The Benefits and Costs of Employee Stock Ownership Plans in China

Abstract

Research Issue

We investigate the deliberations of controlling shareholders in assessing the trade-offs between costs and benefits preceding the adoption of an Employee Stock Ownership Plan (ESOP). Furthermore, we explore the market responses to ESOP announcements and their associations with the private benefits of control. Moreover, our study delves into the modifications in private benefits of control, changes in employment dynamics, and subsequent operating performance subsequent to the implementation of ESOPs.

Research Insights

We conduct our research employing a comprehensive dataset encompassing the adoptions of ESOPs within publicly listed Chinese companies during the period spanning from 2014 to 2020. Our empirical findings reveal that firms characterized by diminished private benefits of control, as indicated by a reduced wedge between control rights and cash flow rights, as well as a lower frequency of related party transactions, are more inclined to consider the adoption of ESOPs, especially when the potential for productivity gains is substantial. These firms also elicit more positive market reactions upon the announcement of their ESOP initiatives. While ESOPs do lead to heightened productivity, the overall enhancement in operating performance remains relatively modest due to the significant cost burden imposed on shareholders by the large unearned employee compensation. Our results suggest that controlling shareholders who partake in fewer private benefits of control are more inclined to forego these entitlements in favor of embracing ESOPs as a strategic mechanism for realizing productivity gains. However, it is imperative to acknowledge that such gains may be considerably offset by substantial increases in employee compensation expenses. Despite the prevalence of short-lived features in Chinese practice, we lack substantial evidence supporting their inhibitory effects on the increased monitoring and productivity following ESOP adoption.

Academic Implications

This study provides a comprehensive examination of recent ESOPs in the Chinese context, offering insights into the regulatory complexities within the largest emerging market. The research contributes to the existing literature by unveiling the intricate relationship between private benefits of control and the decision to adopt ESOPs, as well as their subsequent implications. Notably, our findings, particularly the observed neutral impact on operating performance, augment the ongoing discourse surrounding the efficacy of ESOPs in augmenting shareholder value.

Policy Implications

This research introduces ESOPs as an innovative mechanism for mitigating private benefits of control, particularly in the context of emerging markets where controlling shareholders tend to accrue significant private benefits of control. The incorporation of performance-related criteria within the ESOP framework serves as a means to effectively manage the additional compensation associated with these plans, thereby enhancing their overall efficacy.