Revisiting Executive Pay, Firm Performance, and Corporate Governance in China.
The size, growth and strength of Mainland China's economy, since her early-1980 reform, have been attracting attentions from economists and businesspersons worldwide. China's Gross Domestic Products has been become only next to that of the US since 2010, and her total trade in tangible goods has taken the global lead since 2013 (currently as the top exporter and the second importer in the world).
Different from her Western counterparts, China's economy receives strong driving and supporting powers from her large numbers of State-Owned Enterprises (SOEs), which have been partially privatized/securitized and listed on the Chinese stock exchanges, yet still under the indirect influence or even direct control of governmental authorities. Such reforms have changed Chinese corporate governance features such as their management structure and board composition of directors, thus enabling Chinese firms to operate more efficiently yet without losing the importance of state governance in the remaining largest "socialism economy" or "state capitalism economy" (Chen et al., 2006; Firth et al., 2006 and 2007). It is interesting for international corporate researchers to explore how such unique characteristics can affect the setting of management wages and bonuses in Chinese firms, which have been argued to what extent they belong to a market economy according to the Western standards.
Our study focuses on the interactions among Chinese management compensation, firm performance and corporate governance between 2009 and 2015. In 2009, Beijing starts imposing the pay restriction policy on CEOs of those SOEs administered by the central government, possibly twisting the pay-for-performance relation from then on. Furthermore, the Chinese stock market, even though experiencing upturns and downturns since its opening in 1990, have not yet suffered such a dive as deep as that in the late October of 2008, down more than 72% from peak to trough of the market cycle. The Chinese stock market indices gradually recovered since then, abruptly rising about 50% during 2014, climbing another 60% in the first six months of 2015, and then melting down by about 50% within the following three months. (The Chinese stock market thus stayed bearish until early 2019.) Our empirical research hence covers the most recent full cycle of "(after-trough) expansion --peak--contraction--trough" experienced by Chinese stock market. The management pay-for-performance link can be evaluated on the basis of accounting performance measures (e.g., asset utilization efficiency and profitability ratios) in combination with financial market terms (e.g., stock price returns). However, as the Chinese stock market is aptly described as highly volatile, speculative or even casino-like (He et al., 2019), the stock returns could deviate considerably from corporate operating performance, it is thus necessary to examine at least a full market cycle in attempt to better estimate the Chinese CEOs' pay-for-performance association. Yet to our knowledge, there has been no prior published works that concentrate on this most-recent stock market cycle for exploring the Chinese CEO pay interactions with firm performance and corporate governance. We thus attempt to fill this gap.
According to the agency cost theorem (e.g., Jensen & Meckling, 1976) for maximizing owners' wealth, firms try to design their executive compensations so as to motivate their management and prevent moral hazards (Jensen & Murphy, 1990). US executive pay is positively associated with subsequent firm performance, showing a significant incentive effect (e.g., Fong et al., 2010; Frydman and Saks, 2010; Conyon, 2014). In such studies, US executive compensations are proxied in three measures: total compensation with the expected value of option granted to executives, total compensation with the realised value from exercising the stock options, and the total cash compensation. Firm performance is measured in accounting profit abilities (such as ROA) and stock returns. Shue & Townsend (2017) strongly support that US corporate executives are highly paid but not overpaid for performance, with being monitored effectively and rewarded fairly by their board of directors. Frydman & Papanikolaou (2018), however, argue from a new angle that US CEOs' pay level is not justified by their corporate progress in technological innovation.
