Are Stock Option Grants to Directors of State-Controlled Chinese Firms Listed in Hong Kong Genuine Compensation? ——Zhihong Chen, Yuyan Guan, Bin Ke,2013,The Accounting Review. 范周乐 16720854

Content 1. Introduction 2. Prior research 3. Sample, data sources, and descriptive statistics 4. Directors’ stock option compensation in state-controlled red chip firms: insights from interviews and media reports 5. Determinants of the annual stock option grant decision 6. Directors’ stock option exercise behavior 7. The impact of stock options on managerial behavior 8. Summary and conclusion

1 Introduction

1.1 Three Questions Why do state-controlled Red Chip firms grant directors stock options? How do state-controlled Red Chip firms implement such stock option compensation plans, including the grant and exercise of stock options? How does directors’ stock option compensation affect the behavior of state-controlled Red Chip firms?

1.2 Approaches Unstructured Interviews Statistical Analyses We first use unstructured interviews with two former directors of state-controlled Red Chip firms and two investment bankers familiar with the IPOs of state-controlled Red Chip firms to gain first-hand institutional knowledge about the practices of executive compensation in state-controlled Red Chip firms. Our second approach uses statistical analyses to provide corroborating evidence for the conjectures derived from the first approach.

1.3 Executive compensation literature Contributions Executive compensation literature International corporate governance literature Offers useful information to regulators and foreign investors

2 Prior research

2 Prior research Our knowledge on equity-based compensation in non-U.S. countries is limited. The few studies that examine equity-based compensation outside the U.S. primarily focus on developed countries with relatively strong investor protection. There are two competing views on executive stock option compensation in the extant literature. The efficient contracting view and the rent extraction view. However, these studies do not examine the authenticity of directors’ stock option compensation.

3 Sample, data sources, and descriptive statistics

3.1 Sample and data sources First, we identify all the firms that are listed on the Hong Kong Stock Exchange and covered by DataStream. Second, we manually check the ownership data of all these firms annually over our sample period of 1990–2005 and retain only the Red Chip firm-years. Data sources: DataStream and annual reports

3.2 Descriptive statistics——Table 1

3.2 Descriptive statistics——Table 2

3.2 Descriptive statistics——Table 3

4 Directors’ stock option compensation in state-controlled red chip firms: insights from interviews and media reports

4 Questions Survey question one Survey question two Why state-controlled Red Chip firms adopted stock option compensation? Survey question two Whether the stock options granted to directors of state-controlled Red Chip firms are genuine ? （directors who hold vested in-the-money stock options can freely exercise the options and keep the gains from the option exercises） Survey question three Whether managerial stock option compensation in state-controlled Red Chip firms resulted in any positive impact on managerial incentives and firm performance?

5 Determinants of the annual stock option grant decision

5 We next examine whether stock option grants to directors of state-controlled Red Chip firms are partially driven by the demand of foreign investors using the following Tobit regression model: GRANT_DELTA: The natural logarithm of 1 plus the average delta (in US$) of the stock option grants per director in a firm-year. Result: The results in column (1) indicate that consistent with our prediction, the coefficient on FOREIGN is significantly positive. FOREIGN: A dummy variable that equals 1 if a firm has at least one foreign block owner.

6 Directors’ stock option exercise behavior

6 Model (2) examines how a director makes his option exercise decision during year t, conditional on the availability of vested in-the-money stock options in year t. FRACTION_EXERCISED: The number of vested in-the-money options exercised in year t divided by the number of initially granted stock options that are vested and in-the-money in year t. Result: Consistent with our prediction, the coefficient on SOE is significantly negative. SOE: A dummy variable that equals 1 if a listed firm’s immediate largest shareholder is the Chinese Government directly or indirectly, and 0 otherwise.

7 The impact of stock options on managerial behavior

Accounting Performance 7.1 Managerial behavior Dividend payout Accounting Performance

7.2 Dividend payout we use the following Tobit model to test the relation between directors’ stock option ownership and dividend payout: SOE: A dummy variable that equals 1 if a listed firm’s immediate largest shareholder is the Chinese Government directly or indirectly. OPTION_OWN: The average number of fiscal year-end stock options owned per director as a fraction of total common shares outstanding in a firm-year.

7.2 Dividend payout Consistent with our predictions, the coefficient on OPTION_OWN is significantly negative and the coefficient on SOE X OPTION_OWN is significantly positive.

7.3 Accounting Performance GRANT_DELTA: The natural logarithm of 1 plus the average delta (in US$) of the stock option grants per director in a firm-year. SOE: A dummy variable that equals 1 if a listed firm’s immediate largest shareholder is the Chinese Government directly or indirectly.

7.3 Accounting Performance The evidence is consistent with the hypothesis that state-controlled Red Chip firms’ stock options of directors are not genuine and therefore do not provide significant managerial incentives for shareholder value maximization.

8 Summary and conclusion

8 Approaches Questions Implications Findings 1.Unstructured interviews 2.Statistical analyses Questions 1. Why do state-controlled Red Chip firms grant directors stock options? 2. How do state-controlled Red Chip firms implement directors’ stock option compensation plans? 3. How does directors’ stock option compensation affect the corporate decisions of state-controlled Red Chip firms? Implications 1.Hidden institutional forces 2. Hong Kong securities regulators and investors 3. Foreign investors Findings State-controlled Red Chip firms’ stock option compensation for directors is not genuine.