Optimization Research On Executive Equity-Based Incentive Contract For Listed Companies In China After Equity Divison Reform

Executive equity-based incentive is to provide managers with stock or stock options, which link manager's personal interests to business interests. This mechanism can reduce agency costs and enhance long-term enterprise value, as well as connect the residual claim with the corresponding control. As the promulgation of the new Company Law and Securities Law in 2005 , China's Securities and Exchange Commission issued "Management Methods for Repurchase of Shares from the Public (Trial)" and "Management Methods for Equity-Based Incentive of Listed Companies (Trial)" in 2006. SASAC and the Financial Ministry issued "Pilot Scheme for the Implementation of Equity-Based Incentive of State-Controlled Listed Companies" jointly. These Regulations allow that listed companies which have completed the equity division reform can use equity incentives. So, how to optimize the equity-based incentive and achieve perfect governance structure by learning from Western incentive manager of the equity research results, it's an urgent problem need to solve after equity-based incentive in China. That's the goal of my thesis.Tooling by principal-agent model, this thesis quantitative analyzes and optimized the four key elements which are the type, the grant (exercise) price, quantity and duration inspire in equity-based incentive contract derived in the equity-based incentives. First of all, I show the existence of the optimal solution for the model to ensure the equity-based incentives can be an incentive function. Secondly, I analyze the incentive effect of restricted stock and stock options for managers who have the same risk preferences with the shareholders or are risk-averse. Thirdly, I analyze how to determine the optimal grant quantity, grant or exercise price and validity period for the equity-based incentive contracts by considering the value and cost of equity-based incentive for managers and shareholders respectively. Finally, I build the new model which target function is to reduce the agent cost for shareholders and for creditors. Then I identify the characteristics of this new optimal contract by creditors, shareholders and managers Game analysis.The main work and conclusions of this thesis are as follows:1. The review and sum up of development process for equity-based incentives in China's enterprises. By reviewing, we can see the equity-based incentive before the equity division reform is different from the equity-based incentive after the equity division reform since the legal constraints for sources of incentive stock, non-currency of incentive stock holdings, and the deficiency of corporate governance structure.2. The empirical study of positive and negative effects for equity-based incentive after equity division reform. The positive effect is that the equity-based incentives can promote the company's performance and the negative effect of equity-based incentives means it may be lead to self-interest opportunistic behavior for managers. I get four conclusions by empirical study sampling by the listed companies which disclosed the equity-based incentive plan from 2006 to 2007. First, the company's performance is statistically significant improved after the equity-based incentives granted in the control of the other factors which impact of performance, indicating that the equity-based incentives have a positive effect after the equity division reform. Second, the restricted stock incentive has more incentive effect than stock option incentive now. Third, the managers have the opportunistic behavior of timing the equity-based incentive plans disclosure to depress the grant or exercise prices. Fourth, the independence of the Evaluation Commission has an important role at inhibiting the negative effects of equity-based incentives.3. The optimize research on the elements of equity-based incentives contracts. I get some new conclusions tooling principal-agent model by quantitative analysis. First, when the managers are risk-averse, stock option incentive can get more incentive effect than restricted stock incentive which grant to managers with zero price. However, when managers have the same risk preferences with shareholders, the restricted stock incentive have greater incentive effect than stock option incentive if the grant price for restricted stock equals to the exercise price for stock option. Secondly, the grant price for restricted stock should be as high as possible regardless the risk preference of managers. The optimal exercise price for stock option should be determined by the principle which the value of stock option for managers deduct the cost of stock option for shareholders. Third, the lock period for the restricted stock should be as short as possible regardless the risk preference of managers. As for the incentive stock options, if the managers and shareholders have the same risk preferences, the optimal period should be the peak of the curve corresponds to the value of stock option for managers deducted by the cost of stock option for shareholders for smaller stocks volatility and the period should be as short as possible for larger stock volatility. If the managers are risk-averse, the optimal period should be as same as the managers have the same risk preferences with shareholders for smaller stocks volatility. Fourth, incentive quantity can be determined by shareholders subjectively regardless of restricted stock or stock options. Fifth, the creditor's efforts to reduce agency costs have an important impact on the managers' remuneration level and structure. When the manager are risk-averse, the increase in the number of equity-based incentives