Research On The Influencing Factors Of Managerial Pay Performance Sensitivity On The Perspective Of Trade-off

The fundamental issue the corporate governance deals with is to induce managers to make decisions consistent with shareholders'interests by providing appropriate compensation contracts. In the design of compensation contracts, pay performance sensitivity setting is the core. Accordingly, the study on the influencing factors of pay performance sensitivity constitutes the core of compensation contracts study. Based on existing theories and literatures, the study on the influencing factors of pay performance sensitivity can be divided into two categories which are defined as non-trade-off perspective and trade-off perspective in this thesis. The non-trade-off perspective is based on the empirical studies which discover the fact that high intensity compensation contract is not common in the practice. These studies believe that the agency problem can be eased as long as the pay performance sensitivity increases. Accordingly, such literatures focus on finding the reasons of low pay performance sensitivity. On the other hand, the studies based on the trade-off perspective pay attention to the opportunistic behaviors of managers aimed to avoiding compensation risk. Thus, the increase of pay performance sensitivity does not mean the improvement of governance efficiency. The setting of pay performance sensitivity is a process of trade-off.Managers can avoid compensation risk by the implementation of following opportunistic behaviors:the conflict of decision-making horizon, overinvestment, earnings management and rent seeking of managerial power. Accordingly, the design of compensation contract should place in context of above opportunistic behaviors in order to identify the influencing factors of pay performance sensitivity. According to the foundation of opportunistic behaviors, this thesis divides them into information-based conflict and power-based conflict. Information-based conflict results from the information asymmetry between shareholders and managers. The managers have information superiority. Thus, shareholders should consider the incentive costs while providing compensation contracts. Incentive costs are information costs which are excess benefits of managers. Accordingly, shareholders should trade off information costs and surplus loss. The setting of pay performance sensitivity becomes a process of trade-off of agency costs. The identification of influencing factors of pay performance in the context of information-based conflict takes the incentive models of the classic principal-agent theory as the tool. Based on the incentive models, we identify the particular factors influencing the trade-off orientation. Correspondingly, the identified factors are factors influencing the setting of pay performance sensitivity. Power-based conflict results from the mismatch of decision-making hierarchy and incentive structure. Such mismatch causes managers to influence the signing and implementation of compensation contracts. Therefore, the compensation contains power rents. The managers will trade off the benefits and the rent-seeking costs. The setting of pay performance sensitivity becomes a process of managerial rent seeking trade-off. The identification of influencing factors of pay performance sensitivity in the context of power-based conflict takes the multiple regression models as the tool. Based on the multiple regression models, we identify the particular governance structures influencing trade-off orientation in listed companies. Correspondingly, the identified factors are governance structures influencing the setting of pay performance sensitivity.The main contents and results are as follow:Firstly, corporate value is created by a series of business activities with short-term or long-term effects. Long-term business activities contain greater risks relatively. In order to avoid the risk of pay fluctuations, the managers may adopt growth strategy which is detrimental to the long-term growth. The conflict of decision-making horizon arises. Accordingly, the design of compensation contracts need to place in the context of such opportunistic behavior.Contrast to moral hazard, the information structure of the conflict of decision-making horizon expands in the aspect of distribution of efforts. In the context of such opportunistic behavior, the information costs are insurance costs which are the remuneration the shareholders offer for the possibility of wrong performance evaluation. Accordingly, the pay performance sensitivity settings need to trade off the insurance costs and the surplus loss. We construct an incentive model containing two performance indicators which are stock price and accounting profit. As the stock price reflects the summary of the expected return of all business activities, the accounting profit plays the role of adjusting decision horizon and controlling the overall risks. Because of the diversification of signals, the setting of pay performance sensitivity consists of two dimensions:the absolute weight and relative weight. The absolute weight determines the intensity of incentive while the relative weight determines the decision-making horizon. The risk of performance indicators affects the absolute weight which is demonstrated as the greater the performance risks are, the smaller the absolute weight is. Similar to the absolute weight, the relative weight is subject to risk. However, due to the role the relative weight plays in the decision-making horizon, the relationship between performance risk and relative weight is no longer linear. On the condition of unchanging output value, as the decrease in the risk of accounting profit, the relative weight of accounting profit and stock price increases and then decreases. As the increase in the risk of stock price, the relative weight of accounting profit and stock price goes through