question of why this is the case. One reason to seek answers to this
question is that companies often mask the presence of gray directors by projecting them as
independent directors, though their “independence”is suspected. Therefore, it is reasonable
to propose that this might become disadvantageous to minority shareholders. In this
connection, it is noteworthy that there is no evidence to show that gray directors provide
assistance either in executing a control function (the USA model) or in delivering an
expertise function (the Japanese model).
If members of a corporate board owe their position on the board due to either their
controlling stake or their ability to offer some functional or strategic expertise, the
presence of gray directors becomes problematic. This problem may be further
compoundedbytherelationshipbetweenafirm’s ownership and board composition. If
afirm’s ownership lies predominantly with a few controlling shareholders who might
have been instrumental in appointing gray directors, the phenomenon of psychological
contracts is bound to exercise its impact on gray directors. Accordingly, this is likely to
encourage gray directors to behave as if they were the beneficiaries in their relationship
with their CEO or top management executives. Thus, there is also a point of concern here
about which a word of caution is due. Besides not contributing to firm performance and
firm value, the presence of gray directors is also found to be positively associated with
earnings management and corporate fraud (He et al., 2009; Houston et al., 2017). It is clear
that there are no justifiable theoretical underpinnings behind the presence of gray
EJMBE

directors. It is not naïve, therefore, to suspect that this could be a case of cronyism as it is
not possible to justify the purpose of the selection of gray directors with compelling
arguments. Furthermore, it is quite probable that gray directors might only be
reciprocating their appointment as a matter of social exchange that they wish to make
because of the implicit psychological contract with the CEO and a few other top
management executives of their company. Therefore, we argue that the presence of gray
directors would be associated with executive compensation and this phenomenon occurs
more in family controlled firms than in other categories of firms:
H1a. The proportion of influence of gray directors on the board is positively associated
with executive compensation.
H1b. The proportion of influence of gray directors on executive compensation is higher
in family controlled firms than in other categories of firms.
Controlling shareholder duality and executive compensation
As observed by Berle and Means (1932), the distribution of capital among a significantly
high number of shareholders allows greater freedom to managers in the use of enterprise
resources in publicly traded companies. However, this might lead to agency conflict over the
allocation and distribution of corporate resources ( Jensen and Meckling, 1976). Furthermore,
the information asymmetry that exists between managers and shareholders, which creates a
moral hazard problem, does not enable shareholders to verify whether the actual
performance of a firm is due to luck or hard work (Rose, 2005). Against this background, the
pay-for-performance theory suggests that CEO pay should be fixed to incentivize CEOs for
their hard work (Bebchuk, 2005).
In terms of publicly traded large firms wherein a controlling shareholder himself/herself
occupies the position of CEO, a situation which we term the controlling shareholder duality,
conflict of interest is apparent. Controlling shareholder duality would lead to unfavorable
consequences. For instance, fixing one’s compensation would expropriate what is otherwise
legitimately due to minority shareholders. Expropriation of resources that belong to
minority shareholders is known as “tunneling.”It manifests itself among CEOs in the form
of fixing their compensation (Cheung et al., 2005). This process of “tunneling”is likely to be
supported by gray directors too. In this regard, Holderness and Sheehan (1988) provide
evidence regarding managers, who are majority shareholders in publicly held corporations,
having received marginally higher salaries than others. Similar research findings support
this phenomenon in other settings ( Jiang, 2011; Mangel and Singh, 1993; Mehran, 1995;
Ozkan, 2011).
In contrast, scholars have argued that majority shareholders negatively influence the
compensation of professional CEOs, and minority shareholders influence the same
positively (Abraham and Singh, 2016). As a result, there would be a conflict between the
majority and minority shareholders when the compensation of the controlling shareholder-
CEO is higher than that of a professional CEO in the same position. Those CEOs who belong
to the controlling shareholders’group may also influence the remuneration committee that
fixes the CEO’s compensation ( Jaiswall and Frith, 2009). Jaiswall and Bhattacharya (2016)
conclude that the ownership characteristics of Indian private sector firms are positively
related to ownership structure. The relationship between ownership characteristics and
ownership structure would result in lowering the standards of corporate governance of the
firm. Thus, we arrive at the following hypothesis:
H2a. CEOs who are controlling shareholders receive higher pay than professional CEOs.
H2b. CEO pay in family controlled firms with dominant controlling shareholders is
higher than CEO pay in firms of other categories.
Gray directors
and executive
compensation

Constructs
CEO compensation
We define CEOs to be those who have the designation of being not only the CEO of their
respective companies but also executive directors who may have designations such as those
of executive chairman, managing director or joint managing directors. CEO is not a commonly
used title of designation for the executive head of companies in India. CEO compensation, for
this study, is the aggregate of salary, bonus and perquisites paid to the executive head.
Gray directors
We define gray directors as those non-executive directors who do not qualify as independent
directors.
