014 International Conference on Management Science & Engineering (1 th ) August 17-19, 014 Helsinki, Finland The Relation between Executive Compensation and Firm Performance in Chinese Family Firms: Moderating Role of Family Management WANG Qi,WU Chong,WANG Xu School of Management, Harbin Instute of Technology, Harbin 150001, P.R.China Abstract: The purpose of this paper is to research the impact of family management on the incentive effect of executive compensation in Chinese family firms. This paper examines the relation between executive compensation and corporate performance from perspective of family management using a sample of 31 Chinese family listed companies during the period of 010-01. This study indicates that family management has the moderating role on the relation between executive compensation and firm performance. Furthermore, we also find that this role is the entrenchment effect. Therefore this paper indicates that family management is closely related to the incentive effect of executive compensation. These results may support family management explanation for the strength of the incentive effect of executive compensation and provide references for family enterprises to establish a reasonable executive compensation mechanism. Keywords: Chinese family firm, executive compensation, family management, firm performance 1 Introduction Since the separation of ownership and control, executive compensation has become an important corporate governance topic [1-]. One of the crucial research questions in this area is whether executive compensation has an impact on firm performance. So far, some scholars have researched on this question deeply, but there are no inconsistent results [3]. One potential explanation for these mixed results could be provided by the fact that these researches do not examine the effects of potential moderating variables on the relation between executive compensation and firm performance. So, this question is worth our further study. In China, most studies about the relation between executive compensation and firm performance have focused on state-owned enterprises. But, few extant leratures consider Chinese family companies. Since China started s economic reform in 1978, the family economy has been booming, and the quanty of family listed corporates is increasing quickly. Currently, China s non-state sector accounts for around 65% of s GDP and 70 80% of s GDP growth. Compared wh state-owned enterprises, family companies wh clear property rights can help avoiding the insider control. These family firms have also some specific characteristics in terms of the shareholding structure, corporate governance, agency problem and so on [4]. So this study which focuses on the relation between executive compensation and firm performance about family companies is of theoretical and practical significance. This issue also attracts our attention. At present, we often find that family management is common, and the distinct feature in Chinese family companies [5]. High concentration of family ownership is prevalent among Chinese family listed companies. Majory of family are likely to make important management decisions such as operations, wages and benefs, human resource management, and long-term corporate decisions. In this context, some researchers have argued that family management has the effects on corporate governance [6]. Because executive compensation is an important corporate governance question, so we predict that family management is likely to have significant impact on the relation between executive compensation and firm performance. Therefore, the objective of this study is to examine how the relation between executive compensation and firm performance is moderated by family management. Theory development and hypotheses In family firms, family involvement in management can effectively reduce the owner manager agency conflict, but can also produce new agency cost [7]. This indicates that Type I and Type II agency problems more or less exist in modem family firms. Due to family benef and trust, family members become the executives themselves, and participate in the operation of enterprises actively. Moreover, the altruism among family members can make family executives receive more paid, more privileges and more opportunies of promotion than non-family executives, but compared wh non-family executives, family executives have less expert knowledge, implying that they commonly damage firm performance in China s family firms [8]. These indicate that contract enforcement of family executives is problematic. In addion, is possible that the mutual trust between family members makes owner tolerant the inefficient work of family executives, implying that non-family executives tend to be lazy and take other 978-1-4799-5376-9/14/$31.00 014 IEEE - 971 -
