Doctor of Philosophy
School of Accounting and Finance
Pan, Xiaofei, Political connection, CEO incentives and firm performance: evidence from China's listed firms, Doctor of Philosophy thesis, School of Accounting and Finance, University of Wollongong, 2011. http://ro.uow.edu.au/theses/3315
Ever since SOEs were reformed and restructured in 1978, corporate governance has been a major topic in China. As the two main aspects of corporate governance, managerial compensation and CEO turnover have been used as CEO incentives to monitor and align their interests with the shareholders. Their relationship with firm performance has also been studied extensively. In addition, the political and regulatory environment plays an important role in the Chinese market because it is underdeveloped and many of China’s listed firms are state owned and politically connected. Therefore, the main concern of this research is the effectiveness of corporate governance in China.
This thesis first examines the association between political connection and CEO turnover and the CEO turnover performance relationship to provide evidence on the effectiveness of corporate governance. This thesis further identifies the implicit incentives for CEOs, namely the political promotion generated from their concerns about a political career, and investigated the interaction with explicit monetary incentive. Finally, this thesis examines the compensation incentive for CEOs and the effect that ownership structure has on the relationship between CEO pay and firm performance.
With regard to monitoring CEOs, this thesis investigates the relationship between political connection and CEO turnover and its relationship with firm performance. This research found that CEO turnover is associated with poor firm performance, a pattern that is more significant in privately controlled firms. This thesis also provided evidence that politically connected CEOs are less likely to be dismissed and political connections can weaken the CEO turnover-performance relationship. Moreover, the turnover-performance relationship within politically connected firms is weaker with managerial ownership. This thesis also documents an improvement in firm performance following turnover. The evidence suggests a substitute effect of political connection for disciplinary mechanisms, and political connections influence the turnover-performance relationship through managerial ownership when firms confront an underdeveloped market environment.
In addition, this thesis identifies an important incentive system in SOEs; CEO political promotion. Many CEOs are politically appointed by the government and as such, are more concerned about being assessed by government officials. As a unique incentive mechanism exercised in China’s SOEs this thesis finds that the probability of CEO political promotion is positively related to firm performance. Interestingly, this thesis also finds that the incentive effect of CEO political promotion is a substitute for CEO compensation-based incentive. This thesis also points out that the incentive of CEO political promotion helps mitigate weak explicit incentives in China’s SOEs. These results are robust corrected for endogeneity between CEO political promotion and firm performance, including a new definition of political promotion.
Finally, this thesis examines the relationship between managerial compensation and firm performance using data from China’s listed firms. The results show that the pay-performance relationship is positive and significant in China’s listed firms. As the largest shareholder is always acting as the controlling shareholder who exercises effective monitoring, this thesis further divides the total sample into three groups based on their actual owners: SOEs affiliated to State Asset Management Bureaus (SAMBs), SOEs affiliated to the central and local Government (SOEs), and privately controlled firms. This thesis found that the positive pay-performance relationship in SOEs and privately controlled firms remains, however, CEO pay is positively related to firm accounting performance in SOEs, while market performance is positively related in privately controlled firms. This thesis also examines the effects of ownership structure on the pay-performance relationship by measuring the ownership structure by two variables: cash flow rights and excess control rights (the divergence between the control rights and cash flow rights of the largest shareholder). Previous studies suggested a positive incentive effect of cash flow rights and a negative entrenchment effect of excess control rights (Claessens et al., 2002; Lemmon and Lins, 2003). Consistent with the evidence from previous studies, the estimation results show that cash flow rights have a positive effect on accounting performance based pay schemes in SOEs and market performance based pay schemes in privately controlled firms. This thesis also provides evidence that excess control rights have a negative effect on different CEO pay schemes in either SOEs or privately controlled firms. This thesis also distinguishes firms with and without foreign investors, and finds evidence that firms with foreign investors compensate their CEOs more highly than those without.
Overall, this thesis examines the main aspect of corporate governance, CEO pay-performance relationship and the CEO turnover-performance relationship, and provides evidence that political connections and ownership structure exercise significant effects on corporate governance. Specifically, political connections can entrench poorly performing CEOs and weaken the turnover performance relationship. After being identified, political promotion shows a positive effect on motivating CEOs and substitutes for a monetary incentive, which suggests that facing the environment with an underdeveloped legal system and weak corporate governance, political connections are not always inconsistent with the aim of maximizing firm value. Furthermore, the ownership structure of the controlling shareholder can affect the application of performance based pay schemes across listed firms, among which cash flow rights have positive effects while excess control rights have negative effects on monetary incentives.