Corporate governance of the parent company and executive compensation contracts in subsidiary firms: Evidence from China

Abstract

ABSTRACT This paper studies whether the corporate governance of the parent company affects the executive compensation contract of its listed subsidiaries. Based on a quasi-natural experiment on the board reforms in the Chinese central state-owned enterprises (CSOEs), which improves the corporate governance in the ultimate parent company, we find the following: (1) The improved corporate governance of the parent company can effectively restrain the managerial power of listed subsidiaries and reduce excess managerial pay. (2) The above-documented effect is more pronounced when cash flow rights (the wedge between control rights and cash flow rights) of the ultimate parent company is low (high), or when the listed company is at the bottom of the pyramid, or when the managerial power of the subsidiary firm is higher. (3) The improved corporate governance of the parent company can also effectively alleviate managerial perk consumption and the executive–employee compensation gap at their listed subsidiaries. This study suggests that the governance improvement in ultimate parents has a spillover effect in that it enhances the governance at their listed subsidiaries.