Behind the Numbers: State Capitalism and Executive Compensation in China

China now ranks second behind the United States in the number of entities included in the Forbes’ list of the world’s largest 2,000 public corporations.  The rapid rise of Chinese companies in the global economy has drawn great scholarly attention to Chinese corporate governance. Scholars of comparative corporate governance however often observe the significant limitations of using standard theories or Western experience to understand Chinese companies. Among the various areas of Chinese corporate governance, executive compensation is an important yet difficult part to research. As the Economist aptly noted years ago, ‘How executives are rewarded is one of the many mysteries of China's increasingly powerful companies. Unravelling it is important, not least because it should help to explain corporate China's transformation from a state-controlled to a consumer-driven creature.’

The common research method of Chinese executive pay literature relies on pay figures disclosed in listed companies’ annual reports and tends to take the disclosed numbers at face value. In the paper ‘Behind the Numbers: State Capitalism and Executive Compensation in China’, I discuss three informal pay practices that constrain the usefulness and reliability of executive pay data formally disclosed in annual reports of Chinese listed companies, especially those owned by the state: on-duty consumption, nominal versus actual pay, and zero compensation.

On-duty consumption involves various benefits enjoyed as a result of one's position. Typical benefits include housing allowance, personal use of corporate cars, shopping vouchers, travel expenses, and entertainment expenditures. The true amount of perk consumption is difficult to estimate because China’s listed companies are not required to disclose such information. Even if disclosed at all, perk consumption is likely underreported or significantly obscured. It has been estimated that the average managerial perks could be as high as eight times the average cash pay.  

Still, ostensibly reasonable compensation figures disclosed in the corporate annual report can be misleading, particularly for Chinese state-owned enterprises (SOEs). The pay disclosed in the annual report sometimes may be a nominal figure, rather than the actual amount paid to SOE managers; and the gap between the nominal pay and the actual pay can be very large. The nominal versus actual pay practice traces back to the overseas listing wave among Chinese SOEs in the 1990s. It was created as an expedient solution to the disparity between the pay level allowed in China’s state-owned sector and the pay level demanded in the international capital markets.  A recent study suggests that stock options granted to executives of Chinese SOEs listed on the Hong Kong Stock Exchange, many of which are also on the New York Stock Exchange, are merely window dressing to satisfy the taste of foreign investors.  Executives of Chinese listed SOEs are never allowed to freely exercise stock options shown in corporate annual reports; and even if exercised, they are expected or required to surrender the gain to the parent company. 

In my paper, I collect data to show the striking yet overlooked zero-pay puzzle presented in Chinese listed companies’ annual reports, where a considerably large proportion of board members of Chinese listed firms are reported to earn no compensation (including cash and equity) paid by the listed companies that they serve. To the best of my knowledge, this is the first systematic analysis of the zero-pay puzzle in extant scholarship. The zero-pay puzzle must be understood against a backdrop of slack regulations and corporate group structures being used to support the interests of the Chinese state-owner. By leveraging the complex corporate group structure and complementary disclosure rules, the state-owner effectively conceals actual SOE compensation practices notwithstanding mandatory disclosure of the compensation paid to each executive by the listed firm. The zero-pay data problems are not alleviated by cross-listing in better disclosure regimes such as the stock exchanges of the United States and Hong Kong.

These informal pay practices raise questions about whether executives of China’s listed firms are capable of discharging their fiduciary duties to the listed firms they serve. Furthermore, they offer a nuanced view on the perennial scholarly debate about the trajectory of national corporate governance systems. They also suggest that politics play an important role in the formal rules and actual practices of executive compensation. Finally, they offer an insightful perspective to evaluate China’s recent SOE reform agenda.

Li-Wen Lin is Assistant Professor at the Peter A. Allard School of Law (University of British Columbia).