Family controlled firms
Family controlled firms are divided into two categories. First, where the dominantshareholder
owns the majority of the shares, i.e., Indian individuals or families hold more than 50 percent
of shares of the respective companies. Second, where the dominant shareholder owns more
than 25 percent but less than 50 percent of shares of their respective companies.
Other categories of firms
This includes firms where the majority of the shares are owned by the state (government/
public sector undertakings (PSUs)), the majority of shares are held by foreign individuals/
institutions (FORGN) and Indian firms where no individuals/institutions own more than
25 percent of the shares.
Controlling shareholder duality
Controlling shareholder duality exists when the CEO of the firm is the controlling
shareholder, or he/she belongs to the family that possesses a controlling stake in shares of the
respective company.
Control variables
We controlled for CEO duality, profitability, firm size (FS), board size (BS), growth
opportunities and risk. The pay-for-performance theory is interlinked with traditional
agency theory, which states that executives should work toward maximizing the value of
their firm and shareholders. If this were true, we would expect that the level of pay is an
increasing function of firm performance ( Jensen and Murphy, 1990b; Veliyath and
Ramaswamy, 2000). Hence, we controlled for profitability.
We also controlled for other factors based on prior research. For example, Mehran (1995)
points out that FS is generally found to be positively related to CEO compensation. Hence,
we considered FS as a control variable. We also controlled for BS as it was found to have a
positive association with executive compensation. Scholars have argued that large boards
are less effective at monitoring (Core et al., 1999) corporate affairs. A lower degree of
monitoring will increase the power of CEOs on the board. The trade-off between the degree
of monitoring and power of CEOs emerges because inside directors are expected to be loyal
to their CEO (Pfeffer, 1981). Hence, we argue that bigger boards may lead to higher
compensation. However, prior studies have documented a non-linear relationship between
BS and CEO compensation (Agoraki et al., 2010; Yeung, 2018). The non-linear relationship
between BS and CEO compensation implies that BS demonstrates a positive association
with CEO pay up to a point beyond which this relationship is expected to become negative.
Increase in BS, beyond a point, is likely to bring in diverse and independent opinions.
Hence, BS may exercise a constraining effect on the magnitude of CEO pay. Therefore, we
include the square of BS as a control variable to control for this potentially non-linear effect.
EJMBE

Furthermore, previous studies have also established a positive association between CEO
being the chairman of the board, i.e., “CEO Duality”and executive compensation (Dorata and
Petra, 2008; Tien et al., 2013). Hence, we include CEO Duality as a control variable. Furthermore,
prior research argues that firms with higher growth opportunities would have businesses which
are complex to manage. Therefore, CEO compensation may be higher in those firms which
have higher growth opportunities (Core et al., 2003). Consistent with prior research, we use the
price-to-book ratio as a proxy for capturinggrowthopportunity(LiandKuo,2017).
Sample and methodology
Sample
We divide publicly traded firms into five categories based on their shareholding pattern.
This categorization is partially derived from how corporate ownership is classified by
Balasubramanian et al. (2013):
(1) family controlled firm –dominant shareholding (FC-1): Indian firms with controlling
shareholder(s) who own more than 50 percent of shares;
(2) family controlled firms –non-dominant shareholding (FC-2): Indian firms in which
the shareholding of the controlling shareholders is between 25 and 50 percent;
(3) PSUs: promoted by the central/state government with their shareholding being more
than 50 percent;
(4) firms controlled by foreign controlling shareholders (FORGN): firms listed in India
with a foreign controlling shareholder who owns more than 50 percent of shares; and
(5) MCF: Indian firms in which nobody owns shares more than 25 percent.
The sample herein consists of 438 publicly traded firms listed in the NIFTY 500 index of the
National Stock Exchange (NSE), which constitutes over 95 percent of the free float market
capitalization. This sample covers all five categories of firms delineated above. The Nifty
500 is a broad-based index and an appropriate sample that adequately represents publicly
traded Indian firms. We have drawn sample firms from 11 industries (GICS classification),
i.e., communication services, consumer discretionary, consumer staples, energy, financials,
health care, industrials, information technology, materials, real estate and utilities. The
NIFTY 500 index comprises 501 listed companies. We considered Tata Motors Ltd
(ordinary shares) and Tata Motors Ltd (DVR) as a single firm. Accordingly, the number of
sample firms would come down to 500 firms. Next, we eliminated 18 firms which were listed
after March 2013 as the data for these firms were not available for a full period of five years.
Furthermore, the CEO compensation data for 44 companies were either unreported or
unavailable for a full period of five years. We excluded these companies from further
inquiry. Hence why the final sample size comprised of 438 publicly traded firms. Table III
reports the sample firms based on ownership categories.
We collected data on board structure and compensation from the Indian Board Database
(NSEINFOBASE), which provides details about directors of the companies listed in NSE.
