Executive Pay-performance Sensitivity and Mandatory Upper Limits

In 2009 and 2015, during the reform of state-owned enterprises, Chinese government introduced mandatory upper limits of executive compensation to resound to public outrage of excessive executive compensation. However, the limits were cancelled in 2018. Lsing Difference in Difference method, this paper empirically examines the changes of executive pay performance sensitivity after the cancellation of mandatory upper limits in 2018 for the first time. The results provide evidences that after the cancellation, executive pay performance sensitivity increases and moreover, the stronger ability the executive has, the more executive pay -performance sensitivity increases. It suggests that direct government intervention on executive compensation restricts large payoffs for exceptional performance and thus weakens incentives provided by compensation packages. In the circumstances where managers are excellent, the negative effect of mandatory upper limits on incentives is more obvious. These findings provide theoretical and empirical support for the new round of reform of compensation system of state-owned enterprises in China and helps for the policy makers to reevaluate the rationale of setting a mandatory upper limit.