Conclusion

This chapter points out that three factors cripple the functions of compensation committees and their independent directors: first, executives command a huge influence over the board and the independent directors of compensation committees;

second, compensation committees are unable to create executives stock option

64 Elson, supra note 31, at 653.

65 Yang Hong Chang, The Structure Change of Outside Directors’ Compensation in US Companies and its Implication, No.6 Journal of Nanjing University of Finance and Economics 70, 71 (2005).

66 Zhang Jian Feng, Looking on the Institutional Defect of Stock Option from the View of Financial Scandal of U.

S. Large Companies, No . 2 Journal of Liaoning University ( Philosophy and Social Sciences Edition) 109, 111 (2004).

67 Lucian Bebchuk & Jesse Fried, Pay Without Performance: The Unfulfilled Promise of Executive Compensation (Cambridge, MA: Harvard University Press, 2004), at 34.

68 Arthur Levitt, Jr., Corporate Culture and the Problem of Executive Compensation, 30 J. Corp. Law. 749, 752 (2005).

packages by themselves; and third, there are shortcomings that exist within employing the use of independent directors. In China, most listed companies have controlling shareholders, and as long as executives collude with controlling shareholders, minority shareholder cannot really play a role in nominating and benefiting the independent directors, thus reducing executives’ influence on the independent directors.

Considering the framework of this dissertation, this chapter only focuses on addressing two problems: the compensation committee having limited power and independent directors being paid without incentivized compensation. This chapter suggests that the compensation committee should be granted the exclusive power to make executive stock option compensation packages, including hiring, paying, supervising and firing its own compensation consultant. If this method seems too radical, the chapter also suggests another method: if the board decides to amend or withdraw a draft made by the compensation committee, it has to disclose the reasons why it did so in detail. Furthermore, the independent directors in the compensation committee shall be granted stock compensation so as to align their interests with those of shareholders.

Chapter Two Ex Ante Strategy (2) of Enhancing Supervision Inside the Company: Improving the Disclosure

of Executive Stock Option Compensation

I. Introduction

The disclosure of executive stock option compensation can play a critical role in addressing agency problems of the compensation. More understandable, transparent and comprehensive disclosure can expand the role of independent directors in the compensation committee and make them more independent from the executives and the controlling shareholder¹ in the company. Specifically, the disclosure can remedy non-independence limits experienced by independent directors, prevent independent directors from being recruited away by professional consultants, and force independent directors in the compensation committee to work under more efficient shame sanctions, which maybe the most important tool for supervising independent directors in China. With independent directors able to play a more key role in supervising executives, the influence of the executives over the independent directors in the company can be reduced. Thus, when they perform their duties, they will be truly “in good faith, honest and diligent” and “maintain the interests of the company and all its shareholders”.² In this scenario, it becomes more difficult for the executives to gain excessive stock option compensation.

Since the rules on disclosure of executive stock option compensation are made by the CSRC itself, the CSRC can update or amend these rules quickly to meet the needs of the current market and address certain agency problems related to executive stock option compensation, which is useful and efficient with regard to resolving agency problems in China. For example, just in 2008, the CSRC promulgated three memos on

1 See Martin J. Conyon & Lerong He, Executive Compensation and Corporate Governance in China, 17 Journal of Corporate Finance 1158, 1160 (2011) (“The ownership of China’s publicly traded firms is highly concentrated. In most firms there is a single dominant shareholder whose large share ownership gives considerable power and influence over the way the firm is run. This is especially the case regarding the appointment and compensation of the CEO or the board. Typically, the largest shareholder owns about 43% of the Firm’s shares, the second largest about 9%, and the third largest about 4% . ... China’s ownership pattern stands in stark contrast to the US, where low-concentration and ownership diffusion is the norm. It is rare for investors to own more than 10% of common equity in Anglo-Saxon firms.” ).