The Indian Board database provides the details such as the names of directors, designation,
whether the directors are independent or not, whether the director/CEO belongs to the
controlling shareholder’s group, and the presence of CEO duality. This information is not
available in other databases that provide information on Indian boards. We collected data
such as profits and total assets from Ace Equity database. Data on price-to-book ratio and
Bloomberg one-year default probability were retrieved from the Bloomberg database.
All data for all sample firms span March 2013 to March 2017. While the majority of the firms
followed April to March as the financial year, a few of them followed the calendar year
( January to December) as their financial year.
Gray directors
and executive
compensation

Model
The relationship between CEO compensation, gray directors, ownership structure and
control variables (Model 1) is tested using the following equation with variable definitions
provided in Table IV:
ln CEO payðÞ¼b0þb1PROPGDþB2CSDUAL þb3FC 2þb4PSU þb5FORGN
þb6MCFþB7CEODUAL þb8PFT þb9SIZE þb10 BS þb11 BS2
þb12PTB þb13 DRSK þYearEffect þIndustryEffectþet:(1)
Ownership categories
Number of
firms in
NIFTY 500 %
Number of
firms in
the sample %
Family controlled firms –FC-1 185 37.00 161 36.76
Family controlled firms –FC-2 159 31.60 138 31.51
Public sector enterprises –PSU 55 11.00 48 10.96
Firms controlled by foreign controlling shareholders (FORGN) 54 10.80 50 11.42
Management-controlled firms –MCF 48 9.60 41 9.36
Total 501 100.00 438 100.00
Note: NIFTY 500 index comprised of 501 firms. The differential voting rights (DVR) shares issued by a firm
were also included in the Index
Table III.
Ownership categories
of the sample firms
Variables Measurements of variables
Ownership variables
Family controlled firms –dominant controlling
shareholder (FC-1)
A dummy variable takes 1 if a controlling shareholder
owns 50 percent or more of the shares, 0 otherwise
Family controlled firms –non-dominant
controlling shareholder (FC-2)
A dummy variable takes 1 if a controlling shareholder
owns 25–50 percent of the shares, 0 otherwise
Government/public sector undertakings (PSUs) A dummy variable takes 1 if the controlling shareholder
is central or state government, 0 otherwise
Firms controlled by foreign controlling
shareholders (FORGN)
A dummy variable takes 1 if a foreign controlling
shareholder owns 50 percent or more shares, 0 otherwise
Management-controlled firms (MCF) A dummy variable takes 1 if the controlling
shareholders holding is less than 25 percent, 0 otherwise
Controlling shareholder duality (CSDUAL) A dummy variable takes 1 if the CEO belongs to the
controlling shareholders group, 0 otherwise
Board structure variables
The proportion of gray directors (PROPGD) Computed by dividing the number of gray directors by
the total number of directors
CEO duality (CEODUAL) A dummy variable takes 1 if the CEO is chairman of the
board, 0 otherwise
Board size (BS) The number of directors on the board
Board size squared (BS
2
) Square of board size to test for potential non-linearity
Other variables
Profitability (PFT) A dummy variable takes 1 if ROE is positive, 0 otherwise
Firm size (SIZE) Log of total assets
Price-to-book ratio (PTB) Market price per share divided by book value per share
Risk (DRSK) Bloomberg one-year default probability
Note: The table reports the operational definitions of all independent variables
Table IV.
Description of
variables and their
measurements
EJMBE

To control for changes in variables, which may be due to time and industry-specific
factors, we included year and industry dummies in the model. By doing this, we also
controlled for the presence of serial correlation in the panel data (Basuroy et al., 2014).
We checked the data for the presence of outliers that could affect the predictive power of
the results. For this purpose, we performed the Grubbs test (also known as the maximum
normed residual test). The results indicate that there are no incoherent values in
any variables.
To examine the association between the presence of gray directors and CEO pay based
on ownership category, we split the sample into five ownership categories listed above.
Splitting the sample is consistent with the method adopted in earlier studies (Raithatha and
Komera, 2016; Saravanan et al., 2017). In the following equation (Models 2 and 3), we
consider the presence of gray directors (PROPGD), controlling shareholder duality
(CSDUAL), CEO duality (CEODUAL), FS, profitability (ROE), BS, growth opportunities
(PTB) and risk (DRSK) on CEOs of family controlled firms (FC-1 and FC-2):
Ln CEOPayðÞ¼b0þb1PROPGDþB2CSDUALþB3CEODUAL þb4PFT
þb5SIZEþb6BS þb7BS2þb8PTB þb9DRSK
þYearEffectþIndustryEffect þet:(2)
In the following equation (Models 4–6), we test the relationship among variables such as
gray directors, CEO duality, FS and profitability on CEOs’pay of the other three ownership
categories (PSUs, FORGN and MCF):
Ln CEO payðÞ¼b0þb1PROPGDþB2CEODUAL þb3PFT þb4SIZE þb5BS þb6BS2
þb7PTBþb8DRSK þYearEffect þIndustryEffect þet:(3)
We estimated Equations (1)–(3) on our pooled time-series data using generalized least
squares (GLS) random effects models with robust standard errors, thus mitigating against
omitted variables bias, autocorrelation and heteroscedasticity. GLS random effects models
have been used to examine CEO compensation in prior studies (Combs et al., 2010;
Grasse et al., 2014).
