Ownership Structure And The Effectiveness Of Compensation Contracts

This paper investigates how different stock ownership structures affect the effectiveness of compensation contracts of managers through affecting agency cost, using the samples of 583 China's non state-owned companies listed on both Shanghai and Shenzhen Stock Exchange during Jan.1st,2007 to Dec.31st,2008. We find that, managers are paid more and their compensation contracts are less effective in companies with more dispersed stock ownership structures, while they are paid less and their compensation contracts are more effective in companies with more balanced stock ownership structures. Our results prove that the effectiveness of compensation contracts is the result of companies'agency cost. In those companies with dispersed stock ownership structures, stockholders would act as free-riders when supervising managers, which means the agency cost between stockholders and managers is relatively severe and managers would seek rent for themselves, weakening the effectiveness of their compensation contracts. In those companies with balanced stock ownership structures, stockholders would supervise each other and managers, enhancing the effectiveness of managers'compensation contracts. Our results suggest that non state-owned companies could reduce agency cost and enhance the effectiveness of compensation contracts through the improvement of stock ownership structures.Our major contribution is to distinguish between directors'compensation contracts and CEOs' when studying the influence of agency cost on managers'compensation contracts. When studying the compensation contracts for managers, we discuss the compensation contracts for directors and CEOs separately. We point out that, when directors are paid within the listed companies, they would be motivated, in the same way as CEOs, by compensation contracts designed by stockholders and the compensation contracts of both directors and CEOs are affected by the agency cost caused by stock ownership structures. But when directors aren't paid within the listed companies, they would be better aligned with stockholders and supervise CEOs more effectively, so the compensation contracts for CEOs are less affected by the agency cost caused by stock ownership structures.