From boots to suits: do military directors protect shareholders’ wealth?

Military institutions produce officers who are trained to lead in winning wars, overcoming internal conflicts as well as making success in international military alliances (Hannah et al. 2009). Leadership is and continues to be a mainstay of the military. Culturally, militaries are enamoured by leadership, and they endeavour to develop leader competencies and skills needed for the next level of leadership through formal education, operational assignments, and self-development (Hannah et al. 2009). Since they are trained to analyse and assess risks, to ask questions that challenge the status quo, as well as to make decisions and command often under intense pressure, such incredible skills can be utilized beyond the war cabinet and war fields. Hence, it is not surprising to find military personnel, especially retired officers, taking on key leadership roles in the respective country’s political affairs and offer their services to support the political and civic establishments (An et al. 2020; Jaroenjitrkam and Maneenop, 2022; Kim et al. 2017; Li and Rainville 2020, 2021).

It has been widely observed, especially in developing countries, that military intervention in politics is often associated with economic crisis and stagnation in economic growth, and governments are also more likely to be overthrown by force when economic conditions deteriorate (Mayer 2008). One prominent example of interventionist economy is China, which is characterised by cheap labour, higher productivity, and moderate levels of corruption. Military directors are strategically appointed to help improve governance quality and curb illicit practices such as bribery and corruption in the Chinese corporate sector. Despite stringent policy to curb corruption, Lin et al. (2021) found firms with military directors to underperform and have higher risk, highlighting the discrepancy between policy and practice.

On the other extreme is Egypt, with an ex-military chief holding the presidential office and the Egyptian army directly controlling the country after the coup d'etat of 2013. The country until now is characterised by cheap labour, poor productivity, higher levels of corruption, and illicit political practices such as kickbacks and bribes in the economic affairs. Military directors are appointed due to their strong network ties to the Egyptian establishments regardless of whether it is a military or bureaucratic setup, but such military directors are found to be detrimental for Egyptian corporations as they tend to underperform and affect the economy adversely (Eissa and Eliwa 2021). Likewise, despite being a constitutional monarchy, Thai army has launched 12 coups since 1932 (the last one in 2014) and has entrenched itself to the economic sector of the country to the extent that it controls some of the key financial and non-financial institutions of the country. Similar to China, Jaroenjitrkam and Maneenop (2022) report that Thai firms with military-experienced directors underperform and have higher risk. Interestingly, despite the prolonged exposure to military rule during their formative years, South Korean army’s role in the economic affairs of the country is diminishing from the corporate sector. Kim et al. (2017) report that South Korean firms with military directors are less likely to commit corporate fraud.

In the case of Pakistan, its military has been strategically entrenched into the politico-economic affairs of the state since its independence in 1947. The economic decline under the kleptocratic elite and the political instability exacerbates the decline in export-oriented sectors and the flow of foreign direct investments (FDIs), causing recurring balance of payments crises that require bailouts. Furthermore, unlike China, Pakistani businesses are globally uncompetitive. Hence, due to difficulty in mustering resources required to compete at a global scale, consolidation of the military is seen as a plausible solution to fix “political uncertainty and instability [which] are anathemas to a market-based economy” (for more details, see, Husain 2009). In other words, the alliance between the country’s civic-and-military establishment was formed to fight the economic war of survival. Consequently, Pakistan military becomes heavily involved in the reconfiguration of the economic and international trade policy to resolve the macroeconomic challenges. This strategic shift is akin to its strategic ally, China, which initiated its economic revival with military-run organizations and over the decades has developed companies that have a more global outlook.

