Equity-based Incentives Research Articles

Environmental, social and governance (ESG) performance and abnormal positive tone

Purpose The purpose of this study is to explore the relationship between environmental, social and governance (ESG) performance and tone management in the annual report. This is based on the notion that managers, driven by personal interests, may use their ESG accomplishments by using an abnormal positive tone to enhance their reputation or career prospects. Design/methodology/approach Using panel data from Chinese listed companies from 2010 to 2022, this study first investigates the relationship between ESG performance and abnormal tone management. The study then uncovers this relationship is mediated through the mechanisms of equity-based incentive and analyst coverage. The conclusions of this paper hold even after a series of robustness tests, such as propensity score matching, Heckman two-stage method and two-stage least squares with instrumental variables. Findings This study finds a positive correlation between ESG performance and the presence of abnormal positive tone in annual reports. Furthermore, the mechanistic analysis reveals that managers in companies with strong ESG performance are motivated to use an overly positive tone, largely due to their vested interests in equity-based compensation. Moreover, in an effort to alleviate the pressure stemming from heightened financial analyst coverage and enhance the impression conveyed through analysts' reports, managers with superior ESG performance also tend to inflate the tone within their annual reports. Practical implications This study provides significant insights into the ongoing dialogue surrounding ESG-related equity incentives, which incentivize managerial manipulation of stock prices through the use of abnormal positive tone. The findings call upon investors to exercise greater vigilance in examining narrative information in annual reports, as abnormally positive tones may not always faithfully represent performance but rather reflect managerial self-interest. Social implications There is an emphasis on the importance of robust oversight mechanisms within corporate governance bodies to curb the manipulation of tone for managers’ personal gain. Originality/value This study enhances the theoretical foundation of ESG studies, offering a holistic perspective on the intricate interplay among ESG performance, managerial behavior and financial markets, with potential implications for researchers, investors and regulators.

A Critical Review of Executive Compensation Policies Grounded in ESG Principles

High executive salaries often lead executives to prioritize short-term gains over long-term ESG benefits. This review explores how reducing executive compensation, influenced by environmental regulations, impacts innovation in sustainable technologies. As shareholders demand more ESG-focused models, the traditional compensation model is shifting to link compensation with environmental and social goals. The literature focuses on greenhouse gas emissions, employee satisfaction, and regulatory compliance. This review covers global ESG-based incentives, followed by country-specific approaches in China, France, Germany, India, Italy, South Africa, Sweden, and the United States. It concludes with alternative frameworks from financial institutions. Executives are more likely to engage in environmental initiatives when personal gains are tied to these goals. Equity-based incentives are favored over salary-based bonuses. Concepts like the parity pill aim to increase investor trust and transparency. As investors become more environmentally conscious, they expect companies to align with these values. Executives are encouraged to prioritize long-term sustainability over short-term personal gains.

The effects of firm-specific incentives (stock options) on mobility and employee entrepreneurship

We consider the effect of employee stock options on employee mobility and employee entrepreneurship. Employee stock options are firm-specific, long-term, equity-based incentive instruments—attractive properties for affecting employee behaviors and decisions. We argue that employee stock options reduce employee mobility levels. By contrast, we posit that employee stock options increase employee entrepreneurship levels, and even more so when a firm's knowledge scope is narrow. Using the semiconductor industry as the setting, we document not only the negative effect of employee stock options on employee mobility levels but also the positive impact on employee entrepreneurship levels; the positive impact is also more substantial in firms with a narrow knowledge scope. We contribute to the literature that examines the influence of organizational conditions on the origins of entrepreneurship. We also inform research on strategic human capital by explicating the divergent effects of firm-specific incentives on two crucial human capital outcomes for firms.

