Theoretical And Empirical Research On Complementarity Of Incentive Instruments

There are many ways of incentives within organizations; the executivecompensation and equity incentive are two of incentive mechanism which trying to alignbehavior decision of executives with shareholders’ interests. Executive compensation ismainly composed of salary, performance-based bonus and stipends; while equityincentive plans include mainly stock option, restricted stock and appreciation rights. Therisky bonus and equity-based rewards are the real components of paying plans withcharacteristics of incentive. The thesis argues that the theory of these two kinds ofincentives, in fact, is contract theory which is very significant in the modern firm theory，including complete contract and incomplete contract theory.Complete contract theory and incomplete contract theory are complementary, thesetwo theoretical methods sometimes could be combined together to explain economicphenomena. The key idea of Holmstrom and Milgrom (1994) is trying to integrate thesetwo aspects. According to their research of the corporate internal governance structure,the firm is regarded as an "incentive system", which is a coherent set of complementarycontractual arrangement to mitigate incentive conflicts. Remarkably, Holmstrom andMilgrom (1994) emphasized the allocation of property rights in determining thebargaining power and incentives, which belongs to the ownership incentives (forexample, equity-based incentive), thus it indeed contains the elements in the incompletecontract practice. The thesis will integrate these two kinds of contract theories based ontheir complementary theory, in order to explain manager’s equity-based incentive andperformance-based cash compensation are complementary and improve company’sperformance simultaneously. Therefore, the “synthesis” of complete contract andincomplete contract theory constitutes the innovative analytical framework of this thesis.Along with the deepening of market reforms in China, it is extremely important toinvestigate how firms provide incentives to their top executives. In the socialist countriessuch as China, would we expect its executive compensation, ownership incentive andcorporate governance look like it does in the United States? Historically, Chineseexecutives receive only salaries, bonuses and stipends. Equity incentive is very rare, and is permissive only since2006. In the empirical test, based on the panel data of Chinalisted companies from the years of2007to2011, the thesis analyzes the impact ofexecutive compensation, equity incentive and other variables on corporate performance,especially the relationship between these two incentive instruments. Through differenttest methods of complementary, the evidence draws a conclusion that thecomplementarity between cash compensation and equity incentive, which has been foundin Holmstrom and Milgrom (1994), has not happened in China, namely, each incentiveinstrument for executives of China listed companies may be not complementary.