the effect of incentive compensation plans on …

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THE EFFECT OF INCENTIVE COMPENSATION PLANS ON OPERATING PERFORMANCE AND SHAREHOLDER
WEALTH: EVIDENCE FROM TAIWANESE ELECTRONIC INDUSTRY
CHUN-HO CHEN*
CHAN-JANE LIN
YANN-CHING TSAI
ABSTRACT
This paper examines the effect of incentive compensation plans of Taiwanese
electronic companies on their operating performance and stock return. The
results show that the employee bonus ratio measured by fair value has a positive
incentive effect on subsequent operating performance before adjusting the
expenses of employee bonus. But, after considering the expenses of employee
bonus to adjust operating performance, the results show that greater bonus ratio
do not create better subsequent adjusted operating performance. These results
may be caused by excessive profit-sharing before the revising of accounting
treatment for employee bonus. We also find the same results about subsequent
stock return that it links the shareholder wealth. In addition, the results fail to
support the hypothesis that the greater the proportion of the stock bonus the
better the subsequent operating performance and stock return. Our findings
We gratefully acknowledge the comments and suggestions provided by two anonymous reviewers. We also acknowledge the financial support from the National Science Council of R.O.C. * Corresponding author: Chun-Ho Chen, Department of Accounting, National Chung Hsing University, 250 Kuo Kuang Rd., Taichung 402, Taiwan, R.O.C.; Tel: +886-4-2284-0828 #662; E-mail: [email protected].
32 Pan-Pacific Management Review January
provide some evidences to support the amendment in the accounting rules for
employee bonus to reflect the compensation cost.
Keywords: operating performance, stock return, incentive compensation, employee
bonus, incentive effect, dilution effect
(Received: June, 2011; 1st revised: September, 2011; accepted: November, 2011)
INTRODUCTION
The main equity-based incentive schemes in Taiwan include employee stock
bonus plan, employee stock option plan (ESOP), share repurchases transfer to
employee, etc. Among them, the employee stock bonus plan is the most commonly
adopted incentive scheme in Taiwan, and has become the main incentive compensation
scheme of high-tech firms in recent years. The main purposes of granting huge
employee bonus are to attract, motivate and retain excellent employees in order to
improve firms’ future performance.
According to Taiwanese Company Law, companies should state clearly in their
respective articles the percentage of employee bonus plan, in terms of certain definition
of distributable earnings. In practice, the level of the distributable earnings as employee
bonus could be a fixed percentage (e.g., 5%), a certain range (e.g., 5% - 10%), or a
minimum percentage (e.g., no less than 3%).1 The employee bonus plan can be
distributed either in cash or common stock. In contrast to high-tech firms, fewer
companies in the traditional industry adopt the stock bonus plan.
It is well recognized that the stock bonus plan in Taiwan has attracted many
excellent workers to join high-tech industry in last ten years, which has helped to
enhance Taiwan’s competitive power of the electronic fields in the international
market.2 In July 2002, the Asian Wall Street Journal reported that foreign institutional
1 According to Article 235 of Taiwan’s Company Law, firms with net earnings shall cover their prior years’ accumulated losses first. Then, they must appropriate 10 percent of their annual reported earnings as legal reserves before they can distribute dividends and employee bonus. The surplus of net income is called distributable net income. 2 Shih, the founder of Acer Inc., indicated that the employee bonus plan improves the development of high-tech industry in Taiwan. Taso, the former chairman of United Microelectronics Corp, expressed that the unique employee stock bonus plan in Taiwan is one of the main factors that contribute to the
2012 Chun-Ho Chen et al. 33
investors were seriously concerned about the accounting treatment of employee bonus
by Taiwanese enterprises. Under the accounting practice of sample period in Taiwan,
the employee bonus is not recognized as compensation costs in the income statement;
instead, it is regarded as the distribution of earnings as shown in the statement of
changes in owners’ equity. This treatment is not consistent with International Financial
Reporting Standards (IFRS). As a result, companies issuing employee bonus tend to
overstate their reported earnings, which could cause the excessive distribution of
employee bonus and seriously dilute stockholders’ equity. Based on the prevailing
accounting standards worldwide, it is no doubt that the value of the employee bonus
should be booked as compensation expenses (Hsu, Chang, & Yeh, 2003). Whether the
accounting for employee bonus should follow the international standards has received
much debate among corporate management, regulators and academic community since
then. In November 2004, to mitigate the adverse effect of the accounting treatment for
employee bonus, the Securities and Futures Commission of Taiwan required that the
fair value of the employee stock bonus distributed cannot exceed 50% of the net
earning after tax. 3 After the dispute of accounting treatment for employee bonus,
Taiwan’s accounting standards setting bodies announces Accounting Standard No. 39
“Accounting for Share-based payment”, which requires that the fair value of employee
bonus has been recognized as an expense in Income Statement since 2008.
