Deferred Executive Compensation Policies
in Chinese State-owned Enterprises
Deferred Compensation in China
Deferred executive compensation policies are well-established in developed countries.Deferred executive compensation is any arrangement providing payment to an executive in a year or years subsequent to the year in which profit is earned, different from a standard compensation policy in which payment is based on current revenue. Lazear (1998) evaluates deferred executive compensation policies, and states that workers who are paid less than they are worth when young and paid more than they are worth when old appear to be more active in companies. Therefore, the deferred compensation policy is a long-term incentive policy, which keeps qualified managers in the current company, induces them to perform at a higher level of effort, and ultimately benefits the firmrsquo;s long-term performance.
The application of deferred executive compensation policies in China is still in its infancy. China started to reform its industrial sector in the 1980s. The government aimed to change the corporate governance structure by introducing various “managerial responsibility systems”. Managers of SOEs have been granted power to make business decisions and have been provided incentives in the form of bonuses that are tied to firm performance. Many SOEs have adopted this form of personal contract to establish new systems of compensation rules. Typically, personal contracts are signed by enterprise managers as individuals or by a management team. The contracts require managers to meet certain performance indicators and create a structure of rewards and penalties. Generally,profitability is a performance indicator and is often listed as the most important performance indicator.
In current Chinese SOEs, the yearly salary system (YSS), implemented in 1992, is the most successful form of executive compensation reform. In 1992, the State Council approved a pilot program by the Shanghai Hero Pen Company. By 1994, Beijing, Shenzhen, Henan,Sichuan and Liaoning had also commenced their own pilot programs, followed by the national program implemented in 100 large SOEs throughout the country. Generally, there are two parts in a YSS: a fixed component as base salary, which is based on the average wage for ordinary employees and the enterprise size, and a variable component as risk bonus, which is generally related to firm performance. However, compared with the level of responsibility, risk and contribution undertaken by managers, the average level of executive compensation in Chinese SOEs is still far from sufficient (Kato and Long, 2004).
With the massive influx of foreign investment, different kinds of executive compensation policies from developed countries have been gradually applied in China. Chinese SOEs have tried all sorts of methods of executive compensation, including yearly salaries, piece rates, commissions, stock options, bonuses, stock grants, profit sharing, team-bonuses,managerial security deposits and deferred compensation. Currently, Chinese SOEs typically have strong revenue growth. Therefore, it is in the organizationrsquo;s interest to adopt deferred compensation as the major part of its executiversquo;s total compensation package. Deferred compensation can also serve as “golden handcuffs” because executive exchange current cash for the promise of a future higher payment as a result of the regressive nature of Chinarsquo;s tax structure.
Basically, the Chinese Government and managers of SOEs make an agreement that part of the risk bonus in a specific year will be paid to managers in subsequent years. Managers do not need to pay tax for the whole earnings in the given year, because the tax on deferred payment can be delayed until they receive the payment. Even at the time when managers receive the deferred earnings, they might enjoy a lower tax bracket.
For Chinese SOEs, two forms of deferred compensation exist. One form is where the government sets aside some part of a managerrsquo;s bonus and converts it into company stock, which will be saved in a definite account, and the manager cannot sell it until he or she leaves their current post or retires. Before managers get control over their stocks, the voting right of those stocks is reserved by the government, while managers enjoy the dividend of those stocks. This deferred compensation is widely adopted in Wuhan, Hubei province (Lv, 2001), but still has limited utility in the developing market system of China.
The other method of deferred compensation does not involve stock or stock options.Instead, the government puts aside portions of yearly bonuses, which are based on over-fulfilled revenue. Cash bonuses will be uniformly provided to managers year by year. In other words, this device allows SOE managers to enjoy a pre-decided quota of the yearly over-fulfilled revenue, which is the part of real revenue that exceeds the requirement of managerial contracts. However, managers cannot access the whole payment right way, but only gain a certain percentage per year based on the current yearly over-planned revenue.Consequently, this method forces managers to be concerned about the long-term financial condition of their enterprises. The latter method of deferred compensation is currently the dominant method in China.
How can Corporate China Improve Labor Relations
while Enhancing Competitiveness?
