Analyses by a number of researchers, including Professor Chen Donghua in the business school at Nanjing University, show that such covert on-duty consumption has no correlation with company earnings or has a negative correlation. In state-owned enterprises, on-duty consumption has a significant negative correlation with company earnings.
Besides on-duty consumption, under-the-table bonuses can sometimes be a major source of income for top executives as well. One interviewee noted that a securities company in China distributed 300 million yuan in cash as bonuses at the end of 2008. The main beneficiaries were those in senior management. Such generous bonuses usually undergo special accounting treatment so that the public is unaware of them.
Stock Options as Benefits
In terms of stock-option incentives, Chinese companies are rapidly adopting the U.S. model. Among 1,725 public companies in China, nearly 250 offer stock-option incentives, with close to half of them beginning to do so in the past two years. Offering such incentives had achieved positive effects, including revenue growth or earnings growth for some companies.
At high-tech companies, stock options are a common form of incentive and have become an important part of executive compensation. In the case of Shandong Sun Paper Industry Joint Stock Co., a public company in the private sector, the average annual compensation of its top three executives was raised from approximately 250,000 yuan to more than four million yuan with the implementation of stock-option incentives, bringing its executive compensation in line with its earnings. Sun Paper implemented its stock-option plan starting in 2008. The earnings-growth rate in 2009 was 52.97%; in 2010, it was 112.93%. At most private enterprises that are going public, stock options have become the norm.
However, stock-option incentives still are not widespread in China. In 2010, they were offered at only about 15% of the 1,725 public companies in the sample. Nor do they generally carry much weight, given that the average ratio of fixed salary to earnings-at-risk is 3:1, with fixed salary and earnings-at-risk accounting for 75.29% and 24.71% of total compensation, respectively.
Gao acknowledges that stock options are not common in China and believes that they should remain so. Generally speaking, he says, the meaning of incentives is lost when it comes to stock options because of the serious distortions in their use.
Indeed, stock options are morphing into a welfare-system arrangement. In many Chinese companies, the beneficiaries of stock options cover a wide spectrum. For example, the stock-options plan of real estate developer Xinhu Zhongbao Co. in 2010 offered 299.85 million stock options to 851 individuals — approximately 70% of the staff. According to the announcement, the beneficiaries ran the gamut from the chairman of the board to the company’s security department, as well as customer-service representatives of some of the company’s real estate projects.
The strike, or purchase, prices of stock options are significantly lower than prices in the secondary market. The pricing of stock options has a direct bearing on their effectiveness as incentives. The strike prices of stock options at public companies in China are generally lower than their prevailing market rates. The strike prices of restricted stock options in the announced plans of 91 companies in 2010 were mostly lower than prices in the secondary market, with the strike prices of 70% of these companies at only 50% of the prevailing prices of their stocks (on the announcement dates). Some were even less than 30%. It meant that top executives could easily pocket high premiums by the exercise deadlines — a significant departure from the intended purpose of stock-option incentives.
The exercise conditions are extremely lax. For example, spiritsmaker Luzhou Laojiao Co. implemented stock options in 2010 with the condition that the options would not be exercisable if the company’s net profit failed to grow by more than 12% compared to the previous year. Given that the company’s net profit had posted a compound annual-growth rate higher than 33% in previous years, it would be hard to imagine that the options were an effective incentive. Some companies even artificially suppress or withhold their earnings prior to their stock-options implementation in order to lower the exercise conditions.