An Empirical Study Of The Large Shareholders’ Tunneling Behavior On The Impact Of Executive Compensation

Compensation contract is a very important governance mechanism to alleviate the classic principal-agency conflict. Performance-based payment schemes have been a hot research at domestic and abroad. At January7th,2002, the China Securities Regulatory Commission issued the 《Corporate Governance Principles》, requiring the listed companies to establish incentive system for managers’ remuneration based on the company and personal performance. Subsequently, most of the listed companies set up various kinds of performance evaluation criteria and produce performance-based payment schemes. To some extent, this behavior would promote the interest congruence between shareholders and managers, as a result to maximize the shareholders’wealth.However, high concentration of ownership is prevalent among Chinese listed companies. Controlling shareholders could seek private benefits through various kinds of self-dealing transactions. Such transactions are referred as "tunneling" by Johnson et al. When such’ tunneling behavior’significantly affect corporate performance, and further damage the executive managers’self-interest, management would try to bargain with shareholders in order to maximize their benefits. As a result, the proportion of managers’ fixed compensation would be increased, while the sensitivity to their management performance would be lowered. This article would analyze the impacts of the large shareholders’ tunneling behavior on the pay-performance sensitivity of executive compensation, in terms of the capital consumption. And then put forward some reasonable suggestions of designing those payment structures.I would like to start with the principal-agent theory, apply incentive theory and the optimal contract theory to analyze how these theories are used in the executive compensation scheme. After technically analyze the way for shareholders’tunneling behavior to influence the remuneration contract, I would also discuss the impacts from shareholders’ tunneling behavior on the compensation sensitivity by some empirical tests.Chapter Ⅰ is introduction. This chapter covers the background and significance of the research, clarifies some research points, defines the research method, and finally explains the merits and weaknesses of this paper.Chapter Ⅱ is literature review. This chapter reviews domestic and foreign relevant material about large shareholders’ tunneling behavior, executive compensation contract, and their relationships, and then give some comments on those documents while find some valuable parts available to study.Chapter Ⅲ is theoretical analysis. This chapter explains the principal-agent theory, the incentive theory, analyzes large shareholders’tunneling behavior, and discusses whether the pay-performance compensation is reasonable.Chapter Ⅳ is empirical study. On the basis of theoretical analysis and current situation of Chinese listed companies, this chapter produces three hypotheses:(1) With the same other conditions, the higher level of large shareholders’tunneling behavior, the lower pay-performance sensitivity of executive compensation;(2) With the same other conditions, because of shareholders’tunneling behavior,the pay-performance sensitivity of executive compensation in state-owned enterprises would decrease more obviously than those in non-owned ones;(3) With the same other conditions, in the large shareholders’relative controlling enterprises, the pay-performance sensitivity of executive compensation would decrease more obviously.Chapter Ⅴ is conclusions, recommendations and prospect. According to the empirical results, we can see that the hypotheses have been fully validated. With the theoretical and empirical findings, I would like to make some suggestions to control large shareholders’tunneling behavior, and propose some reasonable recommendations to design executive compensation contract.The main contribution of this article is:We provide a more complete perspective of the large shareholders’ governance role. On one hand, large shareholders could help to solve the free-rider problem arising from supervising the management by scattered shareholders; on the other hand, the large shareholders’ tunneling behavior could hamper the adoption of incentive payment schemes in China. Finally, this paper provides a good example of large shareholder and executive both have impact on corporate governance mechanisms and financial management.The inadequacies of this article are as follow:First, this paper mainly uses ratio of other receivables divided by total assets as tunneling’substitute variable, and the natural logarithm of the "three senior executives total compensation" as executive compensation’ substitute variable, therefore the measurement cannot be exactly accurate. Secondly, the pay-performance sensitivity of executive compensation may be a complex result from the entire corporate governance, while shareholders’tunneling behavior may only be one of those factors.