The Impact Of Capital Structure On Executive Pay-performance Sensitivity

Separation of ownership and management, making control of enterprise by ownertransferred to manager. The compensation contract is not complete because of interestsbetween owner and manager is not consistent. According to the optimal compensationtheory, shareholder’s wealth is changed by business performance. So the best executivecompensation should belong to the company performance. But the facts have provedthat executive compensation is not related to company performance.Agency costs theory suggests that a firm’s financial structure can affect the agencyrelationship between shareholders and managers, and also that conflicts of interestbetween shareholders and bondholders can affect the provision of optimal incentives tomanagers. Capital structure can affect executive compensation through two channels,agency cost of equity hypothesis and agency cost of debt hypothesis. However,assuming that capital structure is unimportant to understand how firms set theircompensation packages, studies of executive compensation typically ignore the role offirms’ capital structures. Foreign research has showed that capital structure matters insetting executive pay. By improve corporate governance’s structure, capital structurecan enhance pay-performance sensitivity. Domestic research has just started, foreignresearch results may not be applicable to domestic listed companies, even be opposite.Therefore, by considering our national characteristics and making use of the data ofChinese listed companies, this thesis analyzes the impacts of capital structure onexecutives’ pay-performance sensitivity.Based on the former literature, the thesis explains how capital structure affectsexecutive compensation. According to the different kinds of compensations (Cashcompensation and equity compensation), empirical research will be respectively. Thesample data is from the listed companies of Shanghai and Shenzhen stock market from2008to2011. The empirical research shows that capital structure reduces both kinds ofthe different pay-performance sensitivities. Compared to non-state-owned enterprises,state-owned enterprises have a higher influence.Based on the empirical conclusions, several suggestions are raised as follows.Firstly, short-term incentive and long-term incentive combination will be the bestmanager compensation. What’s more, it should be improve the disclosure of executive compensation information, and increase the transparency of executive pay. Secondly,the agency costs of debt can be reduced by using convertible debt, which introduces aconcave region in the payoff to levered equity. Firms with convertible debt will sethigher pay-performance sensitivities.