The Effect of Insider Control and Global Benchmarks on Chinese Executive Compensation

Abstract

Research Question/Issue: We investigate the effect of insider control from the managerial power perspective and the global\ud pay benchmarks from the behavioral approach on Chinese executive compensation.\ud Research Findings: Based on a balanced panel sample of 502 Chinese listed firms between 2001 and 2006, we find that both\ud CEO duality and CEO ownership exert significant influence on Chinese executive compensation contracting and they\ud contribute to the high level of executive compensation. We support the managerial power hypothesis by arguing that CEO\ud duality and CEO shareholding tend to entrench insider managers further to collude with government officials and extract\ud a firm’s assets. Shareholdings appear to actively restrain managers from serving their self-interests as to their pay levels,\ud including on the board independence and the supervisory board levels. However, private institutional shareholdings\ud perform actively in restraining managerial influence on the executive pay setting. There is an upward increase in the\ud executive pay levels due to the global pay benchmark effects introduced by foreign investment. The compensation committees’\ud decisions on executive pay levels are largely influenced by the global peer group’s pay levels, rather than linking\ud to firm performance as predicted by the optimal contracting model.\ud Theoretical Implications: We extend the optimal contracting model by incorporating the managerial power hypothesis to\ud demonstrate how insider control affects the Chinese executive pay setting. We also add a behavioral approach to reflect how\ud the global pay benchmarks affect the Chinese executive compensation setting via the negotiation between a firm’s compensation\ud committee and its managers.\ud Practitioner/Policy Implications: The Chinese government should consider exerting rigorous restrictions on executive\ud shareholding and management buy-out as an incentive for managers. In addition, the Chinese Code of Corporate Governance\ud should explicitly restrict CEO duality. The government should be aware of the potential influence of behavioral bias\ud in human decisions departing from rational economical criteria, and set policies to balance the benefits of introduction of\ud foreign investment against the costs of resultant excessive executive compensation, and the benefits of setting a compensation\ud committee as a corporate governance control device against the costs of the compensation committees working with\ud the executives together to increase the executive pay level

The impact of corporate governance on state-owned and non-state-owned firms efficiency in China

“…Kato and Long (2006a) find that executive cash compensation is positively related to firm performance and the pay-for performance link is weaker in State owned firms. Chen et al (2010) also demonstrate a positive correlation of pay to performance. Kato and Long (2006b) find that sales growth is significantly linked to executive compensation.…”

Social network contingency, symbolic management, and boundary stretching

“…Yet Peng (2004) has shown that appointing outside directors to board positions in Chinese firms often serves a symbolic purpose without actually improving corporate governance. In addition, Chen, Liu, and Li (2010), and Ding, Akhtar, and Ge (2006) showed that when Chinese firms set up CCs they tend to appoint directors who believe that CEO compensation should be based on comparison with global peer companies (that tend to pay their CEOs much more). This suggests that while in theory CCs are expected to improve monitoring and constrain CEO compensation, in practice CC members are selected with the intention of favoring higher CEO compensation.…”

How to Make Boards Work

“…They analysed the statistics for 502 Chinese listed SOEs from 2001 to 2006 and concluded that CEOs use their excessive board power to push executive compensation to a high level, which leads to the loss of state-owned properties. CEO duality is in a dominant position in smoothing business; however, it needs a sound legal system and mature financial markets, which are currently absent in China (Chen et al, 2010).…”

“…Since the 1990s, China has reformed its SOEs and has listed them in domestic and foreign stock exchanges (Chen et al, 2010). This reform is an innovative attempt to diversify SOE ownership and increase SOE independence.…”