CEO Effects on Firm Performance in China: The Role of Incentives, Firm Governance Arrangements and CEO Human Capital

Lead Research Organisation: National Institute of Economic & Soc Res
Department Name: National Institute of Economic & Soc Res

Abstract

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Publications

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Alexander John Bryson (Author) (2012) CEO bonding : who posts performance bonds and why?

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Bryson A (2013) The Chinese Economy: Introduction in National Institute Economic Review

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Bryson A (2014) Who posts performance bonds and why? Evidence from China's CEOs in China Economic Review

 
Description For many in the West China remains a paradox: a single-party Communist state with a vibrant, thriving economy set to challenge the United States in the coming decade. Some have questioned the sustainability of the Chinese economic growth miracle in the absence of fully-fledged democracy and root-and-branch market reforms. But others point to state-sponsored decentralised market reforms over the past three decades as the key to China's success (Xu, 2012).

In the first decade of the twenty-first century China's GDP grew by 250%. The engine behind its growth was the public listed sector. Its output grew nearly eightfold, accounting for 43% of total Chinese GDP by 2010. Yet little is known about CEO compensation in China's listed firms. Using accounting data for all publicly listed companies listed on the Shanghai and Shenzhen stock exchanges between 2001 and 2010 we examined trends in cash and bonuses among Chief Executive Officers (CEOs) and other board executives (Bryson et al., 2014).

In the West the controversy over executive pay has been febrile, with questions raised as to whether those at the top really deserve to be earning so much more than the rest (Picketty, 2014). We find cash and bonus compensation has been rising rapidly in China, just as it has been in the West. Although cash and bonus compensation for top executives remains well below what Western executives earn (mean compensation stood at US$129,399 in 2010), it has been rising very rapidly, doubling between 2005 and 2010 (Table 1). These earnings are highly sensitive to firm performance and became more so between 2001 and 2010, thus ensuring that CEO fortunes are tied to shareholder interests. The strength of the pay-performance link is similar to that in Europe - even though the country remains a Communist regime with state control of the largest firms. However, the pay-performance sensitivity is lower than in the United States.

As in the West, those running the largest firms are paid the most, in accordance with the principles of a market that allocates the most talented people to the job slots where their productivity has the greatest impact. The sensitivity of pay to firm size is of the same magnitude as that found in classic US studies of the 1980s (Rosen, 1990). Big differentials between top executives mimic the 'tournament' pay structures in the West, creating strong financial incentives for executives to move up the corporate ladder.

In contrast to the West, the state often plays an important role in China's listed firms, either through its direct ownership stake or via the Communist Party which plays an important role in the recruitment and promotion of CEOs and other top executives (Li et al., 2007). But this is also changing. China undertook a massive privatisation programme between 2001 and 2010. The percentage of publicly listed firms that were majority state-owned fell by almost half to 45%. Executive compensation rose markedly in privatised firms - by around 5% in those firms privatised between 2002 and 2010 relative to those whose ownership did not change - just as it had done during privatisation drives in the West in the 1980s (Wolfram, 1998).

Ever since Bebchuk and Fried (2004) argued CEOs are able to exploit their managerial power to extract rents, economists in the West have worried about CEOs' ability to "skim" profits from firms, particularly when there are weak corporate governance structures in place. There have been moves towards better corporate governance in China's listed firms in recent years but it is clear that China's CEOs are able to 'skim' company profits when corporate governance is poor. CEOs get a 10% premium if they start sitting on the compensation committee that determines their earnings and they get a similar premium if they become chairman of the board as well as CEO. This role for managerial power in executive pay setting may reflect the recency of the Stock Market and the regulations underpinning corporate governance.

As Linda Yueh (2011) has argued, future growth in China may depend on the pace of legal and institutional reform. Yet, in so many ways, it would appear the CEO labour market in China has more similarities with the CEO labour market in the West than it does differences. For better or worse, some elements of executive compensation seem to transcend national economic, political and cultural differences.

References

Bebchuk, L. and Fried, J. (2004) Pay without Performance: The Unfulfilled Promise of Executive Compensation, Cambridge: Harvard University Press

Bryson, A., Forth, J. and Zhou, M. (2014) "Same or Different? The CEO Labour Market in China's Public Listed Companies", The Economic Journal, 124, F90-F108

Groves, T., Hong, Y., McMillan, J. and Naughton, B. (1995). 'China's evolving managerial labor market', Journal of Political Economy, vol. 103(4), pp. 873-92

Li, H., Liu, P. W., Zhang, J. and Ma, N. (2007) "Economic Returns to Communist Party Membership: Evidence from Urban Chinese Twins", The Economic Journal, 117: 1504-1520

Piketty, T. (2014) Capital in the Twenty-First Century, Harvard University Press

Rosen, S. (1990) "Contracts and the Market for Executives", NBER Working Paper #3542

Wolfram, C. D. (1998) "Increases in Executive Pay Following Privatization", Journal of Economics and Management Strategy, 7, 3: 327-361

Xu, C. (2011) "The Fundamental Institutions of China's Reforms and Development", Journal of Economic Literature, 49, 4: 1076-1151

Yueh, L. (2011) "The Chinese box: the opaque economic borders of the Chinese state", Oxford Review of Economic Policy, 27, 4: 658-679
Exploitation Route There have been further developments - both political and economic - which affect the size of the public listed sector in China and the mix of compensation options available to pay executives which mean this topic should be the subject of further research.
Sectors Aerospace, Defence and Marine,Agriculture, Food and Drink,Chemicals,Communities and Social Services/Policy,Construction,Creative Economy,Digital/Communication/Information Technologies (including Software),Education,Electronics,Energy,Environment,Financial Services, and Management Consultancy,Healthcare,Leisure Activities, including Sports, Recreation and Tourism,Manufacturing, including Industrial Biotechology,Pharmaceuticals and Medical Biotechnology,Retail,Security and Diplomacy,Transport,Oth