Despite the strong presence of Pakistan military officials both in the public and private sector organisations, especially in state-run economic entities, they are seen as less prone to illicit activities such as kickbacks and bribes relative to the political elite who is at the centre of financial corruption in the country. Besides, Pakistani military has built their own conglomerate, which is worth billions of dollars catering all major economic sectors from real estate, banking and logistics to education services, supports hubs, and bakeries. The fact that military officials, including ex-military personnel, run this military conglomerate suggest that military-trained business leaders possess excellent business acumen in managing diversified businesses. An et al. (2020) note that praetorianism is common in war-affected interventionist economies whereby militaries strategically endorse appointments of their retired servicewomen and men to the corporate boards as a proxy for control over the publicly held corporations. Staniland et al. (2020), in tracing the career path of Pakistani military officers, identify an institutionalised transmission belt that channels military-serviced personnel into the state and civic organisations upon completion of their military service. The study further notes the assumed positions offer influence and generous financial rewards and serve as a second – financially more rewarding – career for the retired military officers. Thus, the deployment of ex-military trained personnel is strategic and not consequential.

However, the effects of military directors on corporate strategies and outcomes remain unexplored in this unique context of Pakistan, thus prompting the conduct of this study to narrow the gap in the literature. Given the different politico-economic setting and military involvement in Pakistan compared to the US, China, Korea, Thailand and Egypt, an analysis of the impact of military directors in protecting shareholders interest in market-based economy can help enhance our understanding of the board diversity phenomenon.

Separation of ownership and control in publicly held companies gives rise to agency costs due to the conflicting interest between the principal and agent (Fama and Jensen 1983). Agency costs comprised of monitoring, bonding, and residual loss (Jensen and Meckling, 1976). Monitoring costs are incurred in hiring external auditors to verify the financial statements and appointing non-executive directors to ensure managers conform to regulations as well as contribute to strategic planning and policies to enhance shareholders’ value. Bonding costs are related to covenants that prevent the company from taking certain actions, such as imposing restrictive dividend payout. Residual loss relates to expenses incurred as a result of conflicting interests between shareholders and managers.

Board of directors, especially non-executive directors, are expected to advise and monitor the agents to enhance shareholders’ interests in terms of appreciation in corporate value and dividend awards, as well as ensure that managers are not compensating themselves with higher rewards that may jeopardise the firm’s financial sustainability. As noted by Nawaz (2022a, b), having the right board composition in terms of knowledge, skills, expertise, and experience will help improve corporate governance quality. Prior studies have considered the impact of military directors on board and concluded that they help improve the quality of decisions as well as decrease divisiveness and conflict at the corporate board level, thereby improving corporate governance quality and corporate strategic outcomes (Benmelech and Frydman 2015; Law and Mills 2017; Lin et al. 2011). We therefore extend prior studies by analysing the impact of military directors on two corporate policies, viz. CEO compensation and corporate dividend payout, that have implications on shareholders’ wealth. We argue that these are relatively better proxies to determine if the inclusion of military directors at the corporate board level will enhance shareholders’ interest by reducing agency costs in the form of CEO compensation and increasing dividend awards to the shareholders.

Board of directors play no executive role in the day-to-day functioning of the company. Their primary duty is to provide strategic direction to the agents such as the CEO while monitoring them to ensure that the agents work in the best interests of shareholders. The CEO is responsible for implementing strategies to enhance shareholders’ wealth. Thus, it is the CEO who is held accountable for the performance outcomes of the company and not the board of directors. As such, the CEO may claim higher financial rewards such as bonuses and increments when the company performs better, and they may get fired by the board if the company does not perform well. Arguably, it is the CEO traits relative to board of directors that may explain corporate performance. Since board of directors are responsible for making strategic decisions including decisions related to CEO compensation and corporate dividend payout policy, their impact on corporate strategic posture would be more pronounced in such decisions relative to performance outcomes. In the following sub-sections, we provide theoretical arguments and extend our research hypotheses, informed by the relevant literature.

There were 539 public listed companies categorised under 21 sectors and sub-sectors on the Pakistan Stock Exchange (PSX) in 2019. We removed all 17 financial companies and 255 companies with missing data for the period 2009–2019, providing us with a final sample of 267 non-financial companies from 12 sectors. This is the maximum study period possible as the PSX observed a floor in prices in 2008, which halted trading.

