1 Institutions, Financial Accounting Information and Executive Compensation Sun Zheng Li Zeng-quan Liu Feng-wei Liu Feng-wei School of Accountancy Shanghai University of Finance and Economics

2 Outline Research questions Research questions Theoretical analysis and hypothesis development Theoretical analysis and hypothesis development Research design and results Research design and results conclusions conclusions

3 Research questions(1) How the institutions affect the role of financial accounting information in the executive compensation contract ？ How the institutions affect the role of financial accounting information in the executive compensation contract ？ Some literatures use the sensitivity of executive compensation towards financial accounting profit as the proxy for efficiency of compensation contract (Jensen and Murphy, 1990; Murphy, 1999; Bushman and Smith, 2001) Some literatures use the sensitivity of executive compensation towards financial accounting profit as the proxy for efficiency of compensation contract (Jensen and Murphy, 1990; Murphy, 1999; Bushman and Smith, 2001)

4 Research questions(2) In this paper, we propose that: In this paper, we propose that: The contract on executive compensation should adapt to the institutional environments. e.g, The relationship between the executive compensation and financial accounting information is sensitive to the institutional environments. The contract on executive compensation should adapt to the institutional environments. e.g, The relationship between the executive compensation and financial accounting information is sensitive to the institutional environments. The validity of the above method is low. The validity of the above method is low.

5 Theoretical analysis The contract which the executive compensation should link with the financial accounting profit are conditional on that: The contract which the executive compensation should link with the financial accounting profit are conditional on that: The financial accounting profit is the proxy for which the shareholders pursue. The financial accounting profit is the proxy for which the shareholders pursue. The costs to measure financial accounting profit are lower enough (Coase, 1937; Alchian and Demstez, 1972; Cheung, 1983) The costs to measure financial accounting profit are lower enough (Coase, 1937; Alchian and Demstez, 1972; Cheung, 1983) The structure of contract on executive compensation should be concerned. The structure of contract on executive compensation should be concerned. The substitution between pecuniary and non-pecuniary salary The substitution between pecuniary and non-pecuniary salary The managerial markets are competitive (Alchian, 1969; Demsetz, 1983; Fama, 1983) The managerial markets are competitive (Alchian, 1969; Demsetz, 1983; Fama, 1983)

6 Hypothesis development Analysis of institutional background Analysis of institutional background Two points Two points Government intervention Government intervention Multiple tasks of SOEs Multiple tasks of SOEs Related party transactions Related party transactions Earnings management Earnings management Tunneling or propping Tunneling or propping The consequences The consequences The correlation between the financial accounting profit and shareholders’ benefits is low The correlation between the financial accounting profit and shareholders’ benefits is low The costs to measure the financial accounting performance are high The costs to measure the financial accounting performance are high

7 Hypothesis development Two hypothesis Two hypothesis H1: Ceteris paribus, the intervention of government weakens the association between top executive compensation and financial statement based performance indicators. H1: Ceteris paribus, the intervention of government weakens the association between top executive compensation and financial statement based performance indicators. H2:Ceteris paribus, the existence of related party transactions weakens the association between top executive compensation and financial statement based performance indicators. H2:Ceteris paribus, the existence of related party transactions weakens the association between top executive compensation and financial statement based performance indicators.

8 Research Design （ 1 ） Sample Sample pooled data pooled data Financial companies are deleted Financial companies are deleted The companies controlled by private agencies are deleted The companies controlled by private agencies are deleted 3399 observations 3399 observations Executive compensation Executive compensation The upper limit of the first interval The upper limit of the first interval

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10 Research Design （ 2 ） Related party transaction (RPT) Related party transaction (RPT) Related sales, related purchases, related credit, related debit Related sales, related purchases, related credit, related debit RPT=1 if all related party transactions scaled by total transaction < median, 0 for others. RPT=1 if all related party transactions scaled by total transaction < median, 0 for others. Government intervention (Market or GOV) Government intervention (Market or GOV) MARKET=1 if Market Index (Fan and Jin, 2002,2003) <median, O for others MARKET=1 if Market Index (Fan and Jin, 2002,2003) <median, O for others GOV=1 if government intervention index (Fan and Jin, 2002,2003) >median, O for others GOV=1 if government intervention index (Fan and Jin, 2002,2003) >median, O for others

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12 Sensitive tests (1) Managerial control Managerial control The corporation is controlled by top executives (Bebchuk and Fried ， 2003) The corporation is controlled by top executives (Bebchuk and Fried ， 2003) Consequences Consequences The expectation is consistent with table 2. The expectation is consistent with table 2. The relationship between pecuniary and non- pecuniary is positive. The relationship between pecuniary and non- pecuniary is positive.

13 Sensitive tests (2) Test Test The proxy for Non-pecuniary (James et al ， 2000 ) The proxy for Non-pecuniary (James et al ， 2000 ) EXP and TVR EXP and TVR Model Model M1: Adj-COMP=SIZE+YEAR+IND M1: Adj-COMP=SIZE+YEAR+IND M2 ： EXP=RCOM+RPT+RPT*RCOM+MARKET+MARKET*RCO M+SIZE+YEAR+IND M2 ： EXP=RCOM+RPT+RPT*RCOM+MARKET+MARKET*RCO M+SIZE+YEAR+IND M3 ： TVR =RCOM+RPT+RPT*RCOM+MARKET+MARKET*RCO M+SIZE+YEAR+IND M3 ： TVR =RCOM+RPT+RPT*RCOM+MARKET+MARKET*RCO M+SIZE+YEAR+IND

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15 Sensitive tests （ 3 ） Compensation regulation Compensation regulation The SOE’s executive compensations are regulated by government (Chen, Chen and Wan, 2005) The SOE’s executive compensations are regulated by government (Chen, Chen and Wan, 2005) The consequences The consequences The expectation is consistent with table 2. The expectation is consistent with table 2.

16 Sensitive tests （ 4 ） Test Test Model 1: Adj-COMP=Regulation +YEAR+IND Model 1: Adj-COMP=Regulation +YEAR+IND Model 2: RCOM=PER+RPT+RPT*PER+MARKET+MARK ET*PER+OTHERS CONTROL VARIABLE Model 2: RCOM=PER+RPT+RPT*PER+MARKET+MARK ET*PER+OTHERS CONTROL VARIABLE

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18 Conclusions The relationship between the financial accounting information and top executive compensation is sensitive to the institutions such as the government interventions and related party transactions. The relationship between the financial accounting information and top executive compensation is sensitive to the institutions such as the government interventions and related party transactions.

19 Comments are welcome! Thanks!