can not motivate managers pursue the risk, instead, reducing the number of equity-based incentives will motivate them to pursue the risk.4. The empirical study on the influencing factors of equity-based incentives levels to see how to determine the quantity of equity-based incentive which can be subjective selected by the shareholders in model. I get three findings through empirical analysis. First, micro-factors can not strongly impact on the levels of equity-based incentive, indicating that levels of equity-based incentives may be influenced by macroeconomic factors mainly impact in China listed companies, or the levels of equity-based incentives are determined unreasonably. Second, institutional investors and creditors have minimal impact on the levels of equity-based incentives, indicating that corporate governance of listed companies still exist some problem. Third, there's significant negative correlation between the level of equity-based incentives and the proportion of independent directors. This indicates that the independent directors of our country have played a role in monitoring the managers.Based on the above findings, this thesis gives some policy recommendations as follows:First of all, it's necessary to improve performance indicators involved in equity-based incentives. Starting from the value of the company, we should design a performance system for equity-based incentives in listed companies. This system should include financial and non-financial indicators, accounting performance indicators and market performance indicators. And we should deal with the problem caused by revising and improving the regulations for management of equity-based incentive.Second, we need to improve the effectiveness of capital markets. And we can reduce the possibility of financial reporting fraud in order to achieve the relevant performance conditions of equity-based incentives through a sound system of information disclosure and the establishment of strict monitoring and enforcement system, and increase disclosure of information in the punishment of violations.Third, it's necessary to improve the internal corporate governance ulteriorly. We need regulate the board of directors and strengthen the role of independent directors, especially improve the independence of the commission of the remuneration and assessment of. We also need fulfil the implementation of the board of supervisors on the supervision of equity-based incentives.The main innovations in this thesis are as follows:1. The thesis optimizes the equity-based incentive contract through the model from the point of view of quantitative approach, determining the optimal incentive quantity, grant or exercise price, incentive type and duration these four key elements of the equity-based incentive contract.Based on the principal-agent model, this thesis use maximization of the incentive effects of equity-based incentives deducts cost-effectiveness of equity-based incentives as the principle to determine the optimal elements of contract. The incentive effects of equity-based incentives include equity-based incentives increasing the mean of output and increasing the variance of output. Cost-effectiveness of equity-based incentives is the ratio of the cost of equity-based incentive to the enterprise value.2. I expansion the objective function of principal-agent model in order to reduce total agency costs including agency cost for shareholders and for creditors.Traditional principal-agent model aimed at resolving agency problem between shareholders and managers. However, the agency cost of a modern enterprise includes the agency costs of creditors besides the agency costs between shareholders and managers. Equity-based incentives for managers can reduce the agency cost between shareholders and managers, but creditors will demand higher risk premium. So the incentive structure for managers is the common efforts by shareholders and creditors to reduce their agency costs in fact. Therefore, adding creditors into the objective function of the agent model, we will use shareholders, creditors and managers Game analysis to determine the optimal incentive contract.3. I revise the assumption that managers are risk-averse in principal-agent model. And I do the analysis in accordance with the managers have the same degree of risk appetite with shareholders and managers are risk-averse than the shareholders respectively.Because shareholders can diversify the investment, the shareholders can use reasonable investment portfolio to avoid the specific risk of the company and bear the system risk. And managers because of their indivisibility of human capital, they can not avoid the specific risk. So, managers must not only bear the system risk but also specific risk of the company. Therefore, in standard principal-agent model, managers are generally taught as risk-averse.However, there's not a sound manager market in China, and there's not a strong constraint come from the market. These show that the manager in China may be the aggressive risk preferences since lack of binding mechanism. Therefore, it's necessary to distinguish between risk-averse managers and have the same risk preference as shareholders to contract optimization.4.I broke the research practice that looks restricted stock as stock options with a zero exercise price in western country, and distinguish grant price of the restricted stock between zero and some given price higher than zero.In accordance with the concept of restricted stock, the managers can get it free of charge as well as for some cost. The implementation of the current restricted stock incentive in China listed companies are also the two situations. Therefore, it needs todistinguish these two grant price for analysis.