Since the studies relating to employee bonus are sparse, the main purpose of this
paper is to fill this gap by investigating the association between the extent of employee
bonus and subsequent operating performance and stock return. In particular, this paper
examines the following issues:
1. Whether there exists an association between employee bonus and subsequent firm
performance, i.e., whether firms with higher employee bonus have a long-term
incentive effect and result in better future firm performance. competitive ability of the company and it could significantly improve firm’s operating performance. 3 When accounting performance is used as the determinant in the compensation contract, managers have strong incentive to manipulate reported earnings (Watts & Zimmerman, 1986; Healy, 1985; Gaver, Gaver, & Austin, 1995; Holthausen, Larcker, & Sloan, 1995). Some companies in Taiwan may distribute a handsome employee bonus to substitute employee salary or cash bonus. The exclusion of compensation cost from income statement would overstate reported earnings and then help boost management compensation or help raise more capital through a higher stock price.
2. Whether different incentive exists with different composition of cash or stock
employee bonus, i.e., whether firms with higher proportion of stock bonus have
better performance in the future.
The remainder of this paper is organized into six sections. Section 2 will review
prior literature relating to incentive compensation and firm performance. In section 3,
the hypotheses are developed, the empirical model is constructed and variables are
defined. Section 4 descries the sample and present descriptive statistics. The empirical
results and analyses are discussed in section 5. Finally, section 6 provides a summary
and conclusion.
LITERATURE REVIEW
The separation of ownership and control induces agency problem between
managers (agent) and shareholders (principal). The fewer shares the managers hold, the
more this problem will aggravate (Jensen & Meckling, 1976). An effective incentive
contract could converge the interests of managers and shareholders, and thereby
mitigate the agency problem, as the incentive contract will create a positive incentive
effect and improve future firm performance.
Holmstorm (1979) developed the basic principal-agent model to decide the
optimal incentive contract. Holmstrom and Milgrom (1991) suggested that companies
should provide a higher incentive contract (e.g., higher bonus) when performance can
easily be measured. Otherwise, the incentive pay should be set lower (e.g., higher base
salary and lower bonus, or fixed salary). An effective incentive compensation plan
motivates the employees to improve future operating performance, thus increase the
stock price and enhance the wealth of shareholders.
As mentioned above, the employee stock options plan has been a widespread
incentive compensation scheme adopted in the U.S. In contrast, a commonly adopted
incentive scheme in Taiwan is the employee bonus plan. Most prior literature on
incentive compensation focuses on executive compensation and employee stock options.
Among these studies, contemporaneous relationship and the impact of current
compensation on subsequent firm performance have been examined. Prior studies
generally found a positive relationship between current compensation and
contemporaneous firm performance (e.g., Murphy, 1985; Lambert & Larcker, 1987;
Sloan, 1993). As it is based on pay for performance, the positive relation between
current compensation and contemporaneous firm performance is relatively reasonable.
But prior studies have also shown inconsistencies in the relationship between
current incentive compensation (such as employee stock options) and subsequent firm
performance. For example, Mehran (1995) provided evidence that executive
shareholding and the proportion of equity-based compensation to total executive
compensation is positively related to subsequent firm performance measured by ROA
and Tobin’s Q. Park and Song (1995) used market value measures of performance
such as Tobin’s Q and Market-to-Book to examine future firm performance of
employee stock ownership plans. Their results showed that the long-term performance
of firms improved after adopting employee stock ownership plans. They also found that
firms with an outside blockholder’s monitoring could improve their future performance
when adopting employee stock ownership plans. Klein (1987) indicated that
implementation of employee stock ownership plan is more effective when the stock
price is higher. The effective plan will increase employee commitment to the
organization and decreases demission of employees. Iqbal and Hamid (2000) also
concluded that a higher stock price after implementing an employee stock ownership
plan would create a positive impact on productivity of employees and operating income.