Results and discussion
Table V presents trends relating to executive compensation in terms of mean, median,
maximum and minimum summary statistics of the independent and dependent variables.
The average remuneration paid to CEOs is Rs9.75m with Rs898.88m being the maximum.
The maximum proportion of gray directors is 0.78, which violates Clause 49 of the listing
agreement of having at least 30 percent (50 percent) independent directors on the board
when the chairman is independent (non-independent). We observe this violation mainly in
PSUs. They report this information in their Corporate Governance Reports. For instance, in
the case of Indian Oil Corporation Ltd, the 2014–2015 report states as follows: “The
company does not have the requisite number of independent directors on its board required
under the provisions of Section 149 (4) of the Act (Companies Act of 2013) and revised clause
49 of the Equity Listing Agreement.”Kaur and Gill (2008) made similar observations about
PSUs. This non-compliance is due to conflicts in the law that governs PSUs. Beyond PSUs,
all other firms were found to be compliant with Clause 49 of the listing agreement.
The mean of absolute total assets was Rs35.95bn with a minimum of Rs0.0481bn and a
maximum of Rs2,973bn. For statistical purposes, we have taken the natural logarithm of
total assets to address the issue of heteroscedasticity (Ramaswamy et al., 2000). Controlling
shareholder duality (CSDUAL) is commonly found in family controlled firms in India.
Similarly, playing dual roles of being a CEO and chairman of the board is also found in
Gray directors
and executive
compensation

many corporate cases. The average BS is 10.86 with the maximum number being 23
directors on the board of Larsen and Toubro Ltd.
Table VI presents a correlation matrix. CEO pay, represented by its natural logarithm, is
positively correlated with the following independent variables: controlling shareholder
duality (CSDUAL), family controlled firms with both dominant and non-dominant
shareholding by controlling shareholders (FC-1 and FC-2), firms with a foreign controlling
shareholder (FORGN) and profitability (ROE). Furthermore, CEO pay is negatively
correlated with the proportion of gray directors, PSU, firms with dispersed ownership
(MCF) and FS (SIZE).
The correlation matrix reveals that multicollinearity is not an issue since the correlation
between the independent variables is low. Furthermore, we estimated variance inflation factors
(VIFs). The average VIF and individual VIFs are within an acceptable range (1.05–1.82).
Table VII provides estimates from Model 1 wherein the log (of CEO pay) is the dependent
variable. The proportion of gray directors (PROPGD) is found to be positively related to CEO
pay. It is found to be statistically significant as hypothesized, at the 5 percent level. Results of
this study thus lend support to the proposition that as the number of gray directors on
corporate boards increases, so too does CEOs’pay. Controlling shareholder duality (CSDUAL)
is also found to be positively associated with CEOs’pay. In other words, the salary of a CEO,
who is also a controlling shareholder or belongs to the controlling shareholder group, ishigher
than that of a professional CEO. Therefore, we fail to reject H1a.AccordingtoKumarand
Singh (2013), controlling shareholders may wield significant influence over the board and
management due to their substantial shareholding and voting rights. Therefore, the higher
pay for CEOs who are controlling shareholders cannot be justified.
CEOs who are also controlling shareholders (CSDUAL) received higher salaries than
professional CEOs. Hence, we fail to reject H2a. CEOs from founding families or the
Variable Obs. Mean SD Min. Max.
ln(CEOPay) 2,190 15.145 1.535 9.210 20.617
PROPGD 2,190 0.157 0.148 0.000 0.778
CSDUAL 2,190 0.170 0.376 0.000 1.000
CEODUAL 2,190 0.423 0.494 0.000 1.000
FC-1 2,190 0.368 0.482 0.000 1.000
FC-2 2,190 0.315 0.465 0.000 1.000
PSU 2,190 0.110 0.312 0.000 1.000
FORGN 2,190 0.114 0.318 0.000 1.000
MCF 2,190 0.094 0.291 0.000 1.000
SIZE 2,190 22.407 1.700 15.386 28.721
ROE 2,190 14.715 14.863 −47.100 124.250
BS 2,190 10.859 2.614 2.000 23.000
BS
2
2,190 124.748 62.178 4.000 529.000
PTB 2,190 4.035 7.765 0.047 251.148
DRSK 2,190 0.003 0.011 0.000 0.370
Notes: ln(CEO pay) is the natural logarithm of CEO compensation defined as the sum of salary, perquisites,
commission, sitting fees and bonuses. PROPGD is the proportion of gray directors on the board. CSDUAL is
controlling shareholder duality. CEODUAL is CEO duality. FC-1 is family controlled firms with a dominant
controlling shareholder. FC-2 is family controlled firms with a non-dominant controlling shareholder. PSU is
public sector undertaking with majority shareholding by the government. FORGN is firms with a foreign
controlling shareholder and MCF is management-controlled firms wherein shares are held severally. ROE is
return on equity, defined as income after tax and extraordinary items divided by average total shareholders’
funds. SIZE is firm size measured by the natural logarithm of total assets. BS is board size. BS
2
is the square
of board size. PTB is the market price per share divided by the book value per share. DRSK is one-year
Bloomberg default risk
Table V.
