The impact of equity incentives on monetary compensation:"Substitution effect"or"welfare effect"
Equity incentives and monetary compensation are significant components of executive compensation and are widely discussed in academic and practical circles.The substitution and welfare effect hypotheses are two competing hypotheses on the relationship between equity incentives and monetary compensation(i.e.,how the implementation of equity incentives affects changes in monetary compensation).The substitution effect hypothesis posits that equity incentives serve as a long-term incentive method with strong pay-performance sensitivity that is capable of replacing short-term incentive to effectively motivate managers.Therefore,a substitutional relationship exists between equity incentives and monetary compensation.After implementing equity incentives,monetary compensation will significantly decrease.By contrast,the welfare effect hypothesis suggests that executives with greater power can influence the preparation of compensation contracts and use equity incentives to obtain more benefits.The equity incentive contract itself has welfare properties.For executives with limited power,equity incentives carry uncertainty,and they may prefer monetary compensation.The implementation of equity incentives increases the risk associated with executive compensation and disrupts the balance between long-and short-term incentives.To re-establish this balance,implementing an equity incentive plan may result in further increases in monetary compensation.Therefore,a mutually reinforcing relationship exists between equity incentives and monetary compensation.After implementing equity incentives,monetary compensation will significantly increase.However,existing research lacks empirical evidence on the direction in which monetary compensation will change following the implementation of equity incentives.The current study uses data from A-share non-financial listed companies from 2006 to 2019 to study the impact of implementing equity incentive plans on executive monetary compensation.To overcome the bias caused by endogeneity issues,this research employs the propensity score matching+difference-in-differences(PSM+DID)research method.Results show that after implementing equity incentives,management's monetary compensation increases instead of decreases,supporting the welfare effect hypothesis.The positive correlation between equity incentives and monetary compensation indicates that equity incentives have welfare properties.A challenging undertaking for listed companies is to use equity incentives to curb the rapid growth of executive compensation.Management can use equity incentives to gain additional private benefits.This study further investigates the factors influencing the positive correlation between equity incentives and monetary compensation.First,the longer the validity period and the greater the intensity of equity incentives,the more significant their welfare effect.The target of equity incentives does not affect the correlation between equity incentives and monetary compensation.Second,positive correlation is significant in companies where executives have limited power and where there are abnormal executive departures.By contrast,positive correlation is not significant in companies where executives have significant power and where there are no executive departures.Lastly,external auditing as an effective supervisory mechanism can reduce information asymmetry between management and board of directors,thereby mitigating the welfare effect of equity incentives.The theoretical significance of this research is reflected in three contributions.First,this study expands the research perspective to the interrelationship among different incentive methods.By studying whether equity incentives and monetary compensation are substitutes or complementary relationships over time,the interactive relationships among different incentive methods can be further revealed.Second,from a theoretical perspective,optimal contract and managerial power theories are the main theories for studying managerial compensation.The current study introduces balance theory into the research framework of managerial incentives and examines the balanced relationship between short-and long-term incentives from a psychological perspective,enriching the theoretical research on managerial compensation incentives.Third,the implementation of equity incentives has a dual purpose:to reduce agency costs or to obtain additional benefits for management.This study incorporates the impact of equity incentives on monetary compensation into the research framework of the implementation effect of equity incentives.Moreover,this research uses the PSM+DID method to solve endogeneity problems,thereby enriching the relevant literature on the economic consequences of equity incentives and equity structure.The research conclusions of this study have certain reference significance for preparing executive compensation contracts and reform.Listed companies should not blindly implement equity incentive plans.The rapid growth of executive compensation cannot be suppressed solely by equity incentives.Instead,it will further promote the increase of executive compensation.Listed companies can improve audit quality,reduce information asymmetry between management and shareholders,and improve the effectiveness of executive compensation contracts.
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