Bell, Landsman, Miller, and Yeh (2002) found that employee stock options are valuable
intangible asset and a form of intellectual capital.
In contrast, Yeo, Chen, Ho, and Lee (1999) discussed whether granting employee
stock options will enhance subsequent firm performance of companies in Singapore.
They found no evidence for better subsequent operating performance. Elayan, Lau, and
Meyer (2001) used Tobin’s Q, ROA and ROE to measure subsequent performance after
adopting an incentive compensation plan. Their results also showed no better
subsequent firm performance. Core, Wayne, and Kothari (1999) suggested that CEOs
earn greater compensation when governance structure is less effective. In addition, their
results showed that the predicted excess CEO compensation had a significant negative
relation with subsequent firm operating performance and stock return performance.
Aboody (1996) showed a negative relationship between the value of outstanding
employee stock options and the stock price. Aboody reasoned that the dilution effect is
greater than its incentive effect of the employee stock options.
Previous studies on the employee bonus plans on equity wealth have inconsistent
conclusion. Chen (2003) provided evidence that there is a positive relationship between
the equity value and the employee stock bonus. He also found that the employee stock
bonus provided a greater incentive effect in firms with higher investment opportunities.
But Chang (1999) found that if the unexpected bonus was higher in the previous period
and is still high in the current period, the cumulative abnormal stock return in the
current period is lower. In addition, he showed if the employee bonus and the directors’
compensation which aren’t recognized as compensation cost are higher, the abnormal
return will be lower. Fan and Chen (2006) found that the dilution effect of employee
bonus becomes stronger after public companies are required to disclose pro forma EPS,
which incorporates employee bonus and directors’ remuneration as an expense in 2003.
Besides, Leone, Wu, and Zimmerman (2006) indicated that CEO cash compensation is
more sensitive to poor firm performance than to better firm performance. But Shaw and
Zhang (2010) found inconsistent conclusion, their results suggest that CEO cash
compensation is less sensitive to poor earnings performance than it is to better earnings
performance.
METHODOLOGY
Research Hypotheses
As mentioned earlier, an effective incentive contract could mitigate the agency
problem between managers and shareholders. Prior studies in the U.S. suggested that an
incentive compensation plan (mainly the employee stock option plan) can enhance
employees’ sense of identity and create positive incentive effect on future operating
performance (e.g., Long, 1978; Park & Song, 1995; Iqbal & Hamid, 2000). For the
electronic firms in Taiwan, it is widely believed that the prevalence of employee bonus
plan has contributed to the whole industry’s success in recent years. We therefore
conjecture that the larger the employee bonus, as measured by the employee bonus ratio
(i.e., the bonus amount divided by the distributable net income), the greater the
incentive to the employee and thus the better the firm performance in the future. The
testing hypothesis based on the above argument is therefore stated as follows:
H1: Ceteris paribus, firms granting higher employee bonus ratio will have better
subsequent operating performance and shareholder wealth.
Since employees granted stock bonus can dispose their bonus shares in the open
market immediately, the total value of the bonus to employees is usually much greater
than the par value (NT$10 per share). Therefore, this study attempts to use two proxies
to measure the level of the employee bonus plan- the book bonus ratio (i.e., the book
value of employee bonus divided by distributable net income) and the market bonus
ratio (i.e. the fair value of employee bonus divided by distributable net income).
As to the measurement of firm performance, this study employed both accounting
and market performance measures, including ROA and stock return.
In contrast to cash compensation (e.g., base salary, cash bonus etc.), Mehran (1995)
indicated that the ratio of equity-based compensation to total compensation of top
executives is positively related to future firm performance. According to Taiwan’s
Company Law, the employee bonus can be paid either in cash or in common stock.
Since the average stock price per share was much higher than the par of NT$ 10 during
the sampling period, we predict that employees would prefer stock to cash bonus.
Therefore, the higher the proportion of the stock bonus granted, the better the
subsequent firm performance. Based on the above arguments, the second testing
hypothesis is described as follows:
H2: Ceteris paribus, firms granting the higher proportion of stock bonus will have
better subsequent operating performance and shareholder wealth.
Empirical Model and Variables
In this study, ROA, adjusted-ROA, and buy and hold stock return are employed as
proxies for firm performance.4 Adjusted-ROA is computed after recognizing the fair
value of employee bonus as compensation expenses to reflect actual operating
performance.