 
Description CEO bonding : who posts performance bonds and why? (NIESR internal seminar) 
Form Of Engagement Activity Participation in an activity, workshop or similar
Part Of Official Scheme? No
Geographic Reach National
Primary Audience Participants in your research and patient groups
Results and Impact NIESR internal seminar

Developed our thinking for the analysis
Year(s) Of Engagement Activity 2012
 
Description CEO incentive contracts in China : why does city location matter? (NIESR internal seminar) 
Form Of Engagement Activity Participation in an activity, workshop or similar
Part Of Official Scheme? No
Geographic Reach National
Primary Audience Participants in your research and patient groups
Results and Impact Although China is now the second largest economy in the world, we know little about what influences the use of executive incentives outside the public listed sector. This paper is the first to examine incentive contracts for CEO's across all sectors of the economy. We do so using World Bank enterprise data for 2005. We show that incentive contracts are commonplace but that their incidence varies significantly across Chinese cities. We test two alternative hypotheses to explain the pattern of incentives across China's cities, one relating to the differential rate of foreign direct investment (FDI) into China's cities, the other relating to the rate at which SOEs were privatised. We find CEO incentive contracts are positively correlated with the speed with which cities privatised their SOEs and negatively correlated with the introduction of FDI via Special Economic Zones (SEZ's).

Helped us deveop our thoughts on the paper
Year(s) Of Engagement Activity 2012
 
Description Same or Different? The CEO Labour Market in China's Listed Companies (Brunel) 
Form Of Engagement Activity A talk or presentation
Part Of Official Scheme? No
Geographic Reach National
Primary Audience Participants in your research and patient groups
Results and Impact A priori it is unclear whether empirical findings on the nature of CEO compensation based on Western developed economies should generalise to the compensation of top executives in China's listed companies. Although China is developing a market-oriented economy it remains a Communist regime in which the state continues to own the largest companies. Using linked employer-employee data for all of China's public listed firms over the period 2001-2010 we find compensation for CEO's exhibits many of the traits familiar in the Western literature, although sometimes in a more muted way, and with some clear exceptions. There appears to be something about executive jobs and how they are managed which transcends national economic, political and cultural differences. The implication is that the Western model is not as unique or indeed dysfunctional as critics suggest.

Finalised paper for publichation
Year(s) Of Engagement Activity 2013
URL http://www.brunel.ac.uk/sss/economics/news-and-events/events-calendar/ne_306465/_nocache
 
Description The market for executives in China's public listed companies (CEP Labour Workshop) 
Form Of Engagement Activity A talk or presentation
Part Of Official Scheme? No
Geographic Reach National
Primary Audience Participants in your research and patient groups
Results and Impact Presentation at Centre for Economic Performance, LSE, in Labour Workshop Series

developed our thinking on the paper
Year(s) Of Engagement Activity 2012
 
Description The market for executives in China's public listed companies (Hangzhou Conference, China) 
Form Of Engagement Activity A talk or presentation
Part Of Official Scheme? Yes
Geographic Reach International
Primary Audience Participants in your research and patient groups
Results and Impact Paper presented at NIESR/Zhejiang Workshop, Hangzhou, China

Solidified and extended research collaboration network
Year(s) Of Engagement Activity 2012
 
Description What do we know about China's CEOs? : evidence from across the whole economy 
Form Of Engagement Activity Participation in an activity, workshop or similar
Part Of Official Scheme? No
Geographic Reach International
Primary Audience Participants in your research and patient groups
Results and Impact All that we know about the CEO labour market in China comes from studies of public listed companies and state-owned enterprises (SOEs). This paper is the first to examine the operation of the CEO labour market across all sectors of the Chinese economy. We do so using World Bank enterprise data for the first part of the 21st Century. Incentive schemes are commonplace throughout the economy and include contracts linking CEO pay directly to firm performance, annual bonus schemes, the posting of performance bonds, and holding company stock. These incentive mechanisms appear to complement rather than substitute for one another. The elasticity of pay with respect to company performance is one or more in two-fifths of the cases where CEO's have performance contracts, suggesting many face high-powered incentives. CEO's also face a real dismissal threat and financial penalties if they fail to deliver. Incentive contracts are used to attract the most talented executives, as indicated by educational attainment and position in the Communist Party. However, government involvement in the appointment of a CEO reduces the likelihood that the CEO will receive an incentives-based contract, perhaps because governments appoint "bureaucrats" to perform roles which incorporate social and political as well as economic goals. Firms with good corporate governance are more likely to deploy incentive contracts. A picture emerges of a well-functioning labour market for executives in China that exhibits many of the traits common to CEO labour markets in the West.

Building of research network
Year(s) Of Engagement Activity 2013
 
Description Who Posts Performance Bonds and Why? Evidence from China's CEOs 
Form Of Engagement Activity A magazine, newsletter or online publication
Part Of Official Scheme? No
Geographic Reach International
Primary Audience Participants in your research and patient groups
Results and Impact audio slides to accompany our China Economic Review paper on performance bonds



http://audioslides.elsevier.com//ViewerSmall.aspx?source=1&doi=10.1016/j.chieco.2014.03.001

reaching out to economists in China and elsewhere informing them of results.
Year(s) Of Engagement Activity 2013