The Analysis of Changes in Director Compensation of Internet Corporations—Taking Alphabet as an Example

As the rapid growth of the significance of the technology sector in global economies gained prominence, this research stems from the need to align director compensation with the internet industry's distinctive characteristics. This article sets US internet companies as research targets and Alphabet as an example. By exploring these factors through quantitative and comparative analysis, this research provides insights into how internet companies shape their compensation strategies to thrive in the digital era. The compensation approach for directors in US internet firms includes equity rewards, cash retainers, stock ownership guidelines, and performance-linked perks. Transparency, benchmarking, and alignment with strategy are vital. This structure aims to lure skilled directors, align interests with shareholders, and enhance governance amidst tech's rapid evolution. Alphabet, Google's parent company, has recently advanced director compensation. Stock options and RSUs are increasingly granted, aligning with industry trends. Cash retainers provide stability. Alphabet's focus on equity-based incentives mirrors broader tech trends. These changes underscore Alphabet's strategy to retain adept directors who shape the company's growth and direction. This research can be used to address how compensation practices reflect the industry's innovation pace, adapt to regulatory changes, and foster effective governance.

An empirical study from Chinese energy firms on the relationship between executive compensation and corporate performance

Purpose: This study investigates the relationship between executive compensation and firm performance in Chinese new energy companies.
 Design/Methodology/Approach: The financial data of 122 Chinese-listed energy companies from 2010-2021 is selected for the empirical study.
 Findings: Executives' monetary compensation and executives' shareholding ratio are positively related to corporate performance. Overseas background and financial background play a moderating role in the effect of executives' monetary compensation and their shareholding ratio on corporate performance.
 Conclusion: The fact that executives' salaries and shareholding both have a significant positive impact on business performance demonstrates the effectiveness of pay incentives and equity-based incentive. The research additionally demonstrates that an executive's financial knowledge and experience in other countries alter the impact of cash and equity pay on company performance.
 Research Limitations/Implications: The research excludes a large number of key energy businesses, especially rising ones in the clean energy sector, as it solely targets publicly traded businesses for ease of data collection.
 Practical Implications: The survey results help to further understand the key factors of compensation incentives for managers in energy companies and are informative for the effectiveness of compensation incentives in energy companies.
 Contribution to Literature: This study provides empirical results on the impact of managerial compensation on firm performance in energy firms in the Chinese context, adding a new step to the existing literature.

Influential independent directors' reputation incentives: Impacts on CEO compensation contracts and financial reporting

We study how reputation incentives of influential independent directors (those holding multiple directorships) affect CEO compensation and firm financial reporting decisions. We find that CEO equity-based incentives, measured by CEO delta, vega and the number of equity grants are positively related to these directors' reputation incentives. These director reputation incentives also mitigate the perverse CEO incentives to inflate earnings, which arise from such high-powered compensation structures, by motivating increased board monitoring to limit discretionary accruals and real activity-based earnings management. These findings are invariant to endogeneity adjustments under multiple approaches, including exogenous changes in reputation incentives.

Pay for prudence

We provide the first evidence that prudential principles shape bankers' executive compensation, a phenomenon we call “pay for prudence” (PfP). We conjecture that PfP incentivizes bankers to balance shareholders' preference for risk with regulators' preference for prudence. Although PfP terms are often used in bank compensation contracts, we find that the use of detailed and concrete PfP terms are positively associated with equity incentives for risk-taking. Furthermore, detailed and concrete PfP terms are associated with lower tail risk, fewer bad loans, and lower likelihood of regulatory downgrades. While we do not find evidence that PfP is associated with lower profitability, PfP is associated with more diversified loan portfolios and reduced exposure to real estate. Our results shed light on a new dimension of bankers' pay and suggest that PfP-based incentives complement widely studied equity-based incentives for risk-taking by acting as guard rails that guide managers’ pursuit of investment opportunities.