2 Article 3 of the Measures for the Administration of Equity Incentive Plans of Listed Companies (For Trial Implementation) (promulgated by the China Securities Regulatory Commission (CSRC), effective Jan. 1, 2006, hereinafter Measures for Equity Incentive Plans).

the matters of equity incentives to address some controversial issues about the disclosure of executive stock option compensation (as well as other issues within executive stock option compensation).³ The disclosure rules of the CSRC are important instruments for regulating executive stock option compensation, considering other supervision mechanisms are weak in China.

Surely, increasing the disclosure of executive stock option compensation has costs.

First, companies have to pay for the drafting, printing and act of disclosing the information, as well as bearing the costs of hiring accountants, lawyers or independent financial consultants and so on.⁴ Second, disclosing executive stock option compensation would likely give rise to the “Lake Wobegon” effect and “Ratchet”

effect, as “company boards generally believed that their executives were above average, or believed that admitting that their executives were below average would undermine investor confidence. In both cases, fuller disclosure of pay appeared to lead more often to pay increases than decreases, as low-pay firms sought to bring pay levels up at least to the average of the relevant peer group.”⁵ A rising tide floats all boats. Thus, every time a CEO moves up the median, the median goes up, thus ratcheting up executives’ compensation.⁶ Third, since more disclosure means more potential legal liabilities for directors, it may cause the board to choose a suboptimal compensation plan. Considering that stock option compensation is not popular despite its positive functions in China, too much disclosure maybe not good for shareholders.

Ultimately, when determining the optimal amount of transparency for executive pay, the important but often ignored costs of disclosure must be weighed against the benefits, namely, helping minority shareholders to collect and analyze information as well as supervise the independent directors in the compensation committee.⁷ What I want to emphasize here, is that the disclosure of executive stock option compensation

3 Respectively, Memo No. 1 on the Matters of Equity Incentive (promulgated by the CSRC, effective Mar. 17, 2008, hereinafter Memo No.1), Memo No. 2 on the Matters of Equity Incentive (promulgated by the CSRC, effective Mar. 17, 2008, hereinafter Memo No.2); and Memo No. 3 on the Matters of Equity Incentive (promulgated by the CSRC, effective Sept. 18, 2008, hereinafter Memo No.3).

4 Deng Hui& Zhang Yi Chao, Rethinking the Functions of Executives’ Compensation Disclosure, No.6 Modern Legal Study 55, 61 (2010).

5 David I. Walker, The Challenge of Improving the Long-Term Focus of Executive Pay, 51 B.C. L. Rev. 435, 453-454 (2010); Richard A. Posner, Are American CEOs Overpaid, and If So, What If Anything Should Be Done About It? 58 Duke L.J. 1013, 1035 (2009) (“If the true level of compensation were publicized it would actually drive up compensation. Some CEOs would learn that they were being paid less than their peers, and they would push for more. This is especially likely because people are highly sensitive to their relative as well as their absolute wage.” ).

6 Charles M. Elson, The Answer to Excessive Executive Compensation Is Risk, Not the Market, 2 J. Bus. & Tech.

L. 403,405 (2007).

7 Kevin J. Murphy, The Politics of Pay: A Legislative History of Executive Compensation, at 10 (Marshall Research Paper Series Working Paper FBE 01.11, August 24, 2011), available at

http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1916358.

is not directly aimed at limiting executives’ compensation, but rather at shedding more light on pay practices to create greater restraint.⁸

This chapter proceeds as follows. Part II briefly discusses the roles that the media and shame sanctions can play in supervising independent directors in the compensation committee in China (It also applies to other independent directors, non-independent directors and even the executives). Part III introduces the rules and practices of executive compensation disclosure (including stock option compensation) in the US. Part IV synthesizes the rules on the disclosure of executive stock option compensation in China. Part V points out several problems in these rules and practices.

Part VI makes some suggestions for improving the disclosure of executive stock option compensation. Lastly, part VII offers a short conclusion.

II. The Roles of the Media and Shame Sanctions in Supervising the