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Institutional Impact on Executive Compensation: A Financial Accounting Perspective

This research explores how institutions influence the link between financial accounting information and executive compensation contracts, proposing that the relationship is sensitive to institutional environments. Hypotheses are developed regarding government intervention and related party transactions, with empirical analysis validating these relationships.

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Institutional Impact on Executive Compensation: A Financial Accounting Perspective

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  1. Institutions, Financial Accounting Information and Executive Compensation Sun Zheng Li Zeng-quan Liu Feng-wei School of Accountancy Shanghai University of Finance and Economics

  2. Outline • Research questions • Theoretical analysis and hypothesis development • Research design and results • conclusions

  3. Research questions(1) • How the institutions affect the role of financial accounting information in the executive compensation contract？ • Some literatures use the sensitivity of executive compensation towards financial accounting profit as the proxy for efficiency of compensation contract (Jensen and Murphy, 1990; Murphy, 1999; Bushman and Smith, 2001)

  4. Research questions(2) • In this paper, we propose that: • The contract on executive compensation should adapt to the institutional environments. e.g, The relationship between the executive compensation and financial accounting information is sensitive to the institutional environments. • The validity of the above method is low.

  5. Theoretical analysis • The contract which the executive compensation should link with the financial accounting profit are conditional on that: • The financial accounting profit is the proxy for which the shareholders pursue. • The costs to measure financial accounting profit are lower enough (Coase, 1937; Alchian and Demstez, 1972; Cheung, 1983) • The structure of contract on executive compensation should be concerned. • The substitution between pecuniary and non-pecuniary salary • The managerial markets are competitive (Alchian, 1969; Demsetz, 1983; Fama, 1983)

  6. Hypothesis development • Analysis of institutional background • Two points • Government intervention • Multiple tasks of SOEs • Related party transactions • Earnings management • Tunneling or propping • The consequences • The correlation between the financial accounting profit and shareholders’ benefits is low • The costs to measure the financial accounting performance are high

  7. Hypothesis development • Two hypothesis • H1: Ceteris paribus, the intervention of government weakens the association between top executive compensation and financial statement based performance indicators. • H2:Ceteris paribus, the existence of related party transactions weakens the association between top executive compensation and financial statement based performance indicators.

  8. Research Design（1） • Sample • 1999-2003 pooled data • Financial companies are deleted • The companies controlled by private agencies are deleted • 3399 observations • Executive compensation • The upper limit of the first interval

  9. Research Design（2） • Related party transaction (RPT) • Related sales, related purchases, related credit, related debit • RPT=1 if all related party transactions scaled by total transaction < median, 0 for others. • Government intervention (Market or GOV) • MARKET=1 if Market Index (Fan and Jin, 2002,2003) <median, O for others • GOV=1 if government intervention index (Fan and Jin, 2002,2003) >median, O for others

  10. Sensitive tests (1) • Managerial control • The corporation is controlled by top executives (Bebchuk and Fried，2003) • Consequences • The expectation is consistent with table 2. • The relationship between pecuniary and non-pecuniary is positive.

  11. Sensitive tests (2) • Test • The proxy for Non-pecuniary (James et al，2000 ) • EXP and TVR • Model • M1: Adj-COMP=SIZE+YEAR+IND • M2：EXP=RCOM+RPT+RPT*RCOM+MARKET+MARKET*RCOM+SIZE+YEAR+IND • M3：TVR=RCOM+RPT+RPT*RCOM+MARKET+MARKET*RCOM+SIZE+YEAR+IND

  12. Sensitive tests（3） • Compensation regulation • The SOE’s executive compensations are regulated by government (Chen, Chen and Wan, 2005) • The consequences • The expectation is consistent with table 2.

  13. Sensitive tests（4） • Test • Model 1: Adj-COMP=Regulation +YEAR+IND • Model 2: RCOM=PER+RPT+RPT*PER+MARKET+MARKET*PER+OTHERS CONTROL VARIABLE

  14. Conclusions • The relationship between the financial accounting information and top executive compensation is sensitive to the institutions such as the government interventions and related party transactions.

  15. Comments are welcome! Thanks!

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