Summary statistics
EJMBE

ln(CEOPay) PROPGD CSDUAL CEODUAL FC-1 FC-2 PSU FORGN MCF SIZE ROE BS BS
2
PTB DRSK
ln(CEOPay) 1
PROPGD −0.054 1
CSDUAL 0.273 −0.031 1
CEODUAL 0.086 −0.106 0.083 1
FC-1 0.119 −0.209 0.361 −0.007 1
FC-2 0.158 −0.023 −0.069 −0.013 −0.517 1
PSU −0.366 0.219 −0.159 0.229 −0.268 −0.238 1
FORGN −0.055 0.126 −0.159 −0.136 −0.274 −0.244 −0.126 1
MCF 0.003 0.011 −0.145 −0.066 −0.245 −0.218 −0.113 −0.115 1
SIZE −0.025 0.214 −0.025 0.010 −0.239 −0.048 0.440 −0.144 0.157 1
ROE 0.225 −0.026 0.081 0.004 0.042 −0.052 −0.094 0.114 −0.011 −0.184 1
BS 0.231 0.147 0.030 0.176 −0.093 0.020 0.163 −0.138 0.098 0.336 −0.004 1
BS
2
0.210 0.129 0.025 0.172 −0.088 0.008 0.165 −0.128 0.096 0.324 −0.001 0.984 1
PTB 0.025 0.011 0.009 −0.073 0.073 −0.074 −0.104 0.153 −0.058 −0.187 0.231 −0.057 −0.056 1
DRSK −0.090 −0.015 −0.008 0.008 −0.012 0.042 0.000 −0.045 0.001 0.074 −0.197 0.046 0.053 −0.089 1
VIF 1.160 1.220 1.170 1.410 1.810 1.340 1.330 1.560 1.140 1.120 1.110 1.050
Tolerance 0.862 0.816 0.857 0.709 0.551 0.744 0.750 0.639 0.879 0.830 0.902 0.953
Notes: ln(CEO pay) is the natural logarithm of CEO compensation defined as the sum of salary, perquisites, commission, sitting fees and bonuses. PROPGD is the
proportion of gray directors on the board. CSDUAL is controlling shareholder duality. CEODUAL is CEO duality. FC-1 is family controlled firms with a dominant
controlling shareholder. FC-2 is family controlled firms with a non-dominant controlling shareholder. PSU is public sector undertaking with majority shareholding by the
government. FORGN is firms with a foreign controlling shareholder and MCF is management-controlled firms wherein shares are held severally. ROE is return on equity,
defined as income after tax and extraordinary items divided by average total shareholders’funds. SIZE is firm size measured by the natural logarithm of total assets. BS
is board size. BS
2
is the square of board size. PTB is the market price per share divided by the book value per share. DRSK is one-year Bloomberg default risk
Table VI.
Correlation matrix
Gray directors
and executive
compensation

controlling shareholder’s group are perceived to wield considerable managerial power in
board decisions (Chakrabarti et al., 2012). The combined effect of the presence of gray
directors on boards and controlling shareholder duality in fixing CEO compensation might
be a matter of concern for minority shareholders.
Ownership structure is found to be a significant determinant of CEO pay in the Indian
context. We find that the salary of CEOs of family controlled firms with dominant
controlling shareholder (FC-1) is significantly higher than that of CEOs of PSUs and firms
controlled by foreign controlling shareholders (FORGN). Hence, we fail to reject H2b. The
CEOs of PSUs received a lower level of compensation. Results of prior research (Ghosh,
2010) also conclude that CEO compensation in state-owned firms is significantly lower than
CEO compensation across other ownership groups. Firth et al. (2007) argue that the CEO is
more likely to be a bureaucrat and his or her managerial skills may be lower than those of a
professional CEO in private firms when the government owns the majority shares in a firm.
They further observe that equilibrium wages will be lower in government-owned firms
(PSUs) when there is a difference in managerial quality. The relationship between lower
wages in government-owned firms and the differences in managerial quality explains the
lower compensation for the CEOs of PSUs. CEO compensation in family controlled firms
with non-dominant controlling shareholder(s) is higher in comparison with FC-1. However,
this relationship is found to be statistically insignificant.
