Research On Asymmetric Sensitivity Of Executive Compensation To Stock Returns

With the development of modern enterprises, more and more contradictions and problems emerged, including executive compensation issues, which caused the widespread concern of scholars and the public. After the financial crisis, there is more and more voice questioning executive compensation. Executive incentive issues became a problem not only for scholars but also for SOE reformers. Due to the separation of corporate ownership and management, executive compensation mechanisms come into being with the principal-agent problem. However, because of information asymmetry, it’s difficult to observe executives’effort. It’s the second best choice to linked executive pay and company performance which can be observed. Effective compensation contracts can reduce agency costs and motivate executives, but inappropriate contracts may intensify the contradiction between owner and agent. Therefore, it’s the core content of and effective corporate governance to establish scientific and appropriate executive compensation system. Nowadays, the public focus on design of compensation contracts and matching executive compensation to corporate compensation.Accounting earnings are usually adopted by executive compensation because of their easy access. However, compensation contracts only based on accounting earnings can lead to some problems. For example, managers may use their information advantage to overestimate future cash flows or invest in projects with negative NPV, in order to get high paid. Once the overestimated future cash flows fail to realize or an investment loss happens, company could require recovering the unwarranted bonus from executive. This leads to an ex post settling up problem. The ex post settling up costs may become high due to the limited tenure and responsibility of executive. One good way to reduce the ex post settling up costs is to design a special compensation contract, which makes executive compensation over-sensitive to unrealized losses and under-sensitive to unrealized gains. Leone et al.(2006) find that changes in CEO cash compensation are more sensitive to poor firm performance than to good firm performance, interpreting this evidence as consistent with Boards of Director using discretion to reduce the costs of ex post settling up in CEO pay. However, Dechow (2006) points out that the approach in Leone et al.(2006) misclassifies a large number of firms with good earnings performance as poor performers, such that the result may be not persuasive. The paper use a three-way performance partition which used by Shaw and Zhang (2010) to reclassify firm performances and research on the asymmetric sensitivity of executive compensation to stock returns.Specifically, the paper is divided into six parts:Ⅰ. Introduction. This part includes the research background and significance, the research content, the research structure and framework, the research method and the main contribution.Ⅱ. Related theory and literature review. This part introduces the topic related theories and reviews both abroad and domestic studies related to executive compensation.Ⅲ. The theoretical analysis and assumptions. This chapter explains and analyzes the compensation sensitivity between accounting earnings and stock returns, and presents two assumptions based on posts ex post settling up problemⅣ. The empirical study design. This chapter introduces the sample selection of empirical study, data processing, variable definitions and other evidence and model selection.Ⅴ. The empirical results and analysis. The empirical analysis, including description statistics, Pearson correlated analysis, regression analysis and robust test, are conducted. A detailed analysis of the empirical results and the reasons are made.Ⅵ. Conclusions, policy recommendations, research limits and prospects. To summarize the whole paper, this chapter gives a brief summary of the empirical analysis, gives some policy recommendations accordingly, presents some limits of the research and gives some expectations of future research.The data of1098companies listed in Shanghai and Shenzhen in2008-2010were selected to study. This paper found there was asymmetric sensitivity between executive compensation to stock returns in Chinese listed companies. This is consistent with boards of directors exercising discretion to reduce costly ex post settling up in cash compensation paid to executives. Furthermore, there was a lower accounting earnings bond, below which pay-performance sensitivity was flat, but there was not such upper bond. Meanwhile, there might be widespread over incentive problems in Chinese listed companies.Here are some main contributions of this paper:first, we add to research not only on the role of accounting earnings in executive compensation plans, but also on the executive compensation-stock return sensitivity. Second, we analyze asymmetric sensitivity of executive compensation to stock return from a new view by present ex post settling up problem. Third, we use three-way performance partition to better identify poor performers, and find asymmetric sensitivity of executive compensation to stock return based on Chinese listed companies data. Forth, the paper not only proves the hypothesis, but also find the over incentive problem existing in Chinese listed companies.