Calypso Consulting

(A version of this article appeared in CHO Magazine in Chinese in 2007)
 
            Executives are different from other employees.  If they are doing their jobs well, then their impact will be felt in the company not only over the current year but over the long-term as well.  Most sophisticated companies believe that this impact should be rewarded.  In other words, in addition to a base salary and an annual incentive plan, executives should also receive compensation for their long-term impact.  This compensation can be paid either in cash or in stock.   The stock issue in China is still complicated and should be the subject of a separate article.  In fact, if a company wants to provide stock to executives, either in the form of grants or options, they would be wise to seek legal council to be sure that their plan will meet the scrutiny of Chinese law.  This is especially true for multi-national firms if their Chinese employees are expected to purchase foreign company shares.
 
            In this article, rather than focus on the technicalities of Chinese law and accounting regulations, I will instead look at the strategic decisions a firm must make when considering executive rewards.
 
Specific Reasons for Providing Executive Compensation
            The first decision a company needs to make when thinking about rewarding their executives differently from the rest of the company is:  Why do we want to do this?  What are our objectives?  Typically, the following objectives justify a special executive compensation program.
·        Strengthening the executives focus on long-term versus short-term goals
·        Providing executives with financial ownership opportunities
·        Encouraging executive retention
·        Requiring executives to make a reasonable equity investment
·        Preparing for an IPO
And there is a special reason that is often seen in China.
·        “Cleaning up” prior ownership commitments that were made “unofficially” to some executives in the past without clear documentation.
If a company has any of these objectives, then a special executive compensation plan can make sense.
 
Cash versus Stock
            There are pros and cons to either approach.  The stock approach is complicated by Chinese law so it usually requires outside assistance, either through a law firm or a specialized executive compensation consultant or both.  Not only are the laws complex, they are constantly changing.  Furthermore, offering stock haphazardly can incur a huge tax liability to the employee, thus minimizing the financial gain.
            While offering cash is a simpler approach than offering stock, it does require an immediate cash outlay.  This may be a problem from a cash flow perspective as well as from a profit and loss perspective.  (Note: the standard in the U.S. is to expense stock options when they are granted.  In China, the laws are a bit less clear and so, again, I strongly recommend that you obtain professional advice regarding whether or not you must expense your stock options at the time you grant them or whether you can wait until they are exercised by the employee.)
            Another argument against offering cash is that it is no different from any other bonus and does not simulate ownership.  What some companies do to mitigate this argument is to tie the cash outlay to the stock price.  In other words, just as in a stock plan, there will be no payout if the company stock does not rise to a pre-defined amount.  Also, companies that use cash for a long-term compensation plan may decide to pay out over a period of time (say three years) in order to increase the program’s employee retention value.
 
Differences between Western Executive Compensation Plans and Chinese Plans
            One big issue to consider when designing an executive plan in China is the relative scarcity of executive compensation market data.  While the data pool is growing exponentially each year, the volume of data in China is much smaller than other locations in the world where executive compensation is common.  As such, it is a good practice in China to collect some of your own data from competitors and/or other companies that you believe are comparable in some way to yours.  This should give you more confidence that you are doing what is common in the market than you would get from a third-party’s market data alone.  If you choose to rely also on foreign company databases, then you should be aware of the following significant differences between China and elsewhere.
·        Eligibility for participation in an equity plan in China tends to be reserved only for the highest executives, as compared to firms in the U.S., Australia and Europe that allow eligibility for ownership at lower levels.  Actually, even in China, multi-national firms tend to go deeper into the firm when determining eligibility than local firms.

• The mix of performance measures in China is also slightly different from elsewhere.  For example, in the U.S., the performance measures for executive plans tend to be primarily related to the company or the division.  In China, the mix includes a large percentage of individual performance.  So, while the company/individual mix in the U.S. might be between 100/0 to 80/20, in China they are more like 60/40.
• Grant sizes in China tend to be approximately 60% those of the U.S.
• Around the world there are large differences in payout schemes for executives in different industries.  While some industry differences exist in China, they are not very significant.

·        The frequency of grants is less frequent in China than elsewhere.  Again, using the U.S. as an example, the most common approach is a payout every year based on three-year goals.  This is called a “rolling” plan.  In China, the most common approach is to pay out every two years with new goals developed at that time.  This is called a “cliff” plan.
Conclusion
Generally, the Chinese human resource professional can learn about executive compensation by studying the plan elements of other countries.  If you are part of a multi-national, then you may be advised to use a similar plan in China.  The primary differences between Chinese plans and those of elsewhere are not in the plan elements but in the details.  Thus, you want to look closely at eligibility, grant size, grant frequency, and the mix of performance measures to assure that your plan is comparable to that which makes the most sense in China.  And again, let me mention for the third time, when looking into such items, it is wise to include a third-party so as to have objectivity and technical expertise when designing the plan.