Executive compensation is positively associated with CEO duality (CEODUAL). The
positive association between executive compensation and CEO duality implies that when
a CEO is chairing the board, the compensation will be higher. Our results support the
findings of an earlier study in India (Saravanan et al., 2017). Hence, firms may consider
Model 1
PROPGD 0.238 (2.27)**
CSDUAL 0.286 (3.38)***
FC-2 0.118 (0.91)
PSU −2.057 (10.69)***
FORGN −0.414 (2.54)**
MCF −0.145 (0.45)
CEODUAL 0.131 (2.25)**
SIZE 0.215 (3.28)***
ROE 0.013 (6.01)***
BS 0.203 (3.28)***
BS
2
−0.004 (2.00)**
DRSK −4.209 (2.58)**
PTB −0.003 (1.66)*
Industry effect Yes
Year effect Yes
_cons −1.202 (5.72)**
n2,190
Notes: Standard errors in parentheses. The dependent variable is the Log of CEO Pay. ln(CEO pay) is the
natural logarithm of CEO compensation defined as the sum of salary, perquisites, commission, sitting fees
and bonuses. PROPGD is the proportion of gray directors on the board. CSDUAL is controlling shareholder
duality. CEODUAL is CEO duality. FC-1 is family controlled firms with a dominant controlling shareholder.
FC-2 is family controlled firms with a non-dominant controlling shareholder. PSU is public sector undertaking
with majority shareholding by the government. FORGN is firms with a foreign controlling shareholder and
MCF is management-controlled firms wherein shares are held severally. ROE is return on equity, defined as
income after tax and extraordinary items divided by average total shareholders’funds. SIZE is firm
size measured by the natural logarithm of total assets. BS is board size. BS
2
is the square of board size. PTB is
the market price per share divided by the book value per share. DRSK is one-year Bloomberg default risk.
*,**,***Significant at the 0.10, 0.05 and 0.01 levels, respectively
Table VII.
Model 1 estimates
EJMBE

separating the positions of CEO and the chairperson of the board (Dorata and Petra, 2008).
As hypothesized, the CEOs of larger firms received higher compensation. Also, the results
indicate that there is a positive relationship between firm performance and executive
compensation. Jaiswall and Frith (2009) and Raithatha and Komera (2016) have also
reported similar findings. Based on this, we can conclude that, in general, there is a
positive association between compensation and firm performance. We again examine the
effect of firm performance on compensation across ownership categories. This analysis
will reveal if the positive relationship between pay and performance exists across the
ownership categories.
BS is a significant predictor of executive compensation. This is an indication of the
possible collusion between the CEO and the board of directors in fixing compensation.
However, it is interesting to note that the nature of the relationship between BS and
compensation is non-linear. Therefore, we infer that the increase in the size of the board of
directors beyond a certain point will reduce CEO pay. These results are consistent Yeung
(2018). The relationship between price-to-book ratio and CEO pay, which is a proxy for
growth opportunity, is negatively related to CEO pay. The negative association between the
price-to-book ratio and CEO pay may be due to the firm’s willingness to commit financial
resources to growth opportunities. Furthermore, default risk is negatively associated with
CEO pay. This indicates that there is no adequate, corresponding reward for the risks that
top executives take in their strategic business decisions.
To test the relationship across ownership categories, we estimated the relationship
between the variables based on the sample split methodology explained earlier. We divided
all the firms into five ownership categories, as described in Table IV. Out of the 438 sample
firms, there were 299 family controlled firms, and the remaining 139 firms were from other
ownership categories. Table VIII presents the results.
Model 2 FC-1 Model 3 FC-2 Model 4 PSUs Model 5 FORGN Model 6 MCF
PROPGD 2.382 (6.36)*** 0.844 (1.72)* −1.084 (2.67)*** −0.410 (0.65) −0.342 (0.80)
CSDUAL 0.287 (2.61)*** 0.217 (1.53)
CEODUAL −0.014 (0.17) 0.316 (3.08)*** 0.040 (0.17) 0.146 (0.77) 0.108 (0.79)
SIZE 0.123 (1.39) 0.267 (3.89)*** 0.215 (2.34)** 0.482 (3.24)*** 0.287 (3.61)***
ROE 0.015 (3.57)*** 0.011 (3.13)*** −0.001 (0.03) 0.018 (2.87)*** 0.011 (1.46)
BS 0.070 (0.91) 0.311 (1.91)* 0.040 (1.35) 0.220 (1.10) 0.122 (0.76)
BS
2
0.001 (0.36) −0.008 (1.28) −0.006 (1.09) −0.007 (0.75) −0.003 (0.60)
PTB −0.003 (2.31)** 0.002 (0.13) 0.003 (0.21) −0.012 (0.09) 0.069 (1.92)*
DRSK −6.857 (1.75)* −2.066 (1.54) −21.101 (1.03) 15.605 (3.22)*** −43.37 (1.43)
Industry Effect Yes Yes Yes Yes Yes
Year Effect Yes Yes Yes Yes Yes
_cons 10.643 (5.08)*** 5.710 (3.07)*** 7.207 (2.66)** 3.629 (1.03) 7.602 (3.43)***
n805 690 240 250 205
Notes: Standard errors in parentheses. The dependent variable is the Log of CEO Pay. ln(CEO pay) is the
natural logarithm of CEO compensation defined as the sum of salary, perquisites, commission, sitting fees
and bonuses. PROPGD is the proportion of gray directors on the board. CSDUAL is controlling shareholder
duality. CEODUAL is CEO duality. FC-1 is family controlled firms with a dominant controlling shareholder.