Describe
Low labor costs are a key comparative advantage for Chinese enterprises when participating in international competition. Along with the sustained rapid expansion of Chinarsquo;s economy, it is inevitable for labor costs to rise in tandem with growth. Labor compensation in corporate China has increasingly become a hot-button issue garnering worldwide attention.Using comprehensive survey data,the author presents a comprehensive analysis of corporate Chinese labor compensation, and its influence on labor
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Deferred Executive Compensation Policies
in Chinese State-owned Enterprises
Introduction
With interest regarding executive performance and compensation increasing worldwide, there have been extensive studies on different executive compensation policies since the 1970s. Researchers have investigated the mechanisms and incentives of different compensation policies. In particular, many researchers have focused on levels of pay, pay-performance sensitivity and compensation packages (Gibbons and Waldman, 1999; Murphy,1999). The majority of the existing published literature on executive compensation focuses on developed countries, where labor markets are more mature than in developing countries. However, few studies have been conducted in transition economies like China, which is experiencing massive institutional changes and reforms. Therefore, it is of considerable importance to study the provision of incentives through executive compensation in the context of the Chinese market.
In China, starting in the 1980s, the government implemented a series of experimental industrial reforms, especially for Chinese state-owned enterprises (SOEs) given the significant role in the economy(Naughton, 1995;Yang, 1997; Megginson and Netter, 2001).Several studies that have investigated the impact of reform on the productivity of Chinese SOEs suggest that performance has improved since the reform (Chen et al., 1988; Dollar,1990; Woo et al., 1994). Of concern to the government is the design and implement of an executive compensation policy to provide appropriate incentives for managers and to reduce the possibility of opportunistic behavior. Packages involving stock and stock options are found to be the most effective methods for executive compensation because they solve the main principal–agent problems (McNeil, 2004). However, the use of such methods is still in the early stages in China because of political policies and the immature market environment. At present, the dominating compensation policy adopted by Chinese SOEs is the deferred executive compensation policy in which compensation is contingent on future firm revenue. This policy shares some ideas with stock and stock option polices, and it can be regarded as an elementary format of these policies. To date, there are only a few studies on the deferred executive compensation policy conducted in China. Therefore, whether this policy can provide sufficient incentives for management teams is still subject to debate.
In the present study, we aim to analyze the application of principal–agent theory by Chinese SOEs and to investigate the incentives provided by the deferred executive compensation policies in China. This paper attempts to contribute to the published literature by deriving a feasible model of executive compensation policies adopted by Chinese SOEs and by evaluating the effectiveness of deferred compensation policies. The findings suggest that managersrsquo; effort levels are increasingly monotonic. More importantly, deferred compensation policies offer incentives for managers to invest in profitable long-term investment, which can generate revenue after managerial contracts terminate. This paper demonstrates the effectiveness of Chinese SOEs adopting deferred compensation policies.
The remainder of the paper is organized as follows. Before proceeding to the details of our model, Section II presents a literature review in the research field of executive compensation. A description of the primary reforms taken in the 1980s in China is discussed in Section III. In Section III, the main idea of compensation contingent on future revenue policy is also examined. Finally, Section IV summarizes the paper and presents further speculations on the process of evolution of the Chinese managerial market.
II. Literature Review
Research on executive compensation and the provision of incentives to corporate managers reveals that appropriate incentives to management teams can dramatically affect the return to shareholder wealth. Therefore, it is important to develop reasonable and effective incentive policies for executives. As a result of the separation of ownership and management in modern corporations, conflict of interest among different shareholders, especially between owners (the principal) and managers (the agent), has attracted the attention of researchers and practitioners. The principal–agent problem is simple because the principal only needs to consider the maximization of the firm profit after paying executives. However, misleading information and conflict of interest make appropriate incentive provisions necessary. In an incentive contract referred to as “alignment of interest”, which relates the interests of the principal with the agent, the agent is induced to act in a way to benefit the principal. Previous research suggests that the most efficient way to solve the principal–agent problem is to determine executive payments based on a firmrsquo;s long-term performance, which makes a deferred compensation policy necessary (Coughlan and Schmidt, 1985; Murphy, 1986;Abowd, 1990;Jensen and Murphy, 1990;Leonard, 1990). The published literature on deferred compensation has primarily investigated the advantage of tax deferral and retirement. Generally, the policy of deferred compensation benefits executives, employees and employers in aspects of wealth accumulation, control and cost (Wallach, 2003).
Among studies on contractual types that provide optimal incentives, the linear contract is widely used in empirical studies for its tractability in testing either incentive strength (Jensen and Murphy, 1990) or other implications, such as risk aversion and relative performance evaluation hypothesis (Aggarwal and Samwick, 1999). Berhold (1971) analyses the basic framework of the general linear profit sharing program and shows that such a compensation schedule could provide mutual benefits for both the principal an
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