opportunistic action. At the same time, the management entrenchment exists commonly. This makes difficult to promote non-family executives to get the important management posions, which hinders the creativy and work efficiency of non-family executives. This means that executive incentive contracts designed by owners may not have the power in restraining the opportunistic behavior of family executives. Then, the owner appoints family members into executives. This means that the conflict of interests arises between controlling owner and minory shareholders is a distinct feature in Chinese family firms, which makes the presence of tunneling by controlling owners [9]. The owners get the private benefs from tunneling in poor environment [10]. Tunneling is often achieved through collusion between owners and family executives. At present, family management is on the rise, implying that the owners tend to hire family executives wh insufficient qualifications instead of capable managers. Family executives that help controlling owner tunnel get compensated [11]. Owners use executive compensation as the tunnel mechanisms. In other word, owners are unlikely to incentivize executives to improve firm performance when they could tunnel resources from the companies. So, tunneling reduces company performance [1], which presents that the executive compensation mechanism can fail. So, we make the hypothesis. Hypothesis: Family management will moderate the relationship between executive compensation and firm performance in such a way that executive compensation will have a less posive effect on firm performance for family executives than for non-family executives. management affects the relation between executive compensation and firm performance in Chinese family firms. Previous empirical studies on the influence of executive compensation on firm performance in family firms provide inconsistent results. On the one hand, some authors find that executive compensation has a substantial effect on firm performance [14]. Other studies find no relation between executive compensation and firm performance [15]. However, these studies typically do not take into account the heterogeney of family firms. Research has highlighted that family firms may have various goals, resources, and needs as well as different management structures. As a result, there seems to be a growing consensus that family firms should be considered as a heterogeneous enty. So far, some evidences indicate that moderator variables may affect the relationship between executive compensation and firm performance [16]. Since family firms cannot be seen as a homogeneous group, they will not all face the same type of agency costs. As a result, we must acknowledge this heterogeney when investigating the relation between executive compensation and firm performance in family firms. After all, the need and impact of the relation between executive compensation and firm performance will be contingent on the type of agency costs. We distinguish several types of family firms based on different management structures, in order to take into account this heterogeney [17]. Hence, we examine whether the relation between relation executive compensation and firm performance depends on family management (see Fig.1). 3 Research design Executive compensation Firm performance 3.1 Sample selection and data resource This paper selects family listed companies on the Shenzhen and Shanghai stock exchange from 010 to 01 as a sample, according to the study standard of Tsang (00) [13]. In line wh prior studies, we exclude firms in the financial industry. Then our study eliminates the abnormal samples and the missing data. Therefore, 31 family listed companies are selected as the research sample. The data come from two different sources. First, China Stock Market Financial Statements (CSMAR) Database is used for the construction of financial variables. This database provides financial data for family companies wh share listings, on eher the Shanghai or Shenzhen Stock Exchanges. The China Listed Firm's Corporate Governance Research Database serves as the second data source. So, we collect 693 firm-year observations. Because of complete data for certain years and companies, we adopt a balance data panel approach wh relevant regression estimates determined using Eviews7.0 software. 3. Research model and variable determination Our main research question asks how family Fig.1 Research design To answer this question, we use two regression analyses to test whether moderating role of family management on the incentive effect of executive compensation. We use Model (1) to test the relation between executive compensation and firm performance. This further examines the incentive effect of executive compensation, which is an important governance mechanism in the agency problem. Model () is used to test family management affects the relation between executive compensation and firm performance. Model (1): PERF = β0 + β1inpay + βfe + β3share (1) + β4debt + β5size + β6ceo + ε Model (): PERF = β0 + β1inpay + βfe () + β3fe * InPAY + β4share + β5debt + β SIZE + β CEO + ε 6 7 Family Management H - 97 -