an accelerated process. Thus, we identify performance risk as the influencing factor of the setting of pay performance sensitivity.Secondly, the scale of listed company is an important factor affecting managerial compensation. The larger the scale is, the higher the pay levels of managers are. The pay based on scale is less risky than the pay based on performance. Therefore, the managers may violate the rule of net present value to avoid compensation risk, which leads to the uneconomic expansion of company size and the damage of shareholders'wealth. Accordingly, the design of compensation contracts need to place in the context of such opportunistic behavior.Contrast to moral hazard, the information structure of overinvestment expands in the aspect of project quality. We categorize project quality into future cash flows and risk level. Based on the extended incentive model, we find the information costs display as the information rent spillover effects. Information rent is the excessive return the shareholders offer to incentive the managers to provide real project quality information. It has the characteristic of externality, which means shareholders must offer higher information rent to the managers with higher quality project than the amount they provide for the lower quality project. Therefore, the shareholder should trade off the information rent spillover effects and the surplus loss when they set the pay performance sensitivity. The greater the growth opportunity the company has, the greater the likelihood the managers possess high quality project. Therefore, the marginal spillover effects decline as the growth opportunity increases. Correspondingly, the growth opportunity affects the trade-off orientation via spillover effects. The greater the growth opportunity the company has, the higher the pay performance sensitivity should be set. As the increase of growth opportunity, the negative relation between risk and pay performance sensitivity declines. To the companies with a little or no growth opportunity, the risk and pay performance sensitivity is negatively related. However, to the companies with big growth opportunity, the risk and pay performance sensitivity is positively related. Thus, we identify growth opportunity as the influencing factor of the setting of pay performance sensitivity.Thirdly, compensation contracts are based on a set of signals in which accounting earnings is a regular choice. As the contractual role accounting earnings plays, managers who control the accounting system may conduct earnings management in order to avoid compensation risk. Accordingly, the design of compensation contracts need to place in the context of such opportunistic behavior.Contrast to moral hazard, the information structure of earnings management expands in the aspect of accounting policies. Based on the extended incentive model, we find the existence of information costs. In order to distinguish the insurance costs relevant with randomness of natural state, we define the information costs here as the insurance costs relevant with accounting system. The insurance costs relevant with accounting system originate from the optional accounting policies which decide the value of earnings. Accounting earnings not only contains output information, but also noises. Signal users cannot distinguish them directly. Therefore, the shareholder should trade off the insurance costs relevant with accounting system and the surplus loss when they set the pay performance sensitivity. The earnings quality affects the trade-off orientation via the insurance costs relevant with accounting system which demonstrated as the worse the earnings quality are, the lower the pay performance sensitivity should be set. We categorize earnings quality into earnings persistency and discretionary accruals. The conclusions are the pay performance sensitivity is positively and negatively related to earnings persistency and discretionary accruals respectively. Thus, we identify earnings quality as the influencing factor of the setting of pay performance sensitivity.Fourthly, the exposure of compensation risks means that managers participate in residue sharing, which changes the company's ownership structure. The managers are able to contend with the board of directors. In the aspect of compensation, managers may affect the signing and implementation of compensation contracts, which results in the phenomenon of self-determining compensation. Accordingly, the design of compensation contracts need to place in the context of such opportunistic behavior.Managers seek rents to avoid the compensation risk. They not only make the contracts favorable to themselves to be approved, but also extract rents through renegotiation after earnings management. Accordingly, the sensitivity between compensation and real performance declines while the asymmetry between compensation book profit sensitivity and compensation book loss sensitivity increases. Based on the multiple regression models, we identify the particular governance structures affecting the trade-off orientation. The empirical result shows that the lower the proportion of independent directors and the transparency of the information disclosure are, the weaker the compensation and the real performance are related. The sensitivity between the compensation and. the real performance is lower in the companies controlled by government. The lower the transparency of the information disclosure is, the stronger the compensation and the book performance are related. The sensitivity between the compensation and the book performance is higher in the companies which do not set remuneration committee or controlled by government. Thus, we identify the remuneration committee, the independency of the board of directors, the controlling shareholders and the transparency of information disclosure as the influencing factor of the setting of pay performance sensitivity.