Research on risk offset effect of executive compensation in incentive system design

ZHOU Zejiang1 MA Jing2 HU Liufen1

(1.School of Business, Anhui University)
(2.School of Management, Xiamen University)

【Abstract】How to make top management incentive more effective and decrease agency cost has attracted high attention from both of the theory and practice cycles. The existing studies have focused on the rationality dimension of performance evaluation and influencing factors of compensation-performance sensitivity, and ignored the role and function of corporate risk taking. Different from previous literature, this paper tried to test the role of corporate risk taking in the process of setting executive compensation contracts. This paper analyzed the data of A-share listed companies from 2005 to 2016 in China’s capital market, with the following findings: Firstly, after operating performance is controlled, there is a significant positive correlation between risk taking level and executive compensation in the presence of the risk offset effect. Secondly, as risk aversion of top management strengthens, the risk offset effect of executive compensation increases. Thirdly, the risk offset effect of executive compensation is higher in an effective manager market environment. The above results indicate that risk taking is an important inherent influencing factor of executive compensation besides operating performance, and the effects are limited by internal and external situational factors such as risk aversion of top management and manager market. It is supposed to incorporate risk taking level into the process of setting executive compensation in the future, and make further adjustment according to internal and external environments. Further supplementary test shows that executive compensation plays partial mediation effect between risk taking and corporate value, which supports the rationality of incorporating corporate risk taking into the decision-making on compensation contracts. This paper clarifies the role of risk taking in executive compensation contracts and helps understand and recognize how to enhance effectiveness of executive compensation contracts from the risk taking perspective.

【Keywords】 executive compensation; corporate risk taking; risk aversion; manager market; corporate value;


【Funds】 General Project of National Natural Science Foundation of China (71772001) Youth Project of National Natural Science Foundation of China (71302113) Youth Project of National Natural Science Foundation of China (71502001)

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    [1]. ① To be specific, in 2006, State-owned Assets Supervision and Administration Commission of the State Council issued Trial Measures for Implementing Equity Incentive Plans by State Holding Listed Companies (Domestic). At the beginning of 2009, the Ministry of Finance of the People’s Republic of China required state-owned and state holding financial enterprises to stop implementing equity incentive and the employee stock ownership plan temporarily. [^Back]

    [2]. ① When the natural logarithm of the compensation of the top three executives is used for the supplementary test, the results show no substantial change except for a slight change in significance. [^Back]

    [3]. ② The natural logarithm of net profits is adopted as the control variable, mainly based on econometric considerations such as that such treatment will make the interpretation of the regression coefficient more attractive and closer to the classical linear model (CLM) assumption, ease the heteroscedasticity or skewness, and make it insensitive to extreme outliers. However, taking the natural logarithm of net profits as the control variable excludes the observations with loses in operating performance (accounting for about 6.27%). In this paper, when the natural logarithm of return on assets or operating income is taken as the control variable, the research conclusion does not change substantially. [^Back]

    [4]. ③ If the control variable is the same as the moderator variable, it is not controlled again in the regression analysis of models (2a) and (2b). [^Back]

    [5]. ① Except for the data for the calculation of corporate risk taking, the data required for other variables are from the period of 2007 to 2014. Therefore, the number of initial observations in Table 1 is selected from year 2007 to year 2014. In fact, the calculated variable of corporate risk taking is also in the period of 2007 to 2014. [^Back]

    [6]. ① The complete regression results are not listed in this paper. The attachment of the paper can be downloaded at the website of China Industrial Economics (http: // [^Back]

    [7]. ① The data of corporate earnings of years 2005 and 2006 are used to calculate the level of corporate risk taking in 2007, and the data of corporate earnings of year 2006 are used to calculate the level of corporate risk taking in 2008. [^Back]

    [8]. ① In the calculation of the corporate value TOBINQ, the sample observations slightly change compared with the main test (TOBINQ at the current period is taken as the dependent variable, and the number of observations is reduced to 7577, while TOBINQ at the next period is taken as the dependent variable, and the number of observations is reduced to 7433). However, it has no substantial influence on the research conclusion. [^Back]

    [9]. ① After the corporate risk levels are distinguished by industry, this paper does not control the industries in the regression analysis. [^Back]


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This Article


CN: 11-3536/F

Vol , No. 12, Pages 152-169

December 2018


Article Outline


  • 1 Introduction
  • 2 Theoretical analysis and research hypotheses
  • 3 Model setting and sample selection
  • 4 Empirical test results and analysis
  • 5 Analysis of further supplementary test results
  • 6 Research conclusion and policy recommendation
  • Footnote