FC-2 is family controlled firms with a non-dominant controlling shareholder. PSU is public sector undertaking
with majority shareholding by the government. FORGN is firms with a foreign controlling shareholder and
MCF is management-controlled firms wherein shares are held severally. ROE is return on equity, defined as
income after tax and extraordinary items divided by average total shareholders’funds. SIZE is firm size
measured by the natural logarithm of total assets. BS is board size. BS
2
is the square of board size. PTB is
the market price per share divided by the book value per share. DRSK is one-year Bloomberg default risk.
*,**,***Significant at the 0.10, 0.05 and 0.01 levels, respectively
Table VIII.
Estimation of
relationship between
CEO compensation
and independent
variables
Gray directors
and executive
compensation

Estimations of Equations (2) and (3) demonstrate that the association between the
proportion of gray directors (PROPGD) and CEO pay increases for family controlled firms
(FC-1 and FC-2). These results are also statistically significant. Thus, we fail to reject H1b.
The proportion of gray directors (PROPGD) is negatively associated with the CEO
compensation of PSUs, firms with foreign controlling shareholder(s), and MCF. In the case of
PSUs, gray directors of PSUs are nominees of government. For example, in BHEL Ltd, we
observe that the gray directors are from: the Department of Industrial Policy and Promotion,
Ministry of Commerce and Industry; and the Department of Heavy Industry, Ministry of
Heavy Industries & Public Enterprises.
Similarly, in ONGC Ltd, nominee directors were from the Ministry of Petroleum &
Natural Gas. Government is the majority shareholder in PSUs. Therefore, its nominee
directors may be considered as the shareholder representatives on the board. In the case of
firms controlled by foreign shareholders such as 3M Ltd, or BASF Ltd, we observe the
presence of representatives of parent firms on their respective boards. We may consider this
as “international overseeing.”Gray directors, in firms with dispersed ownership (MCF ),
represent institutional shareholders who may happen to be the single largest shareholder
group. For instance, in Larsen & Toubro Ltd, non-executive non-independent directors
represent equity interest of Life Insurance Corporation of India and Specified Undertaking
of Unit Trust of India.
However, in the case of family controlled firms, the role of gray directors leads us to
suspect cronyism. Sarpal (2015) and Srivastava (2015) suggest that there is a negative
relationship between firm performance and the proportion of gray directors. Whilst there is a
negative effect of board structure of family controlled firms on firm performance according to
Bhatt and Bhattacharya (2017). Therefore, based on this evidence, the role of gray directors on
the respective corporate boards would become questionable. Empirical evidence, provided in
this paper, lends support to the implications of psychological contract theory in making sense
of the role of gray directors in influencing the magnitude of CEO compensation.
CSDUAL was found to be significantly associated with CEO compensation of family
firms wherein controlling shareholders own more than 50 percent of shares (FC-1). CEO
duality (CEODUAL) is positively related to the CEO compensation of family controlled firms
with non-dominant controlling shareholder(s) (FC-2). This finding is interesting because
firms belonging to the FC-2 category may attempt to control the board by holding the dual
position of CEO and chairperson. Therefore, we posit that controlling shareholders may
exercise their power to pay themselves high compensation ( Jaiswall and Frith, 2009).
The relationship between CEO pay and CEO duality is insignificant across other
ownership categories. CEO pay increased with FS except in the case of family controlled
firms with dominant controlling shareholder(s) (FC-1). BS failed to explain the changes in
CEO pay across ownership categories except for the FC-2 ownership category.
Results of this study show that profitability (ROE) exhibits a significant positive association
with CEO pay in firms that belong to FC-1, FC-2 and FORGN ownership categories. However,
the relationship between profitability and CEO pay is statistically insignificant among firms
grouped under PSU and MCF ownership categories. There is no evidence for the presence of a
non-linear relationship between CEO pay and BS across ownership categories.
Robustness of results
We reexamined the models using a two-step dynamic panel data model (Table IX)
introducing a lagged dependent variable (Fabbri and Marin, 2012). Dynamic panel
estimation addresses the issue of endogeneity. The utility of estimating a dynamic model
stems from the fact that it accounts for potential dynamic relationships among variables
(Raithatha and Komera, 2016). The outcomes are consistent with the results reported using
GLS random effects modeling.
