Effects of Key Management Compensation on Financial Performance of Listed Manufacturing Firms in Kenya

The aim of this study was to investigate the effects of management compensation on financial performance in Kenya using case of listed manufacturing firms. The study employed census method of data collection and secondary data sources over a period of 9 years, 2010-2018, for 15 listed manufacturing firms. The agency theory complemented by the contingency, self-determination, and expectancy theories was used in the study. The data was analyzed using ordinary least squares regression analysis model as well as the descriptive methods. Eviews software was employed in the data manipulation. The key finding of the study was that key management compensation was strongly positively associated (correlated) with the financial performance of listed manufacturing firms in Kenya while Director Emoluments affect financial performance of listed manufacturing firms negatively but not strongly. Another finding was that debt ratio highly negatively and statistically significantly influenced the relation between management compensation and financial performance of listed manufacturing firms in Kenya suggesting that debt is an important factor in determining the relation between management compensation and financial performance of listed manufacturing firms in Kenya. The findings of the study are important in that they can be employed in formulating policy initiatives and strategies for improving financial performance of firms in the country.


Introduction
The historical context of labor compensation runs from the 1920s to modern day. There were centuries where unpaid slave labor was explicitly legal and normalized and where women were restricted from entering the work force. Before Industrial Revolution, craftwork was the primary means of goods production with many workers being self-employed or working in small shops. It was in the 20 th century that systems of large scale urban production and employment were developed. With the development of machines and standardized parts, companies could start enhancing their production by employing thousands of workers to assemble complex products (Caudill & Porter, 2014).
In the context of labor economics, the price of wage is influenced by the forces of demand and supply of labor and skills just as is the price of any commodity. From the agency (contract) theory, the behavior of the worker and the employer (firm), is influenced by the information asymmetry which means that one party has more knowledge than the other, a phenomenon known as the principal-agent problem. Compensation and its delivery are tools considered appropriate in driving worker productivity maximization. Contemporary debate is rife especially in the US concerning the effectiveness of executive bonuses as a result of the 2008 financial crisis (Spector & Spital, 2011).

Governing Theories
The agency theory interprets the relationship between the agent and the principal through the metaphor of a contract, where the principal delegates responsibility and influence to an agent (Shapiro, 2005;Nouray & Daroca, 2008;Jensen & Meckling, 1976). Within the context of reward systems, the agents are the top management of the firm, and the principals consist of the shareholders of the firm.
According to Eisenhardt (1989), when a principal gives the agent an employment, the agency problem may arise because of conflict of interest and asymmetric information. An underlying assumption of the agency theory is that the agent is mainly driven by self-interest and will act in ways most favorable for him raising the problem of conflict of interest in the contract between the agent and the principal (Jensen & Murphy, 1990). Another problem in the principal-agent relation is related to asymmetric information characterized by a lack of control where it becomes too demanding for the principal to control and confirm that the agent is doing what he or she is supposed to do. Sloof and Praag (2007) and Vroom (1964) explain that the view held within agency theory is connected to expectancy theory which explicates the relationship of incentive systems and the motivation of the individual. Expectancy theory is built on three assumptions of an individual's perception that effort is linked to performance, the individual's expectation that received compensation is linked to performance, and that the individual's motivation is driven by received reward which in turn increases a person's performance (loof & Praag, 2007;Kominis & Emmanuel, 2007). The agency problem between the owners of a company and the top management can be addressed through an incentive system in that the incentive system will allow firm owners to tie the interests of the top management to 77 external reward, which is presumed to increase motivation. A central aspect within the SDT is the clear distinction between autonomous behavior and controlled behavior (Gagné & Deci, 2005) where the controlled behaviour occurs due to external pressure or external reward (the extrinsic motivation) which arises when a person is motivated by external factors to act in a specific way in order to get the opportunity to achieve the reward. In the context of incentive systems, management compensation constitutes of an external reward and a mechanism to control behavior (Dworkin, 1988). The extrinsic motivation part is further important when attracting the most desirable top management to the firm. The interaction between intrinsic and extrinsic motivation is dependent on the assignment at hand as well as circumstances in the environment. The total amount of a person's motivation is dependent on both intrinsic and extrinsic motivation such that by increasing one part, the other part may be reduced and a crowding-out effect can occur (Walton, 2012). Violeta (2015) distinguished between two categories, the external and internal, as determinants of executive compensation based on the firm operating environment. The external determinants of executive compensation include labor market conditions, the country's level of wages, the economic activity engaged in by the company, living standards, the government policy, company ownership and trade unions whereas the internal factors comprise the unique value of the task, relative value of the employee, size of company and the ability of an employer to pay a certain amount of pay. Drawing from classical economic theory, Kakabadse, and Kouzmin (2004) explain that the amount paid in wages is based on the labor market while drawing from the efficiency wage theory, Halaby (2014) explains that the employer will expect return on his investment on the employee through increased productivity and efficiency in execution of duties and tasks. The willingness of the organization to pay more than the current is based on the hope that the higher pay will stimulate increased productivity.

