Does Non-controlling Large Shareholder Monitoring Improve CEO Incentives?

ABSTRACT

This paper investigates the influence of non-controlling large shareholders (NLSs) on CEO pay-performance sensitivity (PPS), using over 2,000 Chinese firms. We find that NLSs’ equity ownership or Shapley value is positively related to CEO PPS, suggesting that cash-flow rights or real voting power of NLSs help align the interests between CEOs and shareholders. This positive impact is more prominent when the benefit of monitoring is larger. There is also preliminary evidence that different types of NLSs boost CEO incentives through different channels. Overall, our study helps understand the monitoring role of NLSs in emerging markets.

KEYWORDS:

• Non-controlling large shareholder
• pay-performance sensitivity
• emerging markets
• blockholder identity

JEL CLASSIFICATION:

• G14
• G32
• G34

Acknowledgments

We thank Gang Bai, Robert Anderson, the editors, and the reviewers for their helpful suggestions on this paper. Hongyan Fang acknowledges financial support from the National Natural Science Foundation of China (No.71202174). Zhiyang Hui acknowledges financial support from the China Scholarship Council (No. 201906980031).

Notes

1. In our sample, the average value of equity holdings of the 2nd (2nd to 5th) largest shareholder is RMB 0.84 (1.61) billion throughout the sample period.

2. For example, 45.91% of CEOs hold firm equity in our sample. Their equity compensation accounts for 70.81% of total compensation. The average PPS is 9.24% for these CEOs, and drops to 1.90% if equity holding is ignored.

3. For a specific firm, the reform is considered complete if its controlling and minority shareholders agree on the reform plan, and the plan also gets approved by China Securities Regulatory Commission (CSRC). For more details of the reform, see Li et al. (2011) and Liao et al. (2014).

4. For instance, the median equity ownership of firms’ controlling shareholders, the 2nd largest shareholders, and the 2–5th largest shareholders are 35.55%, 5.74%, and 14.53%, respectively in 2006, and become 37.50%, 7.86% and 17.52% in 2015.

5. For details of the two events, see http://finance.eastmoney.com/news/1349,20180424862121732.html, http://finance. eastmoney. com/news/1344,20160630638157254.html.

6. For both restricted stock and stock option grants, we carefully read the preliminary and revised version of the plan, firm announcement of adjustment, and exercise announcement, if any.

7. If a firm has more than one CEO in a given year, we select the last successive CEO for that year. Thus for a given firm-year, we only have one CEO.

8. Special treatment, or ST, means that the firm is in financial trouble.

9. The Shapley value captures a large shareholder’s expected ability to form a majority coalition and change firm policy through a majority vote. Hence it is considered a better measure of the large shareholder’s voting power (Basu, Paeglis, and Toffanin 2017; Milnor and Shapley 1978).

10. In unreported tests, we also use NLS in the year as the main explanatory variable, the results are unchanged.

11. DNLS equal to one if the corresponding NLS measure in a certain year is above the industry median value in the year, and zero otherwise.

12. The excess measures are calculated by subtracting the benchmark median value for firms in the same size quintile in the same industry-year (see Larcker, Ormazabal, and Taylor 2011).

13. In unreported tests, we also regress NLS ownership or Shapley value on lagged PPS. We find that blockholder ownership does not exhibit significant changes following changes in the PPS, suggesting that, at least in our sample, NLSs do not show a preference for firms with a high level of CEO PPS.

Additional information

Funding

This work was supported by National Natural Science Foundation of China [71202174].