Corporate Governance

How to Get the Best CEO for the Right Pay

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In mainland China, non-local CEOs attract higher salaries than local executives but do not bring about greater economic growth for their firms, a new study shows

A higher salary plus a generous relocation package is a time-honoured way of inducing talented executives to move home for a new position at the head of a company.

For chief executive officers (CEOs), it provides a clear incentive for facing the costs and disruption involved in moving to a new location, while the firm stands to benefit from the knowledge, skills and experience of a top candidate drawn from a larger talent pool.

In classical economic theory, the practice is regarded as an example of efficient contracting within a rational market mechanism, in which the new CEO is predicted to bring higher growth to the company and create shareholder value by an amount that is no less than the marginal cost of the salary increase.

But does paying more to non-local CEOs always bring such results? A new study by researcher from the Chinese University of Hong Kong (CUHK) examined the impact of geography on CEO pay and company performance in the context of mainland China, where a strong sense of hometown identity has been deeply rooted in the culture since ancient times.

They should consider the characteristics of candidate CEOs and the needs of the company in a comprehensive manner, rather than blindly offering higher salaries to non-local CEOs.

Prof. Zhuang Zili

“China provides a rich tapestry of geographical variations and hometown effects are widespread, making it a great place to study the role of geography in executive pay,” says Zhuang Zili, Associate Professor of the School of Accountancy at CUHK Business School.

The study, Visiting monks: Are nonlocal CEOs paid more? was conducted by Prof. Zhuang, in collaboration with Ms. Lian Guo, Prof. Diefeng Peng and Prof. Yulei Rao, all from Central South University.

“We studied this issue in China because the country’s weak legal institutions and investor protections raise the intriguing question of whether the impact of geographic factors on executive compensation reflects efficient CEO contracting – as it does in the U.S. – or is a pretext for rent extraction, which would have a negative effect on corporate governance,” says Prof. Zhuang.

Visiting Monks Chant Scriptures Better?

The study first examined the relationship between CEO geography and CEO compensation and then looked at the impact of CEO geography on the operating performance and value of companies. The alternative hypotheses of efficient contracting and rent extraction were tested against the results.

A higher salary plus a generous relocation package is a time-honoured way of inducing talented executives to move home for a new position at the head of a company.

The researchers theorised that non-local CEOs may be more likely to engage in rent extraction because they have no hometown identity or attachment to their firm’s location that would serve as an emotional barrier to extracting rent from the company.

In addition, a widespread traditional view that non-locals possess superior traits, which is embodied in the Chinese proverb “visiting monks chant scriptures better,” could give the non-local CEO a convenient pretext for demanding higher pay, regardless of their performance.

“If firms hire non-local CEOs for their superior talent and offer higher pay for such talent as well as for being away from home, then firms with non-local CEOs should have better performance and be valued more highly,” says Prof. Zhuang. “This would be consistent with the efficient contracting explanation of non-local CEO pay.

“In contrast, if rent extraction drives the non-local CEO pay premium, then we should observe that firms with non-local CEOs have poorer performance and that their value is lower. Therefore, we also examine the effect of CEO geography on operating performance and firm value.”

Non-local CEOs Earn More

The study examined a sample of 5,963 CEOs at 2,709 companies that were listed on the Shanghai and Shenzhen stock exchanges between 2005 and 2016, together with information on cash compensation for CEOs and factors such as their age, tenure and overseas experience drawn from the China Stock Market & Accounting Research Database (CSMAR).

It found that non-local CEOs earn about 7.9% more than their local counterparts after controlling for other variables, while both the performance and value of the companies that they lead is lower than for local CEOs.

The study finds that the pay premiums for non-local CEOs are prevalent across mainland China.

The researchers subjected the results to a range of rigorous tests to check that the findings were not due to other factors. For example, they looked at fixed effects for firms and for annual performance at industry and province level, and at companies where a local CEO was replaced by a non-local CEO and vice versa, but found that the results held in all such cases.

The tests were conducted both across a sub-sample consisting of China’s four mega-cities – Beijing, Shanghai, Guangzhou and Shenzhen – and one comprising all other regions in the country; between family-owned firms and those with other ownership patterns; and between CEOs that were hired internally and those hired on the open market.

Further analysis showed that pay premiums for non-local CEOs are prevalent across mainland China, and do not vary with regional marketisation levels, although they are lower in regions that have a greater supply of local CEOs.

However, non-local CEO pay premiums are notably higher in state-owned companies and firms with poor external governance. Companies with non-local CEOs also exhibit lower sensitivity to performance in pay levels, and offer higher managerial perks.

Causes of the Overpricing

While recent research has found that geography is part of efficient contracting in CEO hiring and compensation in other countries such as the U.S., the study suggests that this is not the case in China, Prof. Zhuang says.


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“Our study shows that firms exhibit a degree of non-local bias when paying CEOs who come from other parts of the country,” he says. “It suggests that weak institutions; information asymmetry that is exacerbated by geography; and perhaps the biased belief that non-locals possess superior skills; all contribute to the overpricing of non-local CEOs in mainland China.

“Geography plays a different role when the institutional environment differs and the U.S. and China have very different institutional environments. One cannot blindly generalise findings from one country to another, as they may not hold when the legal, economic and governmental institutions are different.”

Achieve a Dynamic Balance in Employment Markets

For businesses and provincial governments in China, the practical implications of the study’s findings are simple.

The study suggests that firms should give equal consideration to local and non-local CEO candidates.

“When recruiting executives, companies should overcome the bias implied by the proverb ‘visiting monks chant scriptures better’,” says Prof. Zhuang. “They should consider the characteristics of candidate CEOs and the needs of the company in a comprehensive manner, rather than blindly offering higher salaries to non-local CEOs.”

He advises companies that are selecting a new CEO to collect information from multiple channels and perspectives; hire the most suitable candidate; and formulate reasonable and effective compensation contracts.

“Meanwhile, provincial and local governments should optimise their policies for attracting the best talent, and fully leverage the advantages offered by local candidates,” Prof. Zhuang says. “They should encourage firms to give equal consideration to local and non-local candidates; and foster the influx of capital and talent from other regions to supplement the employment market in a beneficial way.

“Such policies will help to achieve a dynamic balance in regional employment markets between effectively redeploying talented and committed local executives and attracting the brightest and best non-local candidates to take up jobs in the area.”