Management Compensation and Financial Performance
Lindstrom and Svensson ( reported a positive and significant relationship between CEO cash compensation and firm performance and a positive but insignificant association between total compensation and firm performance. Further, the study found that firms with larger board size pay their CEOs higher level of total compensation. Sigler (2013)  Niresh and Velnampy (2014)  were employed as proxies for financial performance. The study found that liquidity and firm size affected the financial performance of listed non-financial firms at NSE positively while leverage had no effect. The implication of finding on the firm size is that managers should expand their businesses 80 www.scholink.org/ojs/index.php/ijafs  (Mehran, 1995;Elayan, Lau, & Meyer, 2003). The authors explain that larger firms may have more potential to pay out incentives, relatively to smaller firms. The study employed correlation analysis (Pearson product-moment correlation) and an Ordinary Least Square (OLS) regression analysis. The study found a weak positive effect of variable compensation on firm performance.
Using firm size and age, Stella, Aggrey, and Eseza (2014)  executive compensation and firm performance by employing board size, non-executive directors, leverage and boardroom ownership as control variables. The authors found strong evidence for the greater influence of executive compensation on firm performance than the pay-performance framework.
Their findings supported the tournament theory compared with the agency theory perspective.
In their study on relationship between corporate governance practices, CEO compensation, and firm profitability of 205 U.S publicly traded large firms operating in a variety of different industries including food, chemical, and electrical industries, Robert and David (1999) reported that firms with weaker governance structures have greater agency problems in that CEOs receive greater compensation and firms record the lowest return on equity. Oyerogba, Riro, and Memba (2016)

Conceptual Framework
The conceptual framework focuses on both the theoretical framework (interrelationship of the variables) and the empirical or analytical framework (data analysis procedures). The governing premises of the study are the agency theory (Jensen & Meckling, 1976) and the contingency theory (Donaldson, 1996;Balking & Gomez-Meija, 1987). Figure 1 presents the interrelationship of the variables to be employed in the proposed study. The dependent variable is the firm performance measured by the earning per share ratio (EPS ratio) in line with Oyerogba, Riro, and Memba (2016). The independent variable is the management compensation measured by the log of total key management compensation. The three control variables are firm size, growth, debt ratio. The proxy for the firm size control variable is the log of total revenue. The growth control variable is operationalized by the rate of change of revenue while the proxy for the debt ratio control variable is the ratio of debt to total assets.

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Published by SCHOLINK INC. Gomez-Mejia, Tosi, & Hinkin, 1987;Elayan, Lau, & Meyer, 2003). The growth control variable is included since firms with a high growth rate are able to generate higher profits due to higher degree of investments (Farmer, Archbold, &Alexandrou, 2013;Fallatah, 2015;Mehran, 1995). The debt ratio control variable is included in the regression model in order to capture possible effect of financial leverage on firm performance (Elayan, Lau, & Meyer, 2003).

Results and Discussion
The study obtained the value of the mean of the earnings per share with two standard errors (2SE = 2.5301) of the mean implying that the value of the mean of EPS is highly statistically important indicator of financial performance of listed manufacturing firms in Kenya. This finding suggests that, more than not, investors in the manufacturing businesses can correctly compare alternative investments, project performance over time, as well as measure the net income available to shareholder.
The regression results show a positive coefficient of the key management compensation at 13.90 with p-value<0.0143. This finding indicates that key management compensation positively and statistically significantly influences financial performance. This result implies that key management compensation is an important factor that influences financial performance of listed manufacturing firms in Kenya. For instance, the finding shows that, a 5 percent increase in Kenya management compensation will lead to a 14 percent increase in financial performance of listed manufacturing firms in Kenya. There is enough evidence against the null hypothesis, and hence we reject the null hypothesis.

Conclusion
An important conclusion of the study is that the incentive systems of the key management compensation have a positive and significant effect on the financial performance of listed manufacturing firms in Kenya.