Because the employee bonus of each company may fluctuate in different years,
this study uses the average bonus ratio over the three-year period prior to the base year.5
The empirical models of this paper are as follows:
ROA i t+k β0 + β1 EBR i t-2,t + β2 ESBi t-2,t + β3 SALARYit + β4 RDit + β5 ln(ASSETit)
+ β6 CEOit + β7 DIRit + β8 DIRCHit + β9 STDROAit +β10 YEARit +
εi t+k …………………………………………………………………......(1)
BHR i t+k β0 + β1 EBRi t-2,t + β2 ESBi t-2,t + β3 SALARYit + β4 RDit + β5 ln MVEit +
β6 CEOit + β7 DIRit + β8 DIRCHit + β9 STDRETit + β10 MTBit + β11YEARit
εi t+k…………………………..………………………………….....(2)
The dependent variables (subsequent performance indicators) are defined as follows:
ROAi,t+k the average return on assets from year t+1 to t+k for firm i, where return on
assets is defined as earnings before interests and taxes divided by total asset.
BHRi,t+k the buy and hold stock return from year t+1 to t+k for firm i, where Rt+k is
the annual stock return at the year t+k.
The independent variables are defined as follows:
EBR it-2, t the average bonus ratio from year t-2 to year t for firm i.
The ratio of the book value of the employee bonus to the distributable net income
is called the book bonus ratio (EBR_BV). In addition, the ratio of the fair value of the
employee bonus on ex-dividend day to the distributable net income is called the market
bonus ratio (EBR_MV).
4 Due to lack of data of non-financial performance indicators, this study doesn’t employ any non-financial performance indicators to measure subsequent firm performance. 5 In this study, year 1999 is defined as the base year to investigate the association between employee bonus and subsequent firm performance. In sensitivity analysis, year 1997 was used as an alternative for base year.
ESBit-2, t the average proportion of stock bonus to total bonus measured in book
value from year t-2 to year t for firm i.
SALARYit the reported salary expense per employee at year t for firm i to control for
the possible impact on subsequent firm performance.
RDit the R&D intensity at year t for firm i, which is defined as R&D expenditures
divided by net sales.
Prior studies employed R&D investment as the proxy for growth opportunity
(Smith & Watts, 1992; Mehran, 1995). In addition, prior studies found that there is a
positive relationship between R&D expenditure and future firm performance
(Sougiannis, 1994; Lev & Sougiannis, 1996; Deng, Lev, & Narin, 1999).
ASSET it total assets at the end of year t for firm i to control for size effect on firm
performance.
MVE it the market value of shareholder equity at the end of year t for firm i to
control for size effect on stock return (Banz, 1981).
CEO it the shareholding of CEO at the end of year t for firm i.
Corporate governance literature indicated that higher CEO ownership would
mitigate the agency problem between shareholders and managers and therefore result in
better firm performance.
DIR it the directors’ and supervisors’ shareholding at the end of year t for firm i.
Core et al. (1999) found that subsequent firm performance is affected by
ownership and board composition. It is predicted that directors with higher ownership
will have higher motivation to monitor firm performance.
DIRCH it the change in directors’ and supervisors’ shareholding over year t for firm
i. DIRCH it represents directors’ expectation about firm future performance under
information asymmetry. A positive relationship between the change of the directors’
shareholding and subsequent firm performance is expected.
STDROA it the standard deviation of return on assets over the past five years (from
year t-4 to year t) for firm i to control for earnings variability or business risk
(Mehran, 1995 ; Core et al., 1999).
STDRET it the standard deviation of the 52 weekly stock returns at year t for firm i
to control for variation of stock return (Core et al., 1999).
MTB it the market-to-book ratio of equity at the end of year t for firm i to control for
Market-to-Book effect (Fama & French, 1992). A negative association is
expected.
YEAR it a dummy variable, which is equal to one if the base year of observations is
year 2001, and zero if the base year of observations is year 1999 to control
for the effect of business cycle.
SAMPLE AND DESCRIPTIVE STATISTICS
Data and Sample
This study tries to explain the association between employee bonus and
subsequent firm performance of electronic companies listed in Taiwan Stock Exchange
(TSE) from 1997 to 2004. 6 The data needed for this research were mainly collected
from Taiwan Economic Journal (TEJ) database.
