Abstract
Executive incentive has long been a hot topic among academics and practitioners. With the continuous development of China's manager market, the spirit of innovation and entrepreneurship among executives has exerted a greater influence on corporate performance. Enterprise innovation is an important part of the entrepreneurial spirit. Moreover, China's supply-side reforms and compensation system of the state-owned enterprises (SOEs) have been advanced and innovative. Therefore, based on the manager human capital theory and the organizational innovation theory, and using 15,492 firm-year observations from China's Shanghai and Shenzhen A-share listed companies for the period 2005–2018, we constructed various models, including the Gorden model, the Growth Rate of Price–Earnings Ratio model (PEG), the Ohlson and Juettner-Nauroth model (OJ), and the Capital Asset Pricing model (CAPM), to measure the cost of equity. We investigated the effect of the institutional innovation of executive incentives on the cost of equity, and the heterogeneous influence of China's special property rights system on the relationship between the two. We found that the innovations of the executive incentive system have a positive governance effect on the cost of equity. In particular, executive compensation incentives significantly reduce a company's equity costs. We also find that the state-owned property rights may weaken the positive effect of institutional innovation of executive incentives. Furthermore, China's executive incentives system and corporate governance mechanism are imperfect; and therefore, institutional innovation is a matter of great urgency and more innovative ideas for the manager market need to be introduced. China's listed companies should give full play to the spirit of innovation and entrepreneurship, constantly innovating incentive-based compensation systems of companies, and establishing a scientific and innovative concept of the cost of equity. The findings are robust after controlling for potential endogeneity concerns.
Highlights
For China in the economic transition, the key to overcoming the middle-income trap is to enhance the innovation ability and productivity of the Chinese firms, promoting intensive margin growth
We investigated the effect of the institutional innovation of executive incentives on the cost of equity, and the heterogeneous influence of China’s special property rights system on the relationship between the two
We found that the innovations of the executive incentive system have a positive governance effect on the cost of equity
Summary
For China in the economic transition, the key to overcoming the middle-income trap is to enhance the innovation ability and productivity of the Chinese firms, promoting intensive margin growth. Most executives hold few or even no shares in Chinese companies, as shown in our data, and the average rate of executives’ shareholdings is only 5% This indicates that the effectiveness of equity incentives in China needs to be further verified. The implementation of an effective executive compensation contract helps firms attract excellent talent, and promotes the sharing of benefits and risks between the management and shareholders, mitigates the agency problem, and reduces corporate equity cost (Chen et al, 2013; Luong et al, 2021). We propose the following hypothesis: Hypothesis 2: Property rights of state-owned firms weaken the effects of executive incentive systems on the cost of equity.
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