Table 1 provides details on the sample distribution and breakdown of publicly listed firms with military directors on their board across the non-financial sectors. It can be seen that the percentage of firms with military directors has slightly decrease over the years from 22% in 2009 to 17% in 2017 before increasing to 20% in 2019. Sector with the highest percentage of firm having military director is manufacturing (33%) followed by Information, Communication & Transportation (30%), which are both important sectors of the economy.

We collected financial data from DataStream and supplement this with firm-specific data, which was collected manually from annual reports retrieved from the sampled firms’ websites as well as the State Bank of Pakistan’s website. Data on corporate governance features, including data on military directors, was hand-collected from various sources such as annual reports, corporate governance reports, company bulletins, press releases, individual company websites, and local newspapers archives.

i. Dependent variables

Our first dependent variable addressed the agency cost proxy which is related to CEO compensation, as this is considered as the most appropriate proxy for agency costs that firms incur in monitoring to prevent manager’s self-serving behaviour (Elston and Goldberg 2003). Although earlier studies (e.g., Elston and Goldberg 2003; Li and Rainville 2020), have used three diverse proxies to account for agency costs related to CEO compensation, i.e., CEO total compensation, CEO salary-based compensation, and CEO bonus-based compensation, we only considered bonus-based compensations in this study as bonus are associated with level of performance while salary is usually fixed.

Prior studies have used various proxies for corporate dividend policy (see, Ye et al. 2019, among others): e.g., ratio of cash dividends to total assets and cash dividends to net income ratio, to name a few. Onali et al. (2016), however, advocate the use of dividend to equity ratio reasoning that the additional advantage of using equity in the denominator rather than earnings eliminates the problem of dealing with negative dividend payout ratios. Hence, we adopt dividend to equity ratio to proxy for the impact of military directors on corporate dividend policy.

ii. Independent variables

(a) Military directors’ attributes

Military directors are identified in the study based on profile information of each board member available on the company’s website. To be classified as military directors, they must have graduated from military academy or have served in the military. We also collect information on military directors’ education and networks. Hence, we have three proxies related to military directors to measure their impact in reducing agency costs: (i) presence of military directors is a binary variable with 1 if there is at least one military director as outside director on the board, and 0 otherwise; (ii) military directors’ education is a binary variable with 1 if the military outside director has business-related degree, and 0 otherwise; and (iii) military directors’ connectedness or networks which refers to the number of military directors on the board who sit on another board that has at least one military director.²

iii. Control variables

We use three sets of control variables: board attributes, agent/management attributes and firm-specific characteristics. Board attribute variables include board size, measured as the total number of directors on the board, and board independence, which is the number of non-executive directors scaled by board size (Chhaochharia and Grinstein 2009; Ye et al. 2019).

With regards to agent attributes, we considered two aspects that may affect compensation: (i) whether the CEO is classified as specialist or generalist, and (ii) CEO’s tenure. We used Custódio et al.’s (2013) CEO ability index to classify CEOs into specialist (CEOs with a narrower but deeper set of knowledge and skills) and generalist (CEOs with a broader set of knowledge and skills). Since longer serving CEOs may capitalise on their internal/organisational knowledge to influence board’s agenda and decision making, we therefore control for the CEO tenure based on the total number of years the CEO serves in the current firm (An et al. 2020; Li and Rainville 2021).

As for firm-attributes, we controlled for firm size, leverage, growth in sales and firm age as suggested by earlier studies (see, Benmelech and Frydman 2015; Güner et al. 2008; White et al. 2014, among others) to account for their potential impact on CEO compensation and dividend payout policy. Table 2 provides a summary of the operationalisation of the research variables in our study.

