Research On Appling The Tournament Theory To The Exercise Design Of Equity Incentive Plan

Along with the rapid development of China’s economy, the corporate governance problems of the companies, which are the engines of China’s economy, cripple their steady and healthy running. One of these problems is the moral hazard and adverse selection caused by the agency agreements between corporate shareholders and the executives. In the early of1990’s, Chinese enterprises started to apply the equity incentive plan innovated by Americans to relief the agency problems, through which both the interests of corporate shareholders and the executives could come to an consensus.After the smooth reform of the non-tradable shares, it made great progresses in the environment of capital market and the corporate governance normalization, as well as the capital market effectiveness. Especially the revisions of company law and security law wipe out the biggest obstacles of the execution of equity incentive plans. From July1,2005to December31,2013, it published640equity incentive plans within546companies, which amounts to22%of the China stock markets. We will be noticed by three main following issues after statistical analysis of these files. First, the lack of diversity for the type of evaluation index is obvious, which links the market and industry less. Second, all the equity incentive plans adapt to the single standard system. The ways of incentive designing appear to be inflexible and dull. Third, the exercise price is inelastic, as well as the amount. You could exercise your incentive rights with only one possible price and certain amounts when you meet the only one standard of the vesting condition. They will not change unless the influences of the dividends, additional issue and rights issues.This article attempts to apply Tournament Theory to the exercise design of the equity incentive plan, which might overcome the three stated issues above in a certain extent. Central to Tournament Theory is the perspective that increasing the compensations and compensation gap are helpful to enhance the efforts level of the agents. What’s more, the Tournament Theory could judge the agents by the rank orders of their output. It eliminates the uncertainties faced by the agents, which obscure their truly taken efforts.It comes to a good result that the efficiency of supervision will be improved a lot. Based on the view of the Tournament Theory, I devise some scheme examples about exercise design of equity incentive plans to formulate explicitly what I am trying to convey in this article. In the examples, different levels of incentive compensation are arranged to different performance levels. The incentive compensations are match with performance expectation one on one. Lower performance goes to the pre-set lower compensation, vice versa. According to the Tournament Theory, the reasonable gap generated between the higher compensations and the lower ones will encourage agents to work harder to reach the best and possible one. In addition, the evaluation indexes based on relevant market and industry are emphasized to use in the equity incentive plans to reduce the common "noises" when evaluating. In the last, combined with Vanke’s First Restrictive Stocks Incentive Plan, this article discusses its strength, weakness and possible improvements according to the Tournament Theory.