Does executive compensation mechanism balance performance with risk-taking? Evidence from China's banking system

PurposeIn this study, the authors demonstrate the inherent connections between bank risk-taking, performance and executive compensation in the banking sector of China by developing a theoretical model and performing empirical tests with simultaneous equation models.Design/methodology/approachThe authors construct a multi-task principal-agent model to capture agency problems in China, and the model can be extended to various cases. In empirical tests, simultaneous equation models are used to examine the theoretical predictions by eliminating endogenous concerns efficiently compared with the methods in the existing literature.FindingsThe results indicate that the regulator fails to provide bank managers with positive incentives to control risk, whereas the compensation guidance policy (2010) proposed by the CBRC alleviates this problem in China. Additionally, the authors established that shareholders reward bank managers for better and more stable performance. The authors propose the introduction of restricted stock options into the compensation design, as the existing compensation design fails to balance the performance and risk-taking of banks.Research limitations/implicationsFirst, the executive compensation structure and details in China are not available. In addition, the equity-based incentive compensation is forbidden. Therefore, this paper cannot provide more details about how the compensation structure affects bank manager behaviours. Secondly, the database consists only 25 listed commercial banks. Luckily, the assets of these banks could account for the vast majority of China's banking assets. The authors also expect that new methodologies such as machine learning and deep learning will be adopted in the research on bank risk management.Practical implicationsFirst, the regulator should optimise the compositions and payment rule of bank executive compensations. Secondly, it is advisable to adopt restricted deferred share reward or stock option compensation in due course. Thirdly, the regulator can require the banks that undertake excessive risks and troubled by moral hazard to increase the independent director proportion on the bank board according to the authors' empirical tests that higher independent proportion prevents the risk accumulations effectively. Fourthly, except for absolute compensation, the gap between executives' salary and average employee's income should be taken account.Originality/valueThis study provides a theoretical framework that incorporates the manager behaviours, executive compensation and bank regulations, and it provides empirical tests by solving endogenous concerns. Additionally, this study examines the effects of China's compensation guidelines issued in 2010. The authors believe that this study adds value to the existing literature by illustrating the compensation mechanism in China.

Can Short Selling Improve the Quality of Information Disclosure in Clarification Announcements by Firms Faced with Market Rumors?

ABSTRACT Using a sample of clarification announcements by Chinese listed companies and a difference-in-differences approach, this paper discusses the impact of short selling on corporate clarifications. The results show that short selling pressure disciplines managers’ clarification behaviors. Pilot firms are more likely than non-pilot firms to release timely, detailed, and technical clarification announcements, indicating that the ex-ante pressure of short selling improves the quality of information disclosure in clarifications. The results are robust to the use of a propensity score matching sample, the exclusion of extraordinary sample periods, controlling for the category of rumors, and the adoption of the double selection approach. The disciplinary effect of short selling on the quality of information disclosure in clarifications is more significant for companies with higher CEO equity-based incentive ratios, higher stock liquidity, and higher media coverage than for other companies. More intensive short selling activities, implying an increased ex-post threat of short selling, also lead to improvement in the disclosure of clarifications. Additional research shows that the improved disclosure increases stock price informativeness, and short selling enhances this effect.

CEO duality, CEO compensation, and earnings management: Evidence from China

This paper investigates whether chief executive officer (CEO) duality and CEO compensation influence earnings management. We obtain the data of the A-shares companies listed in both the Shanghai Stock Exchange (SSE) and Shenzhen Stock Exchange (SZSE) from the Chinese Securities Market and Accounting Research (CSMAR) database. Using a sample of 8,419 firm-year observations of 881 unique listed companies in China from 2011–2022, we find that the firms with CEO duality exhibit a higher level of earnings management, through both discretionary accruals and real activities. In addition, CEOs with higher cash-based compensation are more likely to engage in earnings management, while CEOs with higher equity-based incentives are less likely to engage in real earnings management. We further examine the moderating role of CEO duality and find that CEOs who also chair the board are more likely to engage in real earnings management. Additional analysis shows that state-owned companies are less likely to engage in earnings management activities. However, equity-based compensation provides incremental incentives for the CEOs of state-owned companies to manage earnings through accruals rather than real activities.