Consistent with the aims of our study, we tested the impact of military directors on agency cost related to CEO compensation and dividend payout ratio, while controlling for corporate governance and firm-specific variables. The two main equations tested using OLS fixed-effect multivariate regression were as follows:

In Eq. 1, we tested for only the bonus aspect of CEO compensation while in Eq. 2, we tested the ratio of dividend payout. βMilDirect refers to three attributes related to military directors which are of interest in this study, viz. presence of at least one military trained outside director on the board, presence of at least one military trained outside director on the board with business degree, and the ratio of military trained outside directors on the board with military connection with another board. \({\gamma CG}_{i,t}{\prime}\) and \({\delta X}_{i,t}{\prime}\) are controls for corporate governance (including both board and agent/management attributes) and firm-specific variables, respectively, while \({\theta }_{i}\) and \({\upeta }_{i}\) represent industry fixed effects and year fixed effects. \({\varepsilon }_{i,t}\) is the error term to mitigate the concern on omitted variables.

Table 3 presents the descriptive statistics for all research variables. As can be seen in column two, the mean values for the main dependent variables are as follows: CEO bonus-based compensation is Pakistani Rupee (PKR) 39,462,000 while the dividend payout ratio is 18.6%.

Turning to attributes of the military directors, it can be seen that 19% of the companies included in the sample have at least one military director serving on their boards, 20% of military directors graduated with a business degree and 32% of them have military connections in other boards. As for the corporate governance mechanisms, the results indicate that the average board size of sampled companies during the study period is 4 with 59% of the boards dominated by independent non-executive directors. Turning to agent heterogeneity, about 72% of the companies are led by specialist CEOs while the average tenure of CEOs working in current firm is 4 years with the longest tenure being 14 years. As for firm-related control variables, firm size and leverage have mean values of PKR426,782,000 and 54%, respectively. The mean growth in sales is 17% while the mean for firm age since inception is 17 years.

Table 4 presents the correlation matrix along with the multicollinearity diagnostics, using the variance inflation factor (VIF). The mean VIF value is 1.54 with a maximum and minimum of 2.72 and 1.01, respectively. The results indicate that there are no concerns of multicollinearity for the independent variables.

We use Eq. 1 to analyse the impact of military directors’ attributes on CEO bonus-based compensation and the results are reported in Table 5. The presence of at least one military director on the board is found to reduce CEO bonus compensation by 13.2% and it is statistically significant at the 1% level, thus supporting our hypothesis H_1a. This implies that the presence of at least one military director on the board is associated with a 12.4% reduction in CEO bonus compensation. In terms of economic significance, when military director on the board increases by one standard deviation, bonus compensation decreases by 5.7% relative to its mean.

With regards to military director’s education, results show a significant negative relationship, at the 10% level, between military directors with business degree and CEO bonus-based compensation, thus our hypothesis H_1b is weakly supported. Nevertheless, this implies that military directors with business background are well equipped to understand the complexity of corporate business and are well positioned to monitor and reduce agency cost. As for military directors’ network, results indicate no significant relationship with CEO bonus-based compensation, thus our hypothesis H_1c is rejected.

With regards to board attributes, only board size is positively and significantly associated with CEO compensation while for agent attributes, both specialist CEO and CEO tenure are positively and significantly associated with CEO compensation. As for the firm-specific control variables, only firm size and sales growth are positively and significantly associated with CEO compensation.

We perform additional analysis by classifying sampled firms into large vs small firms using the median of total assets as the cut-off point. Surprisingly, results reported in Table 6 indicate military directors’ presence on the board reduces agency cost only for large firms. The direction of the relationship remains unchanged for smaller firms, but the relationship is not statistically significant. These results suggest that the presence of military directors on boards of large companies are more effective in curtailing any excessive rent seeking behaviour by the agents, thereby reducing agency cost.

Likewise, military directors’ education background decreases agency costs only in large firms but for small firms, their presence actually increases agency cost. This is because small firms in Pakistan are closely held or family firms, thus the managers may have more sway on the strategic decisions relative to outside directors even if they have business background. As for the military directors’ connectedness/network, the analysis shows no statistically significant results across both models.

