Stock‐Based Compensation in a Concentrated Ownership Setting: An Empirical Investigation

• Date: 01 January 2016
• DOI: http://doi.org/10.1111/jbfa.12167
• Author: Chen Lung Chin,Jia‐Wen Liang
• Published date: 01 January 2016

Journal of Business Finance & Accounting

Journal of Business Finance & Accounting, 43(1) & (2), 131–157, January/February 2016, 0306-686X

doi: 10.1111/jbfa.12167

Stock-Based Compensation in a

Concentrated Ownership Setting: An

Empirical Investigation

JIA-WEN LIANG AND CHEN LUNG CHIN∗

Abstract: Stock-based compensation has been viewed as an important mechanism for tying

managers’ wealth to firm performance, and thus alleviating the agency conflict between the

shareholders and the managers when ownership is diffused. However, in a concentrated

ownership structure, controlling owners are usually the management of the firm; they can

engage in self-dealing activities to the detriment of minority shareholders’ interests. Yet, outside

investors may anticipate the problem and discount the share price for the entrenchment

behaviors they observe. In this study, we investigate how controlling owners trade off the benefits

and the costs of using stock-based compensation. Based on a sample of Taiwanese firms, our

evidence shows that stock-based compensation is negatively related to the agency problem

embedded in a concentrated ownership structure. This relationship is evident among firms with

more frequent equity offerings. Overall, our empirical evidence suggests that controlling owners

consider the negative price effects of stock-based compensation and trade off these costs with

the benefits of expropriating minority shareholders’ interests, particularly when firms seek more

external equity capital. Our results hold after controlling for selection bias and share collateral

by controlling owners.

Keywords: stock-based compensation, concentrated ownership, controlling owners and minority

shareholders, cash flow rights and voting rights

1. INTRODUCTION

Stock-based compensation has been viewed as an important mechanism for tying

managers’ wealth to firm performance, thus alleviating the agency conflict between

the shareholders and the managers (Jensen and Meckling, 1976). This perspective

∗The first author is at Department of Accounting, National Chengchi University. The second author is at

Department of Accounting, National Chengchi University. The authors thank the anonymous referee and

Steven Young(editor) for their insightful comments and suggestions. The authors are grateful for comments

from workshop participants at National Chengchi University and the 2009 American Accounting Association

Annual Meeting. The authors also acknowledge financial support from the National Science Council (NSC

95-2416-H-004-047-MY2). (Paper received November 2014, revised version accepted October 2015).

Address for correspondence: Jia-Wen Liang, Department of Accounting, National Chengchi University,No.

64, Sec 2, Chihnan Rd., Taipei, Taiwan 116.

e-mail: jiawen@nccu.edu.tw

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132 LIANG AND CHIN

stems from situations where managers own very little of the firms they manage.1

However, in many developed economies and emerging markets, agency conflict

between the controlling owners and the minority shareholders makes this agency

solution questionable.2Potentially, where controlling owners are also the management

of the firms, they can grant themselves excessive stock compensation to the detriment

of minority shareholders. Yet, outside investors may anticipate the problem and

discount the share price for the expropriation behaviors they observe or expect

(Fan and Wong, 2005). This study aims to investigate how firms with concentrated

ownership trade off the benefits and the costs of using stock-based compensation.

Recent research by Baek et al. (2012) suggests that the expropriation incentives

of controlling shareholders imply a relationship between corporate governance and

firm value. Yet, there is little empirical evidence on how controlling owners behave

when facing the trade off of expropriation benefits and the cost of decreased firm

value. Despite its potential benefit of incentive alignment between managers and

shareholders, the use of stock-based compensation has long been criticized for its

transfer of claims on equity from existing shareholders to employees, thereby diluting

the shareholders’ interest. Researchers have also shown that managers use stock

compensation for their own benefit (e.g., Yermack, 1997; Aboody and Kasznik, 2000).

This problem could be even more severe under a concentrated ownership structure

because the management group usually holds the largest blocks of the firm’s stock,

giving them control over the pay-setting process. When the management blockholders

possess control rights (voting rights) that exceed their proportionate ownership (cash

flow rights) in the firm, stock-based compensation becomes a potential expropriation

tool for depriving minority shareholders of their interests (i.e., for rent extraction).

However, such expropriation behavior can come at a price to the controlling owners

and the firms if outside investors anticipate the problem and thus discount the share

prices (Jensen and Meckling, 1976; Classens et al., 2002; Fan and Wong, 2005).3In

addition, it could increase the difficulty firms face when raising equity capital in the

future. Thus, an interesting question for investigation is how controlling owners trade

off the expropriation benefits and the costs of firm value deduction when using stock-

based compensation.

The present research uses a sample of Taiwan-based corporations. The motivation

for using Taiwanese firms stems from the following reasons. First, the relationship

between the ownership structure and stock-based compensation has been less studied

in a concentrated ownership structure context, and in Taiwan, a large percentage

of publicly traded companies have high concentration of ownership (see, e.g., Fan

and Wong, 2005). On average, various family groups control 78% of listed companies

on the Taiwan Stock Exchange. In 57.6% of family-controlled companies, the largest

1 Most empirical studies from this perspective examine the executive compensation contracts of large US

firms that are widely held. For example, Matsunaga (1995), Yermack (1995), Dechow et al. (1996) and

Hanlon et al. (2003), etc.

2 Concentrated ownership structure is still dominant among publicly traded firms globally, including such

places as the US, Western Europe, South and East Asia, the Middle East and Africa. Even in the US and the

UK, some of the largest publicly traded firms, such as Ford Motor, Sainsbury’s Supermarkets and Wal-Mart

Stores, have a highly concentrated ownership structure (see Burkart et al., 2003).

3 For example, Fan and Wong (2005) show that in East Asia economies, including Taiwan, controlling

owners introduce monitoring or bonding mechanism to mitigate agency problem between controlling

owners and minority shareholders.

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