The Impact of Equity-based Incentives on Company Achievements of Enterprises in Sci-Tech Innovation Board: Analysis Based on CanSinoBIO and Hotgen Biotech

This article takes CanSinoBIO and Hotgen Biotech as an example, comparing and analyzing the company data of the first quarter of 2021 to the first quarter of 2022 of the two enterprises. Apart from that, the study illustrates the influence of equity incentive on the financial performance and non-financial performance of Sci-Tech innovation board company, and further gives suggestions for the incentive plans of the two companies. The results show that the time, object and scale of investment of equity incentive have obvious influence on company achievements. Among them, the incentive for senior executives and independent directors will improve the management efficiency of the company.

Equity-based incentive to coordinate shareholder-manager interests under information asymmetry

<p style='text-indent:20px;'>The shareholder's interest oriented from business operation relies on opportunism regulation of the manager under asymmetry. Effective motivation incentives should be exploited to facilitate the manager's effort devotion enthusiasms. This paper establishes a theoretic model in which the shareholder offers equity-based incentive to a fairness-preferred manager to coordinate their interest conflicts and maximize her expected revenue. The manager exerts unverifiable levels of efforts toward both decision and coordination tasks making the most of his private information about fairness preference. Two interrelated performance measures on different hierarchical levels are considered for contracting purposes. In each situation, we derive the equilibrium effort choices and incentive coefficients of both participants, and investigate how these decisions are affected by fairness preference. Research findings suggest that the incorporation of firm equity dominates pure profit incentive in eliciting high effort levels toward two distinctive managerial tasks. Besides, the equity-based incentive weakens the perceived unfairness and facilitates the participants' expected revenue. Comparative statics and numerical analysis are conducted to demonstrate our results and the effectiveness of the proposed equity-based incentive. Finally, we summarize the contributions of this paper and put forward directions for further study.</p>

Equity-Based Incentives, Production/Service Functions And Game Theory: Additional Considerations.

Equity-Based Incentives, Production/Service Functions And Game Theory: Additional Considerations.

Skilled Labor Risk and Corporate Policies

Abstract We measure U.S. listed companies’ skilled labor risk—that is, the potential failure in attracting and retaining skilled labor, by the intensity of discussions on this issue in 10-K filings. We show that this measure effectively captures firm risk due to the mobility of skilled labor. We find that an increase from the 25th to the 75th percentile in the skilled labor risk would increase the skilled labor wage by 22% (or $15,593) and also lead to higher equity-based incentive pay. The skilled labor risk also interacts with other corporate policies such as financial leverage, cash holdings, and M&As. (JEL G30, G32, G34, H20, J20, J24, J40, J41) Received September 28, 2020; editorial decision March 12, 2021 by Editor Andrew Ellul.

CEO inside debt and internal capital market efficiency

Agency theory argues that managerial equity-based incentives are more effective when firm solvency is likely while debt-based incentives are more effective when firms face a greater likelihood of bankruptcy. We examine the relation between chief executive officers' (CEOs') inside debt holdings and the internal capital market allocation of multi-segment firms. We find that CEO inside debt holdings are associated with conservative capital allocation to firm segments, with the result driven by financially distressed firms. Further analysis indicates that although CEO inside debt, on average, is negatively related to firm value, the relation is positive for financially distressed firms. Our evidence indicates that inside debt holdings align the interests of managers and external creditors, inducing managers to pursue conservative capital allocation strategies that appear to be optimal for firms facing insolvency.

Explaining the asset growth anomaly in the restaurant industry: Motivations and consequences

Many business leaders have the tendency to vigorously pursue rapid firm growth, but this focus is often criticized as problematic in terms of operating performance. Accordingly, this study suggested that the asset growth anomaly is an inevitable phenomenon for growing restaurant firms: operating profitability increases as assets grow to the optimum level and then decreases after this level. However, most restaurant firms invest their capital below the optimum level, and only a small number of restaurant firms increase their assets too rapidly. Further, the amount of a chief executive officer’s (CEO’s) bonus payments motivates their investments in asset growth, while the amount of stock options increases the probability of overinvestment practices in restaurant firms. Therefore, even though overinvestment practices are not apparent in most restaurant firms, an appropriate proportion of equity-based incentives is beneficial to prevent overinvestment practices by a few restaurant firms to avoid negatively impacting shareholders’ wealth.

