Summary:
As non-executive employees play an increasingly important role in modern enterprises' technological innovation, long-term incentive plans should cover them in addition to management teams. China Securities Regulatory Commission promulgated the Measures for the Administration of the Equity Incentives of Listed Companies (Trial Implementation) (hereafter “Equity Incentive Measures”) in 2005 and revised it several times thereafter. The Equity Incentive Measures allow listed companies in China to grant performance-vested shares, options, and other long-term stock-based incentives to both executives and non-executive employees in their equity incentive plans. The Equity Incentive Measures also set out restriction rules regarding, among others, who should be granted stock-based incentives and how to price shares. Do these rules affect the effect of stock-based incentive plans, and if so, do they strengthen or weaken the effect？ Is the effect different between top executives and non-executive employees？ These questions require more attention. Unfortunately, most studies investigate the effect of equity incentives for top executives, while few explore the effect of stock-based incentives for non-executive employees and the related restriction rules. This paper investigates the restriction rule regarding who should be granted stock-based incentives and the effect of this restriction on the efficiency of stock-based incentive plans. In China, non-executive employees were added on the stock-based incentive list for the first time by the Equity Incentive Measures, but they are confined to a critical minority, such as core business employees, key technical employees, and other important employees that listed companies identify discretionarily. Thus, employees are divided into incentivized and non-incentivized employees according to the rule and have completely different rights to share the returns of innovation success. This unintentionally increases the income gap between internal employees. Considering the specific practice in China, this paper develops two hypotheses regarding the effect of non-executive employee stock-based incentive plans on corporate innovation. The efficiency hypothesis posits that stock-based incentive plans motivate the rank and file to work hard by mitigating the agency problem, and hence improve the efficiency of corporate innovation. In contrast, the inequity hypothesis stresses that the conflict of interest caused by unequal pay between incentivized and non-incentivized employees weakens the positive effect of stock-based incentive plans. Using annual data on the stock-based incentive plans and patents of Chinese listed companies from 2006 to 2017, this paper examines the above two hypotheses. We find that, overall, stock-based incentive plans significantly promote corporate innovation, but this overall effect is weakened by the passive participation of non-incentivized employees. This effect is generally smaller in SOEs and companies with a smaller income gap between incentivized and non-incentivized employees, and it disappears in companies with many employees covered by stock-based incentive plans. Therefore, properly improving the coverage of non-executive employeeswill help prevent unequal remuneration due to the incentive mismatch and improve the overall efficiency of stock-based incentive plans in China's stock market. This paper contributes to the literature in two ways. First, based on China's specific practice and policies, this paper introduces equity theory to develop an inequity hypothesis of non-executive employee stock-based incentive plans to explain the potential effect of such plans on corporate innovation, adding a new explanation from the perspective of equity theory in addition to agency theory. Second, this paper demonstrates that the effect of stock-based incentive plans on corporate innovation is different for top executives and non-executive employees even if they are both granted shares under such plans. This is a significant advance in the literature that investigates the effect of equity incentive plans and is constructive for optimizing listed companies' stock-based incentive policies in China.
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