Where, we use return on assets (ROA) and return on equy (ROE) as indicators of corporate performance which are dependent variables. The first measure (ROA) is configured as the ratio of net prof to total assets. The second measure (ROE) provides a return-on-equy measure, defined as net prof divided by net assets (owners equy). In China, the components of executive compensation mainly include cash compensation, stock equy, and perk incentives [18]. Cashes were paid based on region, industry, and employee characteristics, such as seniory, tenure, education, gender, and so on [19]. But in China s family firms, the owners control the level of cash executive compensation. A characteristic of the executive compensation environment in China is the general absence of executive stock options. We find that the most common perks were a company car and a housing allowance. Other perks include travel expenses, business gifts, and business apparel expenses. Because perk incentives are hard to be measured, so far, we find that the Chinese lerature about perk compensation is almost non-existent. Meanwhile, we think that the executives are the team, so we employ executive cash compensation, defined as the sum of three highest paid executives total cash compensation in the annual reports of listed companies. Total cash compensation includes basic salary, bonuses, stipends, and other benefs denominated in Chinese RMB [0]. Accordingly, we use InPAY as our independent variable, defined as the natural logarhm of the sum of three highest paid executives total cash compensation. The variable FE provides the level of family management, defined as the number of family executives divided by the total number of executives. FE can also measure the degree of internal altruism. In China, executives mainly include the CEO and his or her immediate subordinates. They are responsible for running the firm. Chinese family listed firms have high percentages of family executives in the executives. Family executive is that the executive is a member of the controlling family. According to this definion, family executives refer to spouse, parent brother, sister, or close relative of the owner. Therefore, family executives are related closely to the owners and represent the interest of family. In addion, following previous research, we include four control variables: concentration of family ownership concentration (SHARE), liabilies level (DEBT), firm size (SIZE) and CEO to take the chairman (CEO). Family ownership concentration (SHARE) is measured as the proportion of share owned by family. The higher level of SHARE indicates the family stronger influence on listed companies because of representation and voting rights on the board. The lerature finds that debt financing should be posively related to firm performance. DEBT is measured as total liabilies over total assets. Firm size is also likely to be a major factor in the determination of corporate performance. Accordingly, variable SIZE, the natural logarhm of a firm's total assets, enters Model (1) and Model () as a separate and important control variable. In Chinese family corporate, is clear that strategic firm decisions often require the approval of the chairperson [1]. We control for this possible effect on firm performance through inclusion of variable CEO. This variable takes on value one in cases where the CEO is also the firm's chairperson. The specific definions of variables are shown in Tab.1. But Aiken and West (1991) found that explanatory variables are related closely to their interaction term []. This may results in the serious multicollineary problem in Model (), which influences this study. So, we need to revise Model (). In the paper of Aiken and West (1991) [], explanatory variables are standardized, we include new interaction terms by using these standardized variables in order to eliminate the multicollineary problem. According to the study of Aiken and West (1991) [], in this paper, InPAY and FE are standardized respectively. That is as follows: InPAY = ( InPAY InPAY) / σ (3) Where, InPAY is the mean of InPAY, and σ is 1 the standard deviation of InPAY. FE = ( FE FE) / σ (4) Where, FE is the mean of FE, σ is the standard deviation of FE. Then, the interaction of InPA Y and F E enters Model () instead of the interaction terms FE * InPAY, to get Model (5): 1 Tab.1 Summary description of variables employed Variables featured in Model (1) and Model () ROA Return-on-Assets, defined as Operating Profs divided by Total Assets. ROE A corporate's Return-on-Equy, defined as Operating Profs divided by Total Shareholders Equy. InPAY Natural logarhm of the sum of three highest paid executives total cash compensation. FE Family management, defined as The Number of Family Executives divided by The Number of The Total Executives. SHARE Proportion of outstanding stock held directly by family. = Number of The Family Shares / Total Number of Shares. DEBT Debt ratio. The variable is calculated based on the variable Debts divided by Total Assets. SIZE Natural logarhm of Total Assets. CEO Dummy variable coded one where the CEO is also defined as Chairman. - 973 -
