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Review of Quantitative Finance and Accounting

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19.10.2018 | Original Research

The efficiency of compensation contracting in China: Do better CEOs get better paid?

verfasst von: Jack K. H. Fung, David Pecha

Erschienen in: Review of Quantitative Finance and Accounting | Ausgabe 3/2019

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Abstract

Over recent years, China adopted a number of ‘western-style’ reforms of corporate governance and executive compensation. We investigate whether boards of Chinese firms evaluate CEO ability and remunerate their CEOs accordingly, an essential tenet of efficient compensation contracting. Using Data Envelopment Analysis to measure CEO ability, we do not find any evidence that CEO ability matters in compensation contracting decisions—it does not lead to either higher pay, stronger pay-for-performance sensitivity, or a higher likelihood of equity grants. This is surprising, since we find evidence that higher ability CEOs achieve superior firm performance. In contrast, we find that powerful CEOs do not overperform, while they enjoy large abnormal pay. Overall, our results suggest that Chinese firms fail to embrace new corporate governance reforms and are unable to fully utilize the reforms’ benefits.

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We are grateful to an anonymous referee for this suggestion.

We exclude state-owned companies (SOEs) from our sample for a number of reasons. First, CEO pay as SOEs is highly regulated and the Chinese government issued a guideline suggesting SOEs to cap CEO pay in efforts to combat perceived income inequality. Additionally, it is widely accepted that CEOs of SOEs are largely driven by non-pecuniary incentives, such as the prospects of political promotion. While our sample is confined only to non-SOEs, the Chinese government is still likely to play a major role in the firm’s overall performance and efficiency.

A detailed review of the development of the Chinese stock market during its first decade can be found in Cheng (2009). Furthermore, a comprehensive review of China's financial system can be found in Allen et al. (2012).

To assure robustness, we also construct an alternative measure of political connectedness based on the number of politically connected managers the firm employs, and another based on the fraction of top managers who are politically connected. Additionally, we also employ several alternative definitions of being or having been a government official. While in the baseline specification, we consider all government official positions, we also try restricting our definition to higher level government positions (i.e. county level official or above) or only to top level government positions (i.e. Communist Party of China Central Committee or National People’s Congress). Our findings are robust to using any of the above specifications.

Alternatively, we also define a government favourite to be any firm within the top decile of state ownership within its industry and province. We also use a rank variable, where firms receive a rank/score between 0 (lowest) and 1 (highest) according to their state ownership stakes. We obtain consistent results.

Even though all our firms are non-SOEs and the government is not their controlling shareholder, we still believe the degree of ‘closeness’ to the government varies proportionally with the size of the minority stake the government retains.

We use 2016 accounting data for our measure of future performance.

A shares are denominated in local currency, RMB, and constitute the bulk of market capitalization of Chinese stock markets. In contrast, B shares are listed in foreign currency and target foreign investors.

The dataset we use in our robustness check consists of a total of 4671 firm-year observations and spans a period of 5 years between 2007 and 2011.

A casual observation suggests that most boards have three independent directors and a major driver of the variation in board independence levels is simply whether the board has nine members (33% independence) or is temporarily down to seven or eight members (43% and 38% independence, respectively) while new non-independent board members are still awaiting approval. This interpretation would be in line with the theme that while Chinese firms diligently comply with new corporate governance regulations, they do not always appear to embrace them in spirit and often implement these regulations uniformly without significant adjustments based on individual firm characteristics and circumstances.

Due to the high risk that equity pay imposes on executives, equity compensation amounts have to significantly exceed the amounts of comparable risk-free salary payments that would deliver the same level of utility to risk-averse managers. Furthermore, although equity-based compensation is officially encouraged by the Chinese regulatory bodies, it is still sometimes perceived negatively in political circles.

We follow consistent definitions of all our variables but we adjust the second step of our CEO ability estimation technique: specifically, we no longer include measures of government power as the required data are unavailable for a significant fraction of our robustness sample (our methodology for estimating CEO ability requires the same set of control variables for the entire estimation sample).

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Titel: The efficiency of compensation contracting in China: Do better CEOs get better paid?
verfasst von: Jack K. H. Fung
David Pecha
Publikationsdatum: 19.10.2018
Verlag: Springer US
Erschienen in: Review of Quantitative Finance and Accounting / Ausgabe 3/2019
Print ISSN: 0924-865X
Elektronische ISSN: 1573-7179
DOI: https://doi.org/10.1007/s11156-018-0765-y

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