The sample firms included in this study must meet the requirement of complete
data of employee bonus and subsequent firm performance. The sample contains
electronic companies listed in the TSE during 1997-2004. Firms having a loss in the
base year were excluded, because they were unable to distribute employee bonus to
their employees according to the Taiwanese Company Law. Firms that went private
were also excluded from the final sample.
Both 1999 and 2001 are considered as the base year to evaluate subsequent firm
performance. 7 The employee bonus for 1997-1999 and 1999-2001 was used to
calculate the average bonus ratio in order to measure the level of bonus ratio smoothly.
In order to compute STDROAt, ROA data over the last five years prior to the base year
6 Because the accounting rules of employee bonuses have been changed since 2008, it will change substantially about employee bonuses plan. Hence, we test this relationship before expensing employee bonus for avoiding this influence. 7 The number of valid observations would have decreased sharply especially in listed electronic companies if an earlier year were selected as the base year. For example, when 1995 was defined as the base year, which would allow a longer window to test subsequent firm performance; but the number of valid observations was less than thirty. In contrast, using a later year as the base year will lead to shorter window to test subsequent firm performance.
are needed. After deleting companies with incomplete data, the final sample contains
164 electronic firms for testing the association between employee bonus and
subsequent accounting performance. Whereas, the final sample consists 160 electronic
firms for testing the relationship between employee bonus and subsequent stock return.
Descriptive Statistics
The descriptive statistics for the employee bonus variables, subsequent firm
performance measures and control variables of the sample firms are reported in Table 1.
The mean (median) of the average book bonus ratio (EBR_BVt-2, t) is 7.32% (7.12%),
with maximum of 18.63%. The mean (median) of the average market bonus ratio
(EBR_MVt-2, t) over the sample period is 39.60% (32.27%), with maximum of 157.74%.
The mean (median) of the average proportion of the stock bonus to total employee
bonus (ESBt-2, t) was 85.59% (100%). In other words, more than half of the sample
firms granted only stock bonus to employees.
With respect to subsequent firm performance, Table 1 shows that, after expensing
employee bonus, the mean adjusted ROA between t+1 and t+3 (A_ROAt+3) is 5.37%,
which is 1.80% lower than mean unadjusted ROA over the same period (ROAt+3).
During our sample period, the mean of buy and hold stock return performed poorly,
with BHR t+3 equal to -30.19%.
All the pearson correlation coefficient of independent variables are less than 0.6 in
the equation 1-3, respectively and the variance inflation factors (VIF) of all independent
variables are less than 10. These results indicate that there is no serious collinearity
problem in our sample.
TABLE 1 Descriptive statistics
Subsequent firm
ROA t+3 (%) 7.17 7.75 37.30 -18.01 7.41
A_ROAt+1 (%) 6.79 7.25 30.46 -9.81 5.38
A_ROA t+3 (%) 5.37 6.09 28.21 -18.01 6.02
BHR t+1 (%) -34.53 -39.69 71.51 -87.7 29.61
BHR t+3 (%) -30.19 -46.27 220.97 -87.63 49.01
Bonus variables:
ESB t-2, t (%) 85.58 100 100 0 26.45
Control variables:
DIR t (%) 26.74 26.67 95.33 5.12 12.70
DIRCH t (%) -3.02 -2.07 15.94 -17.98 4.46
ASSETt (in millions) 12,834 2,062 455,742 1,673 46,484
MVE t (in millions) 27,940 2,513 1,471,879 2,328 126,991
STDROA t (%) 4.82 3.63 18.76 0.93 3.50
STDRET t (%) 8.81 8.88 23.99 3.83 2.11
MTB t 3.26 2.37 12.05 0.53 2.38
Notes:
ROAt+1 the earnings before interest and tax divided by total assets at year t+1.
ROAt+3 the average ROA during year t+1 and year t+3.
A_ROAt+1 the adjusted-ROA at year t+1,after deducting fair value of employee bonus from earnings.
A_ROAt+3 the average adjusted-ROA during year t+1 to year t+3, after deducting fair value of
employee bonus from earnings.
BHR t+1 the annual stock return at year t+1.
BHR t+3 the buy and hold stock return during year t+1 to t+3.
EBR_BVt-2, t the average book bonus ratio from year t-2 to year t. The book bonus ratio is defined as
the book value of employee bonus divided by distributable net income.