Fernandes et al. (2013), after comparing US firms with their counterparts in fourteen other developed economies, argue that "U.S. and non-U.S. CEO pay has largely converged in the 2000s" (p. 323). Some other prior studies (e.g., Huttenbrink et al., 2014; Burns et al., 2015; De Cesari & Ozkan, 2015) find that both EU and US firms employ shareholder protections, disclosure requirements, ownership concentration, independent board, dividend payout policy, and/or pay-for-performance compensation plans to substitute or complement each other, and all such methods can effectively help to reduce agency costs. As for the incentive effect of European executive pay, Ozkan (2011) used stock price return to represent UK firm performance during the 1999-2005 period, observing a positive pay-for-performance link of UK executives, even though such an elasticity of British firms is smaller in magnitude than that of American counterparts. When it comes to the relevance of corporate governance mechanism, Croci et al. (2012) suggest that across 14 Continental European countries, their CEO compensation level is positively and significantly affected by the presence of institutional ownership (especially foreign institutional ownership) but insensitive to the presence of family control.
However, concerning Japanese corporations, Nakazato et al. (2011) find that: i) After adjusting for firm size and externalities, Japanese executives averagely earn 20% less than their American counterparts; ii) Japanese executive incomes are significantly associated with firm size and accounting profitability, but not with the stock returns; and iii) The more concentrated ownership structure and/or board governance, the less the Japanese corporate executives get paid. Pan & Zhou (2018) also reaffirm that the gap between Japanese and American executive pays is too significant to be explained by differences in stock-based compensation plans, while the Japanese executive pay-performance elasticity appears to be weak. On the other hand, researchers (e.g., Basu et al., 2007) do find evidence in large Japanese firms that top executives tend to receive less "excess pay" with stronger corporate governance mechanisms (e.g., more dispersed ownership, less family control, larger board size, and more outside director members). Moreover, the level of such excess pay is negatively correlated to subsequent accounting performance such as ROA, but irrelevant to subsequent stock return performance.
In addition to corporate performance factors and corporate governance variables, researchers also find that in developed economies, some firm-specific characteristics, especially firm size, can considerably add to the explanatory power of executive pay level and/or the pay-performance sensitivity (for US firms--Baker et al., 1988; Schaefer, 1998; Core et al., 1999; Fong et al., 2010; Van Essen et al., 2015; for European firms--Croci, et al., 2012; for Japanese firms--Nakazato et al., 2011; Pan & Zhou; 2018), suggesting that large firms should either be able to attract the most talented CEOs, or be subject to heavier agency problems and greater managerial influential power, thus their CEOs tend to obtain greater compensation. However, it is also interesting to observe by some researchers (e.g., Gabaix & Landier, 2008; Gabaix et al., 2014) that even though large US firms tend to pay their top executives more generously, yet such performance-adjusted executive pay is economically justified without a significant presence of excess compensation, whether before or after the outbreak of 2008 Great Recession.
Compared with the US, EU and Japan, China operates a unique economic system that combines both market competition freedom and state planning and control (Carpenter & Whitelaw, 2017). Only after 2005, Chinese exchange-listed corporations have been required for the public disclosure of individual executive compensation information (Conyon & He, 2011). Since the introduction of contract responsibility system (CRS) in the 1980s, the management in state-owned enterprises (SOEs) can receive off-salary bonuses which are extracted from the retain earning in case of firm well performing. The CEO payment structure is decided by the board of directors. The adding of stock-based incentive compensation (e.g., stock options and warrants) to CEOs was initially proposed in 1999 by China's Central Government, but after collecting and evaluating opinions of economic experts, the stock-based compensation plan was withdrawn, mainly due to the lack of sources for executive cashing out or exercising the stock options/warrants to repurchase shares (Chen et al., 2009). Even by now, the Chinese equity option/warrant market is still very limited in comparison with stock markets and stock index markets. As a result, Chinese corporations, especially SOEs, still determine their executive pay-for-performance reward system largely by the means of explicit profit sharing or even some implicit undisclosed benefits but remain very unusual to reward CEOs by the means of equity incentive (Jiang et al., 2016). Regarding Chinese board structure, since 2003 it becomes obliged that at least one-third of the board must be independent directors, who cannot be relatives of any manager, be one of the top 10 shareholders, hold more than 1% of the company shares, or have a business relationship with the firm.
When it concerns the effectiveness of Chinese CEO pay-for-performance link and corporate governance, Firth et al. (2007) find that executive compensation...
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