Industrial Diversification, Geographical Diversification And Executive Compensation

In today's world,companies are required to choose an appropriate compensation strategy that suits their goals,so as to promote the realization of their operation strategy.As a result,diversification,a commonly adopted operation strategy,and its relationship with executive compensation have drawn wide attention.However, relevant research results are mainly based on data from western countries,such as the United States,and thus can only reflect those countries' corporate behaviour and institutional background.On the other hand,only a few study on this area has been carried out in developing countries,such as China.Therefore,the paper is going to investigate the relationship between the diversification strategy and executive compensation in China.This paper sets up a theoritical framework of diversification strategy and executive compensation by employing agency theory and expectancy theory and referring to the statistics such as corporate size,corporate performance and stock ownership.It studies the distinction between industrial diversification and geographical diversification and analyses their effects on executive compensation,and therefore makes some hypotheses.Under the framework,1891 observed values from 633 Chinese companies listed in Shenzhen and Shanghai stock markets during 2002-2004 have been selected as the sample data in the paper.The paper carries out an empirical test on the effect of diversification strategies on executive compensation by employing the panel data model.It thus concludes that the company with higher degree of industrial diversification and geographical diversification,larger size or higher accounting earning performance will realise a higher annal executive compensation;at same time,the company which adopts geographical diversification strategy will realise higher compensation than the one adopting industrial diversification strategy;that under the current situation,the Executive Stock Option incentives is not able to keep up with corporate development,and can not match corporate diversification strategy;the executive in state-owned enterprises has stronger motivation than that in other enterprises;and that a sound executive compensation incentive mechanism can reduce the possibility of the executive improving its personal income through industrial diversification and geographical diversification.The paper also draws a conclusion that stock ownership,corporate size,corporate performance and accounting earning performance can have an adjusting effect on the relationship between corporate diversification and executive compensation.Based on the multi-task principal-agent model,the paper also develops a incentive contracting model to examine the optimal incentive contract under the diversification operation.The results show that the long-term incentive portion of the contract depends on the cost and benefit of diversification,i.e.when the increase of monitor cost which the board of directors spends on monitoring the executive exceeds the benefit of diversification,the board would increase the incentive portion by continuously increasing the share hold by the executive to realize the alignment effect.The paper also gives following suggestions.Firstly,the company should optimize and innovate the compensation mechanism.In other words,the company should adjust and regulate the executive compensation mechanism to suit its operation strategies.Secondly,the company,especially the SOE,must optimize the stock-ownship structure in order to prevent the phenominon of"inner person control" and "strong incentive,weak restriction";At the same time,efforts must be made to reform the mechanism in SOEs and increase the shares hold by the executive to achieve the alignment effect.Finally,China's executive personnel market should be established and continuously improved,which will help to build up the executive compensation mechanism in line with the market price and reduce the agent cost accordingly.