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| Controlling Shareholder Equity Pledge and Employee Stock Ownership Plan “Instrumentalization”: Evidence from the A-Share Market in China |
| QIU Yangqian, HUANG Juanjuan
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| School of Economics, Xiamen University |
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Abstract With the promulgation of Guidance on the Implementation of Employee Stock Ownership Plans in Listed Companies (ESOP) in 2014, ESOPs provide a new type of employee incentive. In the period following the introduction of ESOPs, equity pledges have been common as an easy way for controlling shareholders to secure loans. These pledges create strong motivations for controlling shareholders to mitigate their risk of control transfer by maintaining stock price stability.
According to the theory of “shareholder opportunism”, controlling shareholders with equity pledges are motivated to find effective tools to manage the prices of their pledged stocks. Equity pledges by controlling shareholders intensify the separation of cash rights from control rights. The existence of pledge arrangements can indicate a company's lack of funds and high potential capital demands. These factors may encourage controlling shareholders to actively participate in the structure of a company's incentive system as a mechanism to align the interests of insiders, such as managers and key employees, with their own. For controlling shareholders, ESOPs provide an incentive method that has low cost, a short planning cycle, low supervision requirements, and almost no performance threshold. Hence, ESOPs offer a highly convenient mechanism to bind the interests of company employees with those of controlling shareholders with equity pledges.
To investigate the relationship between the pledges of controlling shareholders and the implementation of ESOPs, we analyze a 2013 to 2018 sample of A-share listed companies in China. We find that the probability of an ESOP increases significantly if a company's controlling shareholders have equity pledges and also increases with the shareholder pledge rate. Furthermore, the greater the risk of control transfer that controlling shareholders are exposed to is, the higher the probability of an ESOP being implemented is. We argue that ESOPs are useful to controlling shareholders as a mechanism to increase a stock's price in the short term, but they do not improve a company's long-term value and operating performance. Our further research on corporate governance shows that the power of controlling shareholders has a significant positive impact on the relationship between the pledges of controlling shareholders and the likelihood of ESOPs implementation. In contrast, variables relating to the board of directors and independent directors are found to have no significant effect.
Our findings have two main implications. First, because controlling shareholders face the risks of share price decline and threat of losing control, they will encourage ESOPs implementation to serve their self-interests, especially when their equity pledge rates are high. This relationship with the motivations and short-sighted behaviors of shareholders weakens the role of ESOPs as an employee incentive. Second, ESOPs are convenient for controlling shareholders because they offer flexible establishment, short lock-in periods, and low restriction and supervision requirements. Our further finding that internal corporate governance has no significant influence on ESOPs implementation should be important to regulators and investors. The restrictions on ESOPs can be improved by making changes, such as lengthening the lock-up period and increasing the information disclosure requirements. However, internal and external governance should also be improved to reduce the role of self-interested controlling shareholder behaviors in corporate decision-making.
Regarding our contributions to the literature, we expand on research into the economic consequences of equity pledges. By examining the significant impact of ESOPs on company incentive plans, we find empirical evidence that controlling shareholders with equity pledges have significant influence on the binding of stock price management to insider interests. In such a situation, an ESOPs loses its power to improve a company's long-term market value and operating performance. Second, the extensive literature discussion of shareholder and executive incentive systems focuses mainly on the impacts of shareholder power (i.e., the shareholding ratio); we contribute new empirical evidence that controlling shareholders are motivated to reduce their risk of transfer of control by influencing company incentive systems. Our results provide direct and powerful evidence regarding why and how controlling shareholders become involved in company incentive systems.
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Received: 09 February 2020
Published: 02 December 2021
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