arestockoptiongrantstodirectorsofstate-contr

THEACCOUNTINGREVIEWAmericanAccountingAssociationVol.88,No.5DOI:10.2308/accr-505042013pp.1547–1574AreStockOptionGrantstoDirectorsofState-ControlledChineseFirmsListedinHongKongGenuineCompensation?ZhihongChenYuyanGuanCityUniversityofHongKongBinKeNanyangTechnologicalUniversityABSTRACT:Weexaminethedeterminantsandconsequencesofstockoptioncompensationtodirectorsofstate-controlledChinesefirmsthatareincorporatedoutsideChinaandlistedinHongKong,referredtoasstate-controlledRedChipfirms,overtheperiod1990–2005.Wefindthatstate-controlledRedChipfirmsgranteddirectorsasignificantnumberofstockoptionsinresponsetothedemandofforeigninvestors.However,state-controlledRedChipfirmsforcedthedirectorstoforfeitasignificantpercentageoftheirvestedin-the-moneystockoptionsduetoaconflictbetweenthehigh-poweredstockoptioncompensationandstate-controlledRedChipfirms’uniquemanageriallabormarket.Wefindlittleevidencethatdirectors’stockoptioncompensationchangedthebehaviorofstate-controlledRedChipfirms.Overall,ourresultsareconsistentwiththemedia’sallegationthatthestockoptionsgrantedtodirectorsofmany,ifnotall,state-controlledRedChipfirmsarenotgenuinecompensation.Keywords:China;shareholdervalue;stockoptioncompensation;corporategover-nance;state-controlledfirms.JELClassifications:D21;G32;J33;M40;N25.DataAvailability:Datausedinthisstudyarepubliclyavailablefromthesourcesidentifiedinthepaper.Wethanktwoanonymousreviewers,JohnHarryEvansIII(senioreditor),KevinChen,GerryLobo,MichelRobe,T.J.Wong,andworkshopparticipantsatAmericanUniversity,CityUniversityofHongKong,ThePennsylvaniaStateUniversity,ShanghaiJiaotongUniversity,SingaporeManagementUniversity,TheChineseUniversityofHongKong,TheUniversityofHongKong,TheHongKongUniversityofScienceandTechnology,TianjinUniversityofFinanceandEconomics,XiamenUniversity,andthe9thChinaInternationalSymposiumonEmpiricalAccountingResearchforhelpfulcomments.WethankMabelWongattheHongKongStockExchange’sresearchlibraryforassistanceindatacollectionandShenglanChen,YanyanChen,MingcaiLi,JingRao,YongjianShen,QingquanXin,YuanchunZhang,JingXu,SixianYang,GangZhao,andJ.L.Souzaforableresearchassistance.PartoftheresearchissupportedbyagrantfromtheHongKongGovernment’sResearchGrantCouncil.Editor’snote:AcceptedbyJohnHarryEvansIII.Submitted:April2010Accepted:April2013PublishedOnline:April20131547I.INTRODUCTIONTheobjectiveofthisstudyistoexaminethedeterminantsandconsequencesofstockoptioncompensationtodirectorsofstate-controlledRedChipfirmsovertheperiod1990–2005.RedChipfirmsaredefinedasmainlandChineseinvestor-controlledfirmsthatareincorporatedoutsidemainlandChinaandlistedontheHongKongStockExchange.Weexaminethreespecificresearchquestions.First,whydostate-controlledRedChipfirmsgrantdirectorsstockoptions?Second,howdostate-controlledRedChipfirmsimplementsuchstockoptioncompensationplans,includingthegrantandexerciseofstockoptions?Third,howdoesdirectors’stockoptioncompensationaffectthebehaviorofstate-controlledRedChipfirms?Ourresearchquestionsareimportantforseveralreasons.First,despitemorethanthreedecadesofeconomicreforms,manysegmentsoftheChineseeconomyarestilldominatedbylargestate-controlledChinesefirms.Manyofthesefirmshavebeensuccessfullylistedonmajorstockexchangesaroundtheworld,raisingbillionsofdollarsofnewcapitalandcompetingdirectlywithforeignmultinationalcorporationsforscarceeconomicresourcesandproductmarkets.Hence,itisimportanttounderstandthebehaviorofstate-controlledChinesefirms.Second,stockoptioncompensationhasbecomeincreasinglypopularamongstate-controlledChinesefirms.Forexample,bytheendofoursampleperiodin2005,91percentofthestate-controlledRedChipfirmsgrantedstockoptionstotheiremployees.Inaddition,theChineseGovernmentrevisedtheCompanyLawandSecuritiesLawin2005toallowbothHsharefirms,whichareincorporatedinmainlandChinabutlistedinHongKong,andAsharefirms,whichareincorporatedandlistedinmainlandChinaonly,toissueemployeestockoptions.However,itisstillhotlydebatedwhetherstate-controlledChinesefirmsshouldadoptstockoptioncompensationasanincentivealignmentdevice.Whilemanyinvestorscontendthatstate-controlledChinesefirmspursuenon-shareholdervalue-maximizingobjectives,viewsdifferonwhetherWestern-styleincentivemechanismssuchasstockoptionscanhelpimprovestate-controlledChinesefirms’incentivestoincreaseshareholdervalue(Fairclough2007).AnimportantissueinthedebateiswhetherWestern-stylemanagerialincentivecompensationiscompatiblewithstate-controlledChinesefirms’uniquemanageriallabormarket.Inrecentyears,mediareportshavequestionedtheauthenticityofthemillionsofoutstandingstockoptionsgrantedtodirectorsofstate-controlledRedChipfirms,suggestingthatstockoptioncompensationinstate-controlledChinesefirmslistedabroadmaynothaveachieveditsintendedobjectives(WenandMing2008a;Yam2009).Third,despitetherisingimportanceoflargestate-controlledChinesefirmsinglobalfinancialmarkets,theincentivesofthesefirms’executivesremainablackboxtomostoutsiders.Onereasonforthislimitedunderstandingisthatmostcross-countrystudiesintheextantaccountingandfinanceliteratureexcludeChinafromtheirsamplesbecauseofitsuniquepoliticalandeconomicsystems.Th