Strategic deviance and executive compensation——A new evidence from the efficient contract theory

Abstract

Abstract:

According to the principal-agent theory, management is risk averse. Meanwhile, management′s wealth (including compensation and reputation) is largely dependent upon the enterprises risk, so unable to effectively dispersing risk. Therefore, if the owner expects the management to maintain utility, risk compensation must be given. This is view of efficient contract theory, which is an important basis for the formulation of executive compensation.

With the phenomenon of excessive executive compensation in recent years, there is much discussion about the effectiveness of executive compensation contract. Scholars suggest that excessive executive compensation is the result of the interaction between supply and demand of human capital. Also had the scholar propose managerial power theory, it′s assumed that there is rent-seeking behavior in the process of making the compensation scheme. However, is it possible that the high risk of enterprise leads to the excessive executive compensation?

The article attempts to answer this question from the perspective of strategic deviance. Enterprise strategy refers to a series of agreements and actions in order to improve core competition and achieve competitive advantages. Then, strategic deviance is the degree of enterprise strategy deviating from the industry′s conventional actions. And there is a positive correlation between strategic deviance and enterprise risk. Specifically, enterprises with smaller strategic deviance are more likely to meet regulatory requirements, thereby may reducing litigation risk and acquired the government support to obtain the resources. Second, these companies are able to respond quickly to industry risk, because the cost of changing enterprise strategy is relatively low. Third, there are a lot of enterprise experience and expert advice can be used for enterprises whose strategy is similar to most enterprises in the same industry. Therefore, the higher the strategic deviance, the greater the enterprise risk, and the greater the possibility of excessive executive compensation.

Based on the above analysis, and by using the dataset of Chinese A-share non-financial listed companies from 2001 to 2016, this study explored the relationship between strategic deviance and executive compensation. More specifically, we sought to answer the following questions: (1) Does the higher the strategic deviance, the higher the executive compensation? Empirical results evidenced that the strategic deviance significantly increases executive compensation, consistent with efficient contract theory. (2) Can strategic deviance explain the phenomenon of excessive executive compensation? I found more strategic deviation firms are associated with greater executive compensation than industry-level through difference analysis. (3) Does executive ownership affect the relation between the strategic deviance and executive compensation? The results indicate that the impact of strategic deviation on executive compensation are more prominent in companies with lower executive ownership. However, executive ownership cannot make the risk preference of the management and the owner completely consistent.

This study makes three main significant contributions to the existing literature. First, this study is among the first to explains the phenomenon of excessive executive compensation from the perspective of the efficient contract theory. Second, I contribute to the stream of literature that examines the determinants of executive compensation. Finally, the article enriches the research on the economic consequences of enterprise strategy.

Key words: strategic deviance, executive compensation, efficient contract, risk compensation, executive ownership

Han Yanjin. Strategic deviance and executive compensation——A new evidence from the efficient contract theory[J]. Science Research Management, 2021, 42(2): 181-189.

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