EJMBE

Model 1 Overall Model 2 FC-1 Model 3 FC-2 Model 4 PSUs Model 5 FORGN Model 6 MCF
ln(CEOPay)_t-1 0.585*** (0.091) 0.327*** (0.120) 0.688*** (0.197) 0.128 (0.148) 0.764*** (0.274) 0.153 (0.193)
PROPGD 0.544** (0.251) 2.589*** (0.324) −0.341 (0.492) −0.897* (0.506) 0.478 (0.923) −0.912 (0.814)
CSDUAL 0.233*** (0.105) 0.187** (0.098) 0.530* (0.297)
CEODUAL 0.223*** (0.069) 0.168** (0.083) 0.055 (0.129) −0.431** (0.219) −0.388 (0.278) −0.456** (0.196)
SIZE 0.298** (0.136) 0.185 (0.140) 0.644** (0.274) −0.776 (0.743) −0.062 (0.562) 0.533* (0.318)
ROE 0.009*** (0.003) 0.0112*** (0.004) 0.0148** (0.006) −0.015 (0.011) −0.005 (0.013) 0.018 (0.011)
BS 0.227** (0.106) 0.011 (0.153) 0.443* (0.235) 0.381* (0.200) −0.359 (0.525) 0.313 (0.254)
BS
2
−0.006 (0.004) 0.004 (0.007) −0.016 (0.011) −0.010 (0.008) 0.023 (0.026) −0.012 (0.009)
PTB 0.001 (0.004) 0.001 (0.003) −0.010 (0.028) −0.026 (0.096) 0.000 (0.021) 0.039 (0.084)
DRSK −0.081 (5.054) 4.402 (5.120) 8.416 (10.510) −33.06* (17.510) 7.362 (23.230) −35.95*** (13.350)
Constant −2.199 (3.096) 5.415 (3.475) −12.45** (6.258) 28.740 (17.960) 6.363 (11.410) −1.412 (7.732)
Observations 1,314 483 414 144 150 123
Number of firms 438 161 138 48 50 41
Notes: Standard errors in parentheses. The dependent variable is the Log of CEO Pay. ln(CEO pay) is the natural logarithm of CEO compensation defined as the sumof
salary, perquisites, commission, sitting fees and bonuses. PROPGD is the proportion of gray directors on the board. CSDUAL is controlling shareholder duality.
CEODUAL is CEO duality. FC-1 is family controlled firms with a dominant controlling shareholder. FC-2 is family controlled firms with a non-dominant controlling
shareholder. PSU is public sector undertaking with majority shareholding by the government. FORGN is firms with a foreign controlling shareholder and MCF is
management-controlled firms wherein shares are held severally. ROE is return on equity, defined as income after tax and extraordinary items divided by average total
shareholders’funds. SIZE is firm size measured by the natural logarithm of total assets. BS is board size. BS
2
is the square of board size. PTB is the market price per share
divided by the book value per share. DRSK is one-year Bloomberg default risk. *,**,***Significant at the 0.10, 0.05 and 0.01 levels, respectively
Table IX.
Results of dynamic
panel estimator
Gray directors
and executive
compensation

The results indicate that past pay has a significant positive association with current CEO
pay. Also, the results confirm our hypothesis that the proportion of gray directors
(PROPGD) on the board demonstrates a positive and significant association with CEO pay.
The effect is positive for family controlled firms and negative for firms controlled by foreign
shareholders. Furthermore, the estimation using the dynamic panel model confirms the
results presented earlier. For instance, the compensation of the CEO belonging to the
controlling shareholder group is higher than that of a professional CEO. The ROE had a
significant positive association with the CEO pay among the family controlled firms (FC-1
and FC-2). This result confirms the “pay-for-performance”theory. Thus, the results of the
dynamic panel model confirm that our findings are robust and not spurious.
Directions for future research
Future research may focus on describing the role of gray directors on the board based on
ownership categories and investigate the relationship between the presence of gray
directors and firm value. It would also be fruitful to explore possible moderators in the
relationship between gray directors, firm performance, corporate governance and
earnings management.
Conclusion
We hypothesized that the presence of gray directors would be positively associated with the
magnitude of CEO compensation, and the findings reported herein lend support to this.
Furthermore, we found that this association changed across ownership categories. The
presence of gray directors is found to be associated with higher compensation of CEOs of
family controlled firms. However, their presence is found to be associated with decreased
CEO compensation in private foreign, PSUs and dispersed ownership firms. Adding to this,
we found that the compensation of CEOs who are in the controlling shareholder group is
higher than that of professional CEOs.
Furthermore, this paper has situated the relationship between gray directors and CEO
pay on the theoretical rationale advanced by psychological contracts theory. We conclude,
therefore, that gray directors’complicity in fixing unduly high CEO compensation is a
symptom of cronyism. The hybrid board structure that India has adopted, with the desire to
bring the best of Anglo Saxon and Japanese board philosophies, should be held responsible
for the emergence of a self-serving situation. Therefore, this calls for the exploration of fresh
thinking to bring about required changes in the regulatory framework.
Note
1. A NYSE-listed US company must have a majority of directors meeting the independence
requirements under Section 303A of the NYSE-Listed Company Manual.
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Corresponding author
Nandan Prabhu can be contacted at: nandan.prabhu@manipal.edu
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Gray directors
and executive
compensation