Does Chinese State Control Facilitate Relative Performance Evaluation?

Abstract

Previous studies of relative performance evaluation (RPE) for executive compensations in Western developed markets have produced mixed findings. This is partly because the dispersion of share ownership in Western capital markets does not closely correspond with the single-principal/multi-agent theoretical setting assumed by Holmstrom (1982). In this study, we exploit the existence of a large number of state-owned enterprises (SOEs) in China to examine RPE in a setting closer to the theoretical assumption. We find that SOEs are more likely to use RPE for executive compensation than non-SOEs. This is consistent with better cross-firm coordination in executive contracting among SOEs under a common “state” principal than among non-SOEs with dispersed principals similar to Western firms. Furthermore, we find a more pronounced RPE effect among SOEs that are larger or have poorer past performance. This implies that the state principal has greater incentives to monitor strategically important firms or those in distress.