Perk consumption as a suboptimal outcome under pay regulations

Abstract

We examine how perk consumption is determined and whether it impacts firm value in China where executive pay is regulated. We find that perks are provided when the relative pay between top executives and average employees is low, in firms with high free cash flows, economic rent, and growth. Perks are positively associated with firm value, but to a much lesser extent than monetary compensation. This suggests that if perks are converted to cash compensation, shareholder wealth can be further enhanced. However, under China’s regulated compensation structure, this conversion may not be easily achieved and perks likely represent a second-best suboptimal solution in motivating executives.

Keywords:

• Compensation
• perk
• agency conflict
• China

JEL codes:

• G30
• J33

Acknowledgements

We thank workshop participants at the Arizona State University, University of Arizona, University of Missouri, the International Accounting and Finance Conference at Nanjing University in 2008, and the American Accounting Association International Accounting Section Mid-Year Meeting in 2010 for helpful comments.

Disclosure statement

No potential conflict of interest was reported by the authors.

Notes

An earlier version of this paper was titled “Do managers perform for perks?”

1. Following the classification of perquisites from prior studies and the SEC’s interpretive guidance, Andrews, Linn, and Yi (2009) classify all individual perquisite items into 10 broad categories (1) air and long-distance travel expenses; (2) company car and local transportation; (3) entertainment and other extracurricular activities; (4) personal- and family-related perquisites that enhance home/family situation of the executive; (5) severance package and/or special dividend distribution; (6) legal, financial, and tax services; (7) medical allowances and medical expenses paid by the corporation; (8) financial perquisites unrelated to savings or retirement; (9) administrative privileges; and (10) other. We have a partial overlap with Andrews, Linn, and Yi (2009).

2. Andrews, Linn, and Yi (2009) and Grinstein, Weinbaum, and Yehuda (2008) in their examinations of the consequence of the SEC’s enhanced disclosure rules for perks quantify perks but they cover only the year 2007. We hand-collect information on perks from Chinese publicly listed firms’ annual reports for a 12-year period from 1999 to 2010.

3. We do not include long-term incentives in computing this ratio. However, this is unlikely to bias our analysis as long-term incentives are rare among Chinese firms.

4. Consider using an exchange rate of 6–8 RMBs for a US dollar during the test period.

5. Of course, pay regulation also exists in western economies, though to a much lesser extent. Cai and Walkling (2011) find that when the House passed the Say-on-Pay Bill in the USA, which gives shareholders a say on executive compensation, the market reacted positively for firms with high abnormal chief executive officer (CEO) compensation, low pay-for-performance sensitivity, and responsive to shareholder pressure.

6. For example, after the 18th Congress of the Chinese Communist Party in 2013, the government drastically shrunk perk consumptions by the government and state-owned firms.

7. Core, Guay, and Larcker (2008) find that negative press coverage is strongly related to excess annual pay and that negative coverage is also greater for CEOs with more option exercises.

8. Relative pay, Rcp, is computed as (Total top manage monetary compensation/Number of top managers) divided by (Total employee monetary compensation/Number of employee).

9. East coast of China includes Beijing, Tianjin, Hebei, Liaoning, Shanghai, Jiangsu, Zhejiang, Fujian, Shandong, Guangdong, and Hainan.

10. Protected industries include (2) mining; (7) petroleum, chemical and plastics; (9) metal and non-metal; (13) electricity, gas and water production and supply; (15) transportation and warehousing; and (16) information technology.

11. Based on the classifications by the China Securities Regulatory Commission (CSRC), they are: (1) agriculture, forestry, livestock, and fishery; (2) mining; (3) food and beverages; (4) textile, garment, and fur; (5) timber and furniture; (6) paper and printing; (7) petroleum, chemical, and plastics; (8) electronics; (9) metal and non-metal; (10) machinery, equipment, and instrument; (11) pharmaceutical and biological products; (12) other manufacturing businesses; (13) electricity, gas, and water production and supply; (14) construction; (15) transportation and warehousing; (16) information technology; (17) whole and retail sales; (18) finance and insurance; (19) real estate; (20) services; (21) media and cultural; (22) conglomerates. We do not include the financial and insurance industry in this paper.

12. Current year (Year t) cumulative stock return, Stkre0, is the cumulative stock return from the beginning of May of Year t to the end of April of Year t + 1. Cumulative stock return from Year t to Year t + 1, Stkre1, is the cumulative stock return from the beginning of May of Year t to the end of April of Year t + 2. Cumulative stock return from Year t to Year t + 2, Stkre2, is the cumulative stock return from the beginning of May of Year t to the end of April of Year t + 3. Cumulative stock return from Year t to Year t + 3, Stkre3, is the cumulative stock return from the beginning of May of Year t to the end of April of Year t + 4.

13. These enforcement actions are related to (1) failures to provide financial statements in time; (2) inaccurate forecasts; (3) failures to disclosure material events; (4) false disclosures and misguidance; (5) stock price manipulations and insider trading; (6) failures to fulfill other obligations.