A Study Of The Relationship Between Executive Equity Incentives And Over Investment From The Manufacturing Industry

In recent years,with the rapid development of China's economy,enterprise overinvestment has become a widespread problem,causing the squandering of the entire society's resources.For this reason,the question of how to effectively mitigate overinvestment is increasingly significant.In practice,investment behavior within the modern enterprise is not solely determined by the NPV of projects,a commonly held assumption in theory.According to the principal-agent theory,shareholders and management have different objectives:the latter will not necessarily choose the project that maximizes the profit for the largest shareholder.Research abroad has shown that equity incentive plans based on the optimal contracting theory can tie the long-term gains of the enterprise's executives to the future value of the enterprise,which would reduce the number of overinvestment decisions made in the interests of self-gain.However,Chinese scholars are divided over the efficacy of executive equity incentives.A careful literature review will reveal that Western studies often assume a decentralized ownership structure.However this assumption does not hold true for listed companies in China due to a combination of the market environment and various historical reasons.In fact centralized ownership is by no means unusual.Under these circumstances,the single principal-agent relationship is replaced by a double principal-agent relationship,with the dominant shareholders serving two major roles.Therefore,how is the effectiveness of executive equity plans affected by the concentration of ownership,and how would the effects of this differ across enterprises with different ownership structures?The manufacturing industry is a pillar of China's economy—so the efficiency of investments within the industry has serious implications for the entire economy,and is an important indicator of whether resources are being appropriately allocated.This paper will take relevant data from the manufacturing industry,and analyze the relationship between executive equity incentives and enterprise overinvestment,in enterprises exhibiting varying degrees of centralized ownership.Furthermore,the issue of whether the ownership structure affects the performance of executive equity incentives will be investigated,with an aim of providing some general guidelines for devising equity incentive plans capable of mitigating overinvestment.A combination of normative and empirical research methods will be used.First,the principal-agent and optimal contracting theories,etc.are used as the underlying assumptions.Second,data for SSE-listed manufacturing companies(A shares)from the period 2008-2013 is used to estimate the level of investment,and then the model's residuals are used to extract those companies engaging in overinvestment.Third,the samples are classified into two categories by ownership structure,with the level of enterprise overinvestment being the dependent variable,and the executive equity incentives,concentration of ownership,etc.being the independent variables.The relationship between executive incentive plans and overinvestment is determined through multivariate linear regression.The findings include:(1)The problem of overinvestment is widespread amongst the listed manufacturing companies in China,and tends to be more severe in the SOEs that make up a considerable share of the market.(2)In private enterprises,the executives tend to hold a greater share of the equity,and on average ownership is more centralized in SOEs than private enterprises.(3)Rather counterintuitively,when ownership is decentralized,high equity incentives correspond to greater overinvestment,and being an SOE exacerbates this problem.(4)With moderately centralized ownership,enterprise overinvestment is effectively suppressed,which effect is more pronounced is private enterprises.(5)When dominant shareholders are able to gain absolute control of the enterprise,the effects of equity incentives on the problem of overinvestment become distorted.According to the analysis and conclusions above,this paper recommends four guidelines:(1)Listed SOEs should aim to create a clearer delineation between political and corporate affairs,paving the way for SOEs in general to realize the benefits of free enterprise.(2)To ensure equity incentives function as intended,the shares of major shareholders must be kept within a suitable range.When establishing equity incentive plans in enterprises with a decentralized ownership structure,greater care must be taken to institute internal supervisory mechanisms.(3)Increase supervision and regulatory control over controlling shareholders,by introducing greater supervision over when dominant shareholders gaining controlling shares,and seeking more effective executive incentive plans to reduce the possibilities of collusion between management and controlling shareholders.(4)Develop a professional manager market to improve the system by which candidates are selected.A priority for SOEs would be to develop an effective manager recruitment process,to reduce inefficient investment(as a result of pursuing multiple objectives).