PERF = β + β InPAY + β FE + β FE * InPAY + β SHARE 3 + β DEBT + β SIZE + β CEO + ε 5 0 6 1 4 To further test whether family management has the moderating role on the relation between executive compensation and firm performance, we examine this possible mediating effect by using the interaction term F E * InPAY in Model (5). Further, we examine that family management will decrease the relation between executive compensation and firm performance by using the interaction term F E * InPAY. We predict that coefficient β in Model (5) is negative. 3 4 Empirical results 4.1 Descriptive statistics Tab. reports the descriptive statistics of the variables. Tab. shows that the mean cash executive compensation in family listed corporations is 876433.4 RMB for sample, which is not high compared wh counterpart of China s state-owned enterprises. The maximum and minimum of PAY are 353300 RMB and 134500 RMB respectively. The standard deviation of PAY is high. These mean that the gap of executive compensation in different companies is very high. Because the owners determine randomly the level of executive compensation in China's family listed companies through the board. We find that the mean of ROA is 0.094, the maximum and minimum of which are 1.8 and -0.837 respectively. Meanwhile, the mean of ROE is 0.08, the maximum and minimum of which are 0.68 and -0.37respectively. These show that firm performance will be possibly affected by the different level of executive compensation. In addion, the mean of FE is 0.585, and the maximum and minimum of FE are 0.866 and 0.1 respectively, which shows that the ratio of family executives in China's family listed firms is relatively high. In addion, we find that the mean of SHARE is 0.593. This means that high concentration of family ownership is prevalent among Chinese family listed companies. On average, the equy ownership held by family of a firm is more than 50%. The concentrated ownership structure implies that the classical owner manager conflict is likely to be of less 7 (5) concern because the owners have incentives to monor executives, suggesting a highly concentrated ownership structure of Chinese family listed firms. The owners tend to be the controlling shareholders in the China s family firms, playing the important and dominant effect in corporate governance, coincident wh the characteristics of family enterprises. Then, the descriptive statistics of other main variables show that the other features of Chinese family listed firms. 4. Regression results Tab.3 reports the regression results of Model (1) and model (5). First, we estimate the Model (1) whout considering the effect of family management. Then, we estimate the Model (5) from the moderating role of family management. We find that F-statistics of Model (1) and Model (5) are significant at the 5% level, suggesting that the total explanatory variables influence dependent variable significantly. This means that Model (1) and Model (5) are statistically significant. In addion, DW values of Model (1) and Model (5) are both close to, therefore is clear that there is no autocorrelation between residuals. Meanwhile, we find that VIF values of all variables in Model (1) and Model (5) are less than 10, which indicates that there is no serious multicollineary problem. In Model (1), we test whether a significant posive relation exists between executive compensation and firm performance. Meanwhile, t-statistics in all regressions are based on standard errors clustered by firms. This study finds that the coefficients on InPAY in Model (1) through the two performance measures (ROA and ROE) are statistically significant and posive, suggesting that executive compensation in China s family listed firm is related posively to firm performance. The executive talent is successfully motivated by executive compensation which can raise the performance of firm. In a word, the relation between executive compensation and firm performance is an important subject worth studying. According to the study results of Tab.3, we find that the coefficient of interaction terms is -3.91 at the level 5% when using the ROA dependent variable. Compared wh that in Model (1), R-squared in Model (5) is significantly enhanced. This shows that family Tab. Descriptive statistics Variable Obs. Mean Median Maximum Minimum Std. dev. ROA 693 0.094 0.076 1.8-0.837 0.53 ROE 693 0.08 0.031 0.68-0.37 0.05 InPAY 693 7.384 6.394 8.384 5.004 0.384 PAY 693 876433.4 534344.0 353300.0 134500.0 38476.0 FE 693 0.585 0.400 0.866 0.100 0.635 SHARE 693 0.593 0.483 0.79 0.50 0.79 DEBT 693 0.474 0.474 0.908 0.083 0.139 SIZE 693 8.938 8.683 1.351 7.938 0.07 CEO 693 0.333 0.000 1.000 0.000 0.473-974 -