Financial reporting fraud and CEO pay-performance incentives

Because prior studies find mixed results on the relation between CEOs’ pay performance incentives and a firm’s likelihood of financial reporting fraud, we restudy their relationship using innovative research methods. First, we concentrate on incentives from granting options rather than equity-based incentives. Second, we emphasize vested options, disregarding unvested option holdings, and take the logarithm transformation of option incentives. Third, we analyse the impact of option incentives on future financial reporting irregularities. Using this innovative approach as well as a full sample and a matched sample, we find that an increase in executives’ option incentives raises the likelihood of financial reporting violations. Moreover, the effect of option incentives on financial reporting fraud is moderated by auditor effort. In addition, we find that another proxy for the measurement of executives’ option incentives, namely, the number of vested options by executives, is highly correlated with the CEO’s vested stock option sensitivity.

An equity-based incentive mechanism for persistent virtual world content service

Virtual world has the potential to become a future global electronic marketplace, integrating many isolated markets in many areas. To achieve this goal, future virtual world is required to be persistent, implying that a virtual world together with its accumulated content shall exist forever regardless of dynamic changes of its users and owners. Unfortunately, existing virtual worlds, owning by some entities, are not immune from death due to business entity failure. To provide a persistent virtual world, a decentralized architecture is explored, which is constructed on user contributed devices. However, there are many challenges to realize a decentralized virtual world. One important issue is user cooperation in reliable content storage. The devices contributed by users may not be reliable for maintaining all user contents, but users do not have the incentive to provide reliable devices for others. This paper addresses the issue by two steps. First, an indicator, called replica group reliability, is provided to users, which is based on the proposed replicability index. Based on the indicator, users can learn the reliability of their content storage. Then, a new user incentive mechanism, called equity-based node allocation strategy, is proposed to promote user cooperation to collectively maintain reliable content storage. A decentralized algorithm implementing the strategy is designed and the evaluation results show its effectiveness and efficiency.

Disagreement, Speculation and Management Forecasts

Prior research shows that disagreement leads to speculative trading and a speculative premium in stock prices. We examine how managers respond to this speculative premium. Using exogenous variation in speculative trading due to the reconstitution of the Russell 1000/2000 indices, we find that speculative trading reduces the frequency, likelihood, and precision of management forecasts. Consistent with theory, this relationship is significantly stronger when short sale constraints are more binding, and when managers have stronger equity-based incentives. We also find that managers sell equity to benefit from the speculative premium. In summary, our results suggest that managers issue forecasts opportunistically in response to speculative trading: they either keep silent, or issue fewer and more ambiguous forecasts to prolong disagreement among investors and the speculative premium.

Nonfinancial Performance Measures and Risk Taking: Evidence from the Oil and Gas Industry

This study examines the relation between nonfinancial performance measures (NFPMs) and firms’ risk taking. Specifically, using CEO compensation contracts in the oil and gas industry (SIC 1311), I examine the relation between NFPMs and firms’ exploration and exploitation activities. The oil and gas industry provides an ideal setting for my study because firms in this industry are required to disclose their exploration and exploitation activities, which allows me to develop empirical measures for both activities. I find NFPMs that incentivize high risk exploration activities (exploration NFPM) lead to more investment in exploration activities. More importantly, I find that firms with exploration NFPMs also invest in more low risk exploitation activities and achieve better short-term financial performance compared to other firms. These results are consistent with my hypothesis that explicit incentives to invest in risky projects induce risk averse managers to manage the associated downside risk of failure by allocating resources more efficiently across other projects. My findings shed light on how NFPMs can potentially complement equity-based incentives and financial accounting measures to direct and motivate managers to take on risky projects as well as better manage firm performance.