Academic journal article The International Journal of Business and Finance Research

Executive Compensation Stickiness and Peer Group Benchmarks: Evidence from Chinese Firms

Academic journal article The International Journal of Business and Finance Research

Executive Compensation Stickiness and Peer Group Benchmarks: Evidence from Chinese Firms

Article excerpt

ABSTRACT

This paper examines the phenomenon and effect of peer group on executive compensation stickiness in China's listed firms. We find there has been substantial growth in executive compensation in the past 10 years. Consistent with agency theory, executive compensation is positively related to firm performance. However, pay-for-performance sensitivity is asymmetric, and it is lower when firm performance declines suggesting that there is a characteristic of executive compensation stickiness in Chinese firms. Further, we test the effect of peer group on compensation stickiness. We find that the characteristic of compensation stickiness only exists in the firms whose executive compensation is lower than the compensation of peer group. The evidence suggests that compensation stickiness is an important mechanism to provide retention incentives to firm managers, rather than an agency problem in Chinese firms.

JEL: G34

KEYWORDS: Corporate Governance, Pay-For-Performance Sensitivity, Peer Group, Compensation Stickiness

(ProQuest: ... denotes formulae omitted.)

INTRODUCTION

There are two main strands of research on the relationship between executive compensation and firm performance. The first focuses on the effects of compensation as a tool to decrease the agency cost, and they suggest that the compensation of managers should be linked to firm performance to motivate CEOs to maximize shareholder value (Jensen and Meckling, 1976; Jensen and Murphy, 1990; Murphy, 1999). The second strand focuses on the effects of the managerial power on the compensation, and they suggest that managers use their power to influence the compensation-setting process and acquire more compensation than on the basis of firm performance (Bebchuk et al, 2002; Bebchuk and Fried, 2004). In recent years, some scholars have begun to research on the compensation stickiness, which means the relationship between executive compensation and firm performance is asymmetric where managers are rewarded more for good performance but are punished less for bad performance. They point out that the compensation stickiness is a representation of the problem of corporate governance, and it is harmful to the value of companies (Garvey and Milbourn, 2006; Fang, 2009).

The purpose of this study is to investigate the phenomenon of executive compensation stickiness, and understand the implication of compensation stickiness in Chinese firms. China began a process of market economic reforms in the late 1970s and these reforms are being continued today. The reform process has brought about substantial changes in institutional arrangements for top executive compensation. Prior to market economic reforms, there was a highly structured pay scale system for the managers (Firth et al., 2006), and it had no incentive mechanism to motivate managers. Therefore, early studies do not find any relationship between executive compensation and firm performance in China (Huang and Zhang, 1998; Wei, 2000). With the enactment of the Company Law and The Code of Corporate Governance for Listed Firms in China in 2002, executive compensation had a major impact, and executives were allowed to share in the profits generated by the companies. Most executive pay is composed of cash salary and bonus at present, and performance based pay is common in China, although very few firms have executive stock option schemes (Firth et al., 2006; Fang, 2009). According to a survey, more than 80% of the firms use incentive pay systems based on performance (Liu and Otsuka, 2004). These reforms on executive compensation are conducive to aligning interests of managers and owners. A series of recent studies reported a positive relationship between management pay and firm performance after the compensation reforms (Firth et al., 2006; Conyon, 2011; Cao, 2011).

Despite China having introduced market reforms some 30 years ago and having become the largest emerging economy with the fastest growing stock market, corporate governance and compensation of top executives are still at the developmental stage. …

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