EBR_MVt-2, t the average market bonus ratio from year t-2 to year t. The market bonus ratio is defined
as the fair value on ex-dividend date of employee bonus divided by distributable net income.
ESBt-2, t the average proportion of stock bonus to total bonus during year t-2 to year t.
SALARY t the reported salary expense per employee at year t.
RD t the R&D intensity at year t, defined as R&D expenditures divided by net sales.
CEO t the shareholding of CEO at the end of year t.
DIR t the directors’ shareholding at the end of year t.
DIRCH t the change of directors’ shareholding over year t.
ASSET t the total assets at the end of year t.
MVE t the market value of shareholder equity at the end of year t.
STDROA t the standard deviation of return on assets over the past five years (from year t-4 to year t) .
STDRET t the standard deviation of 52 weekly stock returns at year t.
MTB t the market-to-book ratio of equity at the end of year t.
EMPIRICAL RESULTS
This paper examines the relationship between employee bonus of Taiwanese
electronic companies and their subsequent operating performance and stock return.
Since problems of heteroskedasticity generally occur in regression analyses, we use the
White adjusted t-statistic (White, 1980).
Employee Bonus and Subsequent ROA
Table 2 and Table 3 present the regression results of subsequent ROA and adjusted
ROA on employee bonus respectively. The first two columns of Table 2 report the
impact of book bonus ratio (EBR_BV) and average proportion of stock bonus (ESB t-2, t )
on ROA at t+1 and average ROA from t+1 to t+3. It is found that there exists a positive
association with the book bonus ratio but not attain at 10% significant level. However,
we find a negative effect of ESB on subsequent ROA performance. As to the impact of
market bonus ratio (EBR_MV), the results from the third and fourth columns of Table 2
strongly support the hypothesis that higher bonus ratio will result in better subsequent
firm performance. But, we find a significantly negative effect of ESB on subsequent
ROA performance and the second hypothesis relating to the impact of ESB was not
supported either in these two equations. With respect to control variables, the results
indicate that reported salary expense per employee (SALARY), R&D intensity (RD),
directors’ shareholding (DIR) and the standard deviation of ROA (STDROA) has
significant influence on the subsequent ROA performance.
TABLE 2 Regressions of subsequent ROA on employee bonus
Predicted Sign ROA t+1 ROA t+3 ROA t+1 ROA t+3
EBR_BV 0.029 0.054 - -
-0.79 -1.24 -1.70** -1.78**
1.66** 1.86** 1.54* 1.79**
2.73*** 3.65*** 1.46* 2.74***
1.58 0.37 0.80 -0.01
0.42 0.19 0.03 0.01
1.91** 2.31** 2.00** 2.44***
-0.40 0.69 -0.34 0.72
3.55*** 2.11** 3.45*** 2.04**
F statistics 3.85 2.89 5.15 3.26
Notes
2. The coefficient significance statistics produced by regression are modified based on White
heteroskedasticity-corrected standard deviation.
3. t statistics are presented in parentheses. ***, ** and * denote significance at 1%, 5%, and 10%,
respectively.
In Table 3, we noticed that after considering the fair value of the employee
bonus as an expenses, neither book nor market bonus ratio was found to have positive
significantly impact on the adjusted-ROA at t+1 or average adjusted-ROA from t+1 to
t+3. These results are inconsistent with the expectation of this paper and do not support
the first hypothesis H1. Interestingly, all the signs of the coefficients change and become
negative. These results are inconsistent with the conclusion from Table 2, where
unadjusted ROA is a proxy for subsequent firm performance. An explanation for these
differences may be that although the employee bonus has a gross incentive effect, the
granting of excessive distribution of employee bonus (or excessive profit-sharing) leads
to inconsistent results. With respect to the composition of the employee bonus, all the
coefficients of the proportion of stock bonus are negative significantly at 5% or 10%
level. The results show that the proportion of stock bonus has a significantly negative
relation with subsequent one-year adjusted-ROA and three-year adjusted-ROA. In short,
these results fail to support the second hypothesis H2.