We use Eq. 2 to analyse the impact of military directors on corporate dividend policy viz. dividend payout ratio and Table 7 presents the results. The presence of at least one military director on the board increases the dividend payout ratio by 8.17% and it is statistically significant, at the 1% level, thus, supporting our hypothesis H_2a. This suggests that firms with at least one military director on boards tend to award greater dividend payout ratio of 8.17% than other firms. This impact is economically significant. Thus, the presence of at least one military director on board is associated with an 8.51% increase in dividend payout ratio. In terms of economic significance, when firms with at least one military director increases by one standard deviation, dividend payout ratio increases by 3.68% relative to the mean. The pronounced impact suggests that inclusion of military directors on corporate boards facilitates good governance and consequently promotes dividend payouts (Ye et al. 2019). Equally, these results strengthen the earlier arguments pertaining to the role of military in the economic revival of the country (Husain 2009) and the strategic placement of military-trained directors to corporate boards (Staniland et al. 2020) to boost investors’ confidence which may be reflected in higher market value.

With regards to education of military directors, results show a significant positive relationship, at the 1% level, between military directors with business degree and dividend payout ratio, thus, our hypothesis H_2b is supported. This implies that military directors with business background have greater influence on dividend policy. As for military directors’ network, results indicate a significant positive relationship, at the 1% level, thus, our hypothesis H2c is also accepted.

With regards to board attributes, both board size and board independence have significant effect on dividend payout with the former in negative direction while the latter in positive direction. The results imply bigger boards may not be an effective governance mechanism compared to board independence. It is also worth noting that the influence of board attributes for CEO compensation and dividend payout is different; bigger boards tend to award higher compensation but lower dividend payout while board independence only has positive effect on dividend payout. As for agent attributes, only specialist CEO is significantly related to dividend payout. With regards to control variables, only sales growth and firm age are positively related to dividend payout.

When splitting the data based on firm size, results in Table 8 show a significant positive relationship, at the 1% level, between presence of military directors and dividend payout regardless of size. This reaffirms our notion that military directors are more inclined to mitigate free cashflow opportunities that can be exploited by agents for their own interest at the expense of shareholders including in smaller firms. This finding adds new insights to prior related studies on dividend policy (Herron 2021).³ Military director’s education is strongly significant in the case of large firms but weakly significant in small firms. On the other hand, military networks are only significant for large firms. Overall, our results suggest that the presence of military directors on corporate boards, especially those with business qualifications and having more networks, can induce higher dividend payout ratio and reduce agency cost, and this is prominent in the case of larger firms.

Since profitable firms would offer more free cashflow opportunities for the agents to exploit, we therefore analyse the effects of military directors on corporate dividend policy in high profitability (high market value) relative to low profitability (low market value) firms. Results as reported in Table 9 reaffirm that military directors aid in reducing free cashflow opportunities and promote higher dividend payouts which consequently enhance market value. Their impact remains prominent for highly profitable (with higher market value) firms only.

Overall, the divergent impact of military directors on executive compensation and dividend payouts in our work relative to Li and Rainville (2020) for the former and Jaroenjitrkam and Maneenop (2022) for the latter results, provide new insights and extends the existing literature. Likewise, our analysis suggests that inclusion of military directors improves firm performance as reflected in higher profitability which consequently allow for higher dividend payout and boost the market value. The result is contrary to the earlier evidence of Jaroenjitrkam and Maneenop (2022), Kim et al. (2017) and Li and Rainville (2021) for Thailand, Korea and the US, respectively. This highlights the importance to consider the operating environment. More importantly, results observed in our work strengthen Kim et al.’s (2017) argument, who insists that directors exposed to military values develop a heightened sense of duty and ethics, however, these values are largely influenced by the environments in which they operate. Thus, findings observed in one socio-politico-economic environment cannot be generalised to another, especially, if there exist significant differences in terms of economic growth and the rule of law.