Transcript Performance and Compensation – evidence of optimal

Performance and Compensation –
evidence of optimal contracting
by Sun, Li and Liu
Discussant: Oliver M. Rui
The Chinese University of Hong Kong
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Overview
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This paper studies the relationship
between executives’ compensation and
ROE using the data of listed firms in
China to test the optimal contracting
hypothesis.
The results support the hypothesis after
controlling for the governmental
interference and related party
transaction.
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Compensation measure
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The optimal contracting approach states
boards are assumed to design compensation
schemes to provide managers with efficient
incentives to maximize shareholder value.
Most executive pay packages based on the
optimal contract hypothesis contain four basic
components: a base salary, an annual bonus
tied to accounting performance, stock options
and long-term incentive plans (including
restricted stock plans and multi-year
accounting-based performance plans).
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Compensation measure
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What is the composition of the
executives’ compensation package in
China?
Who determines the executives’ pay in
China (compensation committee)?
How important is the compensation in
the executives’ utility function? Do
political career and market control play
any role here in China?
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Compensation measure
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What is the ratio of executives’ hidden
income and her compensation?
What is the executives’ ownership?
Why do you use the highest pay as the
proxy for compensation? Who does
receive the highest pay?
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Performance measures
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How reliable ROE is? It is used by the CSRC
to determine the rights offering and ST and
PT. The managers have the incentive to
manipulate earnings.
Use other accounting performance measures
as robust tests
Tobin’s Q
Stock returns
Relative performance measures
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Omitted variables
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Characteristics of executives (age, tenure,
educational level, professional knowledge and
duality)
Ownership structure (who are the ultimate
owners? Do different owners share the same
objective?)
Board composition
Monitoring difficulty: risk, and growth
opportunities
Lagged performance measures
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The form of regression
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Pay-performance sensitivity (sensitivity
has a more economic interpretation)
Elasticity of compensation with respect
to performance
The function could be nonlinear
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Pooled cross-regression
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The market index did not change over
time. A given firm is included five times.
Without an adjustment, the t-statistics
are artificially inflated. A fixed effects
panel data analysis method should be
adopted to test for temporal instability
in the regression coefficients.
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Minor issues
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RPT is a dummy variable which equals to 1 if
the proportion of four types of related party
transactions between the firm and its large
shareholders is less than 5% of similar
transactions. Why do you use 5% as the
cutoff point for RPT? What is the basic
statistics of RPT activities in China?
How is MARKET correlated with AREA? Could
these two variables measure the same thing?
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Sensitivity analysis
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The managerial power approach predicts that pay will
be higher and /or less sensitive to performance in
firms in which managers have relative more power.
Other things being equal, managers would tend to
have more power when (1) the board is relatively
weak or ineffectual; (2) there is no large outside
shareholder; (3) there are fewer institutional
shareholders; or (4) mangers are protected by
antitakeover arrangement.
How to test this hypothesis?
What do EXP (Administrative fees/Sales) and
Revues/Total Assets) measure?
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Sensitivity analysis
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The pay control hypothesis suggests
that the government controls the pay
level of executives for social equality.
Who determines the pay, government
or board?
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