TABLE 3 Regressions of subsequent adjusted-ROA on employee bonus
Predicted Sign A_ROA t+1 A_ROA t+3 A_ROA t+1 A_ROA t+3
EBR_BV + -0.181 -0.205 - -
(-1.53)* (-1.65)** (-1.70)** (-1.68)**
(1.85)** (2.08)** (1.88)** (2.13)**
(1.57)* (2.92)*** (1.29)* (2.68)***
(0.65) (-0.42) (0.87) (-0.09)
(0.03) (-0.28) (0.15) (-0.11)
(1.68)** (2.29)** (1.94)** (2.56)***
(-0.16) (0.81) (-0.22) (0.74)
(2.48)** (1.52) (2.58)** (1.65)
F statistics 2.76 3.02 2.53 2.79
Notes
3. t statistics are presented in parentheses. ***, ** and * denote significance at 1%, 5%, and 10%,
respectively.
Employee Bonus and Subsequent Stock Return
Table 4 presents the regression results of the subsequent buy and hold stock return,
i.e., the measure of firm’s market performance, on employee bonus variables and other
control variables. Table 4 shows that both book bonus ratio and market bonus ratio has
negative effect on subsequent market performance. Furthermore, these results indicate
that book bonus ratio has a statistically significant negative relation with subsequent
one-year stock return at 10% level.
With respect to the composition of the employee bonus, the coefficients of the
proportion of stock bonus are all negative but not significant. These empirical results do
not support the second hypothesis H2. One possible explanation of these results is that
due to no lock-up period for the employee stock bonus, the employees could sell their
shares immediately after receiving the stock bonus.
With respect to the control variables, the coefficients of the R&D intensity are
significantly positive on subsequent 3-year stock return are presented in Table 4. The
results show that the higher the R&D intensity of electronics companies, the higher the
subsequent stock return. In addition, all the coefficients of the change of directors’
shareholding (DIRCH) are positive and significantly positive impact on subsequent
3-year stock return. This means when the directors sell their own shares and reduce the
percentage of shareholding, the subsequent stock return is lower, which is consistent
with the expectations of this paper. Besides, we also find that salary expense per
employee and the shareholding of CEO have significantly positive association with
subsequent one-year and three-year stock return, respectively.
TABLE 4 Regressions of subsequent stock return on employee bonus
Predicted Sign BHR t+1 BHR t+3 BHR t+1 BHR t+3
EBR_BV -1.223 -0.927 - -
-0.60 -0.52 (-0.51) (-0.53)
2.09** 1.10 2.12** 1.12
1.57* 2.24** 1.56* 2.13**
-1.20 -0.14 -0.73 0.04
0.57 1.93** 0.82 2.00**
1.05 0.90 1.32* 1.04
1.46* 2.31** 1.37* 2.26**
0.37 -0.54 0.27 -0.57
0.01 -0.71 -0.12 -0.68
F statistics 4.65 3.72 4.38 3.66
Notes
3. t statistics are presented in parentheses. ** and * denote significance at 5%, and 10%, respectively.
Robustness Tests
The sensitive analyses in this study include (1) change of the base year (2)
alternative measure of subsequent stock return and (3) alternative measure of fair value
of stock bonus. The results are stated below.
Change of the Base Year
The first robustness test, we try to change the base year from 1999 and 2001 to
2002 and 2004. The regression results of subsequent firm performance on employee
bonus variables and other control variables are presented at Table 5. Panel A and B of
Table 5 present the regression results of subsequent adjusted ROA and subsequent stock
return, respectively.
Predicted Sign One-year Three-year One-year Three-year
EBR_BV + -0.175 -0.218 - -
-2.06** -2.37*** -1.78** -2.64***
Panel B: Regressions of subsequent stock return on employee bonus
Predicted Sign One-year Three-year One-year Three-year
EBR_BV -1.500 -5.411 - -
0.02 0.19 (0.49) (0.55)
3. t statistics are presented in parentheses. ***, **, and * denote significance at 1%, 5%, and 10%,
respectively.
Panel A of Table 5 shows that the change of base year does not affect the findings
related EBR_BV and EBR_MV in Table 3, where the base year is 1999 and 2001. With
respect to the composition of the employee bonus, all the coefficients of the proportion
of stock bonus are significantly negative related to the subsequent one-year and
three-year adjusted-ROA. These results, similar to that in Table 3, fail to support the
second hypothesis H2. Panel B of Table 5 shows that the coefficients of the bonus ratio
are all negatively related to the subsequent stock return and coefficients of the
proportion of the stock bonus are mostly positive but insignificant. These results still do
not support the hypotheses H1 and H2, which is consistent with that found in Table 4.