Tab.3 The results for Model (1) and Model (5) Variable Model (1) Model (5) ROA ROE ROA ROE Coefficient VIF Coefficient VIF Coefficient VIF Coefficient VIF Intercept -.933 5.85-1.566 ** -5.837 * InPAY 5.316 ***.935 4.48 *** 4.394 3.37 *** 3.338 7.930 *** 6.93 FE 1.354* 5.387 0.31*.937 6.938 * 5.787 8.391 **.398 F E * InPAY -3.91 ** 3.18-10.934 * 1.384 SHARE -6.498 ** 3.483-5.834 ** 7.93-4.384 ***.177-3.87 ** 7.03 DEBT -1.463 ** 3.470-3.48 ** 1.837-6.165 *** 7.93-1.938 ***.017 SIZE 5.65 * 4.843 9.374 *** 5.98 10.38 *** 6.89 4.39 3.65 CEO -1.436 5.495 -.384 8.387-0.183 * 4.91-3.09 1.384 R 0.166 0.365 0.83 0.459 F - value.431 ** 3.76 ** 4.89 ** 5.394 ** DW 1.467 1.38 1.85 1.783 Note: *, **, *** indicate significant coefficients at the 10%, 5% and 1% levels respectively. management has the moderating role on the relation between executive compensation and firm performance, consistent wh my hypothesis. In Chinese family listed corporations, altruism may lead to "Samaran Dilemma". This may increase the agency cost and weaken the incentive effect of executive compensation. We argue that the conflict of interests between owners and non-family executives could hamper the incentive effect of executive compensation in China. In addion, the owners could obtain private benefs from their controlling posions through various forms of self-dealing transactions such as selling assets, goods and services to companies at high prices or paying family executives well under family management. Such transactions are referred to as "tunneling", which reduces enterprise performance. Therefore, the owners engaging in tunneling activies have less incentive to demand the high effect of executive compensation. At the same time, our research results can t change when using ROE. In a word, in China's family listed corporations, family management has the moderating role on the relation between executive compensation and firm performance. 5 Conclusions In recent years, the relation between executive compensation and firm performance is debated among scholars. At present, family management is a distinct feature of China's family listed firms. Family management has the impact on the corporate governance. Meanwhile, executive compensation mechanism is an important part of corporate governance, the incentive effect of which is also inevably affected by family management. Yet we still don't understand how family management impacts the relation between executive compensation and firm performance. Therefore, following the extant leratures, this paper empirically studies how family management affects the relation between executive compensation and firm performance by using unique data on China s family listed firms from 010 to 01. This study finds that family management has the moderating role on the relation between executive compensation and firm performance. To be specific, in Chinese family listed corporations, the impact of family management on the incentive effect of executive compensation is negative, and this effect may weaken the incentive effect of executive compensation mechanism, hinder the work enthusiasm of executives, and then affect the development of family listed corporations. This study still has some limations. First, the sample of this study is family listed corporations. This means that our study result is not applied to more study areas. Second, we do not study different family management structure. Different ones lead in different results. This means that our outcome can be uncertain for all family firms. In this sense, the conclusions of this study is only limed to certain type of family firms. Third, this paper only takes into account the monetary compensation, which is obviously not comprehensive enough. Fourth, although this paper found that family management has the moderating role on the incentive effect of executive compensation in family listed corporations, we do not research other moderating variables, so this still need our further study. References [1]Jensen M C, Meckling W H. Theory of the firm: Managerial behavior, agency costs, and ownership structure [J]. Journal of Financial Economics, 1976, 3(4): 305-360. []Elston J A, Goldberg L G. Executive compensation and agency costs in Germany [J]. Journal of Banking & Finance, 003, 7(7): 1391-1410. [3]Firth M, Fung P M Y, Rui O M. Corporate performance and CEO compensation in China [J]. Journal of Corporate Finance, 006, 1(4): 693-714. [4]Xu X, Wang Y. Ownership structure and corporate governance in Chinese stock companies [J]. China Economic Review, 1999, 10(1): 75-98. [5]Maury B, Pajuste A. Multiple large shareholders and firm value [J]. Journal of Banking and Finance, 005, - 975 -
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