A Study Of Correlation Between Executive Compensation Disparity And Firm Performance

Since the policies of reform and opening were carried out in the1980s, China has acquired great achievements on the national economy construction, which are attracting the worldwide attentions. However, the income gap between residents is widening with the years going. A widely accepted international indicator reflecting the income gap is the Gini coefficient. The Gini coefficient in China shows that the income gap has widened out of the international alarming level and been in a serious degree, which arouses closely attentions from people. Especially in the context of the financial crisis and euro’s debt crisis enveloping the world, firm performances are widespread declining, but executive compensation from listed companies’annual reports do not match the performance well and leads to widely questionings from people and attentions from some administer departments. In this regard, the relevant departments quickly introduced regulations, seeking by the administrative means to control the executive pay of the state-owned enterprises and reduce the compensation gap between executives and employees. In such a special time, it is an urgent question to design a compensation mechanism which is more reasonable, incentive and matched to the firm performance for Chinese companies. Researches on executive compensation and performance of the company are always hot materials for the academics. Many researchers conduct the studies in this area and obtain a lot of conclusions. There are also many scholars raising their suggestions about executive compensation design based on their research conclusions. And executive compensation designs not only contain compensation structure, but also the level of compensation. According to the Adams Equity theory, people always compare their ratios of what they get and what they put in with others’. The comparisons will have a decisive influence on their senses of fairness and their working motives and behaviors and at last influence the firm performance. It can clearly be seen that compensation disparity is a focal point in executive compensation design. The compensation disparity has an important role on the compensation incentives and firm performance. At present, among the many interpretations about the executive compensation disparity and firm performance, tournament theory and behaviors theory are widely accepted in academics. The tournament theory thinks that widening the gap can improve company performance through creating positive competitions atmosphere between executives between executives. However the behavior theory holds the opposite views and points out that widening compensation disparity between executives may worsen company performance from three perspectives of the social comparison theory, the organizational politics theory and the allocation preference theory. The negative impacts from expanding the disparity are concerned to these, such as increasing executive’s self-serving behaviors, reducing collaborative efforts and increasing the political intrigues. Thereby the theory contends that the company should narrow the compensation gap between executives. Which theory can be applied well to Chinese public companies? We all know that compensation limitation exists in the state-owned companies and we want to know whether the two theories are reasonable in the state-owned and non-state-owned companies. These questions are all this paper tries to do.The Equity theory emphasizes that people will not only compare their ratios of what they get and what they put in with other executives in the firm, but with external executives’ratios. And they also compare their present ratios with their past ratios. It is difficult to measure the executive job contents and easily estimated subjectively, so the comparison will lastly be measured by compensation. After comparing their ratios, they will get feelings of justice and injustice on the basis of compensation disparity, and the senses will directly affect their future work motivation, working behaviors and at last firm performance. In this way, this paper mainly selects the manufacturing public companies of A-share in2009and2010year and does two parts of empirical studies. One part is about correlation on the internal executive compensation disparity and firm performance and the other is the relationship between the external executive compensation disparity and firm performance.The first part mainly empirically studies relationship between the internal pay disparity in the executive team and performance of the company, but also the compensation gap compared with his compensation in different periods and performance of the company. This paper chooses samples of the listed manufacturing companies and by screening the samples gets the final number of1436, including703samples in2009and733in2010. In the analysis of the disparity between different executive compensation within the company, this paper chooses an alternative way to measure the disparity because the listed companies in China do not disclose detailed information about compensation of the chairman of boards and the general manager. In the alternative way the compensation of CEO level is averagely calculated by compensation of the first three executives and the first three directors, while the average compensation of the rest executive amounts as the non-CEO level, and the balance from this two is the very executive compensation disparity. In the study of executive compensation disparity comparing with compensation in last period, the gap is calculated by the balance between the CEO level pay in this period and the CEO level compensation in last period. The both are absolute variables. However this paper also chooses the relative indicators of the CEO level and the non-CEO level and CEO level in different periods to conduct the robust test to verify the conclusions. Besides these, this paper also selects several controllable variables and establishes the regression analysis model. About the specific empirical research methods, this paper mainly uses the descriptive statistical analysis, correlation test, multiple regression analysis and robust test. The regression results show that:(1) within the company the relationship between the executive compensation disparity and company performance is significantly positive, that is to say, the bigger the gap of executive compensation is, the better performance of the company becomes. This conclusion verifies the hypothesis1of this paper, negates the hypothesis2and supports the tournament theory; the compensation disparity in different periods has a significantly positive correlation with performance of the company and this conclusion supports the hypothesis3of this paper.(2) On studying whether the internal compensation disparity has a lagged influence of performance of the company, the results show that the disparities in the last period have a significantly positive relationship with performance of the company in this period too, which means that the relationship can be delayed.(3) After distinguishing the samples to study the correlation, the results indicate that regardless of the state-owned enterprises or non-state-owned enterprises samples, the relationship between the internal executive compensation gap and performance of the company is significantly positive too. Besides these, the paper also finds that the impact of the regional factors on performance of the company in the samples of state-owned enterprises is more significantly positive than in the non-state-owned enterprises and this conclusion means differences of regional economical development have a significant influence on the state-owned companies; the size of the company only plays a positive role in the samples of non-state-owned enterprises.(4) At last this paper uses the relative variable to replace the absolute variable and conducts the robust test. The results show that the conclusions are consisted with the results above and this means the results are reliable.The second part mainly empirically studies the relationship between the external executive compensation disparity and firm performance. This paper chooses the samples of the listed manufacturing companies in2010. By screening the samples, finally the number of776is suitable. This paper measures the external executive compensation gap with the regression residuals which is calculated by the regression model established by the Core et al.(1999). About the regression residuals, the positive ones mean executives positive disparity and the others are negative disparity. Then we establish the regression model to test the relationship between executive external compensation gap and firm performance. Specific empirical methods are mainly including descriptive statistical analysis, correlation test, multiple regression analysis and robust test. Finally the results show that:(1) generally speaking external executive compensation disparity is positively related to performance of the company; In the positive residuals samples, the correlation between the gap and performance of the company is significantly positive, which indicates the bigger the pay gap is, the better the performance becomes. This conclusion supports the hypothesis4of the paper; in the samples of negative residuals, the disparity has non-significantly negative relationship with performance of the company and this conclusion is in line with Hypothesis5of the paper, which shows that narrowing the external compensation gap has a little certain incentive.(2) This paper also distinguishes the externally negative samples into state-owned enterprises and non-state-owned enterprises, and at last finds that the relationship between the negative disparity and company performance is only significant in the state-owned enterprises but in the non-state-owned enterprises. The possible reason of this conclusion is that executives in the state-owned enterprises have many other ways to compensate themselves for the salary control to stimulate their working behaviors and bring the sense of fairness, such as chances of positions advancing, on-the-job consumption opportunities and so on. However executives can’t enjoy these chances, so they may pay more attention their compensation.(3) Finally, this paper uses the difference comparing the average compensation of the first three executives and directors with the level of the manufacturing industry to be the external executive compensation disparity to conduct the robust test. The results are basically consistent with the above ones, which mean that the conclusions of the paper have a certain degree of reliability.The results of this paper show that executive compensation disparities, including the internal and external compensation disparity, play a positive role in promoting performance of the company and the conclusions support the tournament theory which suggests that in the future the listed companies can design the salary system to widen the executive compensation dispersion on the basis of the present disparity in order to stimulate the executives and improve performance of the company.