Does China Have an Executive-Compensation Problem?

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Executives cash in by resigning from their companies in order to sidestep the exercise period. Exercise periods are necessary for stock options to act as long-term incentives. Top executives are unable to sell the stocks they hold before the expiration of the exercise periods as a way to prevent any short-term actions on their part. However, in the past two years, many public companies in China have seen the departures of top executives soon after their companies went public so that the executives could sidestep the exercise period and quickly cash in their holdings. For example, as of May 31, 2011, a total of 327 executives from the 224 emerging companies listed on the Growth Enterprise Market (GEM), an independent exchange market launched in 2009, had tendered their resignations, equivalent to 8.6% of all senior managers at GEM companies.

Lack of Systems and Laws

China has always sought to learn about modern corporate management from the U.S. and Europe. So how did the philosophy and model it adopted from the West on executive compensation evolve to possess such uniquely Chinese characteristics?

As the Chinese saying goes, oranges grown at the south of the Huai River become tangerines when transplanted to the north. The executive-compensation model in China was shaped by two main factors.

First, China’s systems and laws are extremely inadequate. Taking its capital markets as an example, prevailing provisions in its securities and trading laws are lacking in terms of timely, complete and truthful disclosures. Public companies are only required to disclose the aggregates of their executive compensation. More important, they are not required to disclose their compensation structures. Consequently, most companies make no disclosure of their structures (except for stock options), and the general public has no access to details on the components of executive compensation such as basic salary, bonus, pension plans and on-duty consumption.

(MORE: Are China’s Big State Companies a Big Problem for the Global Economy?)

Chinese Company Law also is a prominent issue. For example, the positions of boards of supervisors and independent directors are vague and can have overlapping functions, seriously weakening the roles they play in the supervision of executives. In addition, no provision in the Company Law restricts the selling of shares by executives when they leave their companies, as noted earlier. In China’s capital market, gains that come by complying with regulations are far less than gains that one can receive from contravening them.

Some shortcomings in the capital market emerged as early as a decade ago, but laws to rectify them were not introduced and therefore never passed.

Furthermore, a uniform salary-management system, rather than performance-based compensation contracts, is the norm at state-owned enterprises. Earnings at state-owned enterprises that are in competitive industries and are fully market-oriented come from the competence of management and staff. However, their executives generally can receive only half of what their counterparts in private-sector enterprises of the same size command. Therefore, these state-owned enterprises are inclined to compensate their executives with hidden income.

Second, a professional manager market has yet to take shape in China. In state-owned enterprises, the most important form of compensation for the performance of executives is promotion, and performance evaluation is a political rather than a market outcome. At many private enterprises, there usually is no open and clear contractual agreement between managers and companies, given the practice of “making contributions before talking about compensation.” Hence, specific information such as operating procedures and results, as well as a performance-evaluation process and outcome, are not transparent or announced. The value placed on a manager is the outcome of private maneuvers and is not determined by the market. There is little incentive from, or supervision by, the market.

Finally, because Chinese enterprises are young and eager to seize opportunities to gain wealth, their compensation incentives are usually crudely designed, and only a handful of them have comprehensive retirement plans. According to Liu Zhiqiang, a partner at Hejun Consulting, “with the exception of a small number of companies, such as Huawei, planning only takes one or two phases at many Chinese enterprises in terms of compensation design, and a phase lasts three or five years. Most of them have yet to consider the pension issue.”

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