Alternative Measure of Subsequent Stock Return
With respect to the different measurement of subsequent stock return, this paper
uses abnormal stock return as an alternative measurement. The abnormal buy and hold
return (BHAR) is defined as follows:
BHAR i , t+k BHR i, t+k , ˆˆ *i i m t kR
Where BHRt+k is buy and hold stock return during year t+1 to t+k; , ˆˆ *i i m t kR
is the required rate of return by using the market model during year t+1 to t+k.8
The untabulated results are similar to that in Table 4 and still do not support the
two testing hypotheses.
Alternative Measure of Fair Value of Stock Bonus
The third robustness test is related to the fair value of employee bonus. In stead of
using ex-dividend price, market bonus ratio was recalculated based on the average
stock price of the last month of the year. The untabulated results remain unchanged. In
other words, our empirical findings are quite robust and are not sensitive to the measure
of fair value adopted.
8 First, we estimate the beta coefficient using 120 daily return observations. Then, we calculate average β coefficient during year t+1 to t+k to estimate β i,t+k . The return of Taiwan Stock Exchange Capitalization Weighted Stock Index (TAIEX) during year t+1 to t+k is used as a proxy of market return Rm, t+k., and one-year rate of Treasury Bill as a proxy of risk-free rate Rf, t+k .
CONCLUSIONS
The employee stock bonus plan is a commonly adopted incentive compensation
scheme in Taiwan, especially in high-tech industry. Under the accounting practice of
sample period in Taiwan, the employee bonus are not recognized as compensation cost,
which results in an overstatement of the reported earnings and induces excessive
distribution of employee bonus. The main purpose of this paper is to investigate the
relationship between employee bonus and subsequent firm performance, in other words,
whether granting higher employee bonus is associated with better subsequent firm
performance. The second purpose of this paper is to examine whether higher proportion
of stock bonus will help enhance better subsequent firm performance.
Using electronic industry as a sample, our empirical results find a significantly
positive relationship between the market bonus ratios of Taiwanese electronic
companies with their subsequent accounting performance measured by ROA. However,
when the fair value of employee stock bonus is considered as an expense according
IFRS, the positive effect disappears. That is, the first hypothesis is no longer supported.
We conjectured that it may be caused by the excessive profit-sharing of employee
bonus.
With respect to the composition of the employee bonus, the empirical results
show that there is no positive relationship between the proportion of stock bonus and
subsequent firm performance (both accounting and market performance). The above
results seem to indicate that electronic companies with higher proportion of stock bonus
did not perform better in subsequent period relative to companies with lower proportion
of stock bonus.
In contrast to prior studies, this paper has two main contributions. First, prior
studies examine the relationship between employee bonus and “contemporaneous” firm
performance (e.g., Murphy, 1985; Lambert & Larcker, 1987; Sloan, 1993). This paper
tries to examine employee bonus plan and “subsequent” firm performance and the
results show excess profit-sharing when employee bonuses are not expensing. Second,
this paper tries to adjust firm performance by expensing employee bonuses according to
IFRS. Our findings indicate the dilution effect exceed incentive effect of employee
bonus plan after expensing employee bonuses.
The results from this paper seem to suggest that companies should be very careful
when making employee bonus decisions to avoid the adverse impact of excessive
dilution effect. The results provide the policy implication for the competent authority.
Our finding indeed is consistent with the notion of the amendment in the accounting
rules for employee bonus to reflect the compensation cost according IFRS. Besides, the
competent authority may pay attention to whether firms grant excessive compensation
to top executives. By doing so, it not only help improve the reliability and transparency
of financial reporting, but also help set a reasonable compensation plan. The future
research may try to explain how investors respond to the employee bonus information
by using a rational expectations model during different period.
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Biographical Sketch
Chun-Ho Chen is an assistant professor of the Department of Accounting at
National Chung Hsing University. He received his Ph. D. in accounting at National
Taiwan University. His primary research focuses on compensation plan, corporate
governance, and earnings management.
Chan-Jane Lin is a full professor of the Department of Accounting at National
Taiwan University. She received his Ph. D. in accounting at University of Maryland,
USA. Her primary research focuses on auditing, earnings management, and corporate
governance.
Yann-Ching Tsai is a full professor of the Department of Accounting at National
Taiwan University. He received his Ph. D. in accounting at University of California, Los
Angeles, USA. His primary research focuses on financial reporting, financial
accounting, and corporate governance.

E-mail: [email protected]

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