Confucian culture and executive compensation: Evidence from China

• Published date: 01 January 2023
• Author: Zhi Jin,Yubin Li,Shangkun Liang
• Date: 01 January 2023
• DOI: http://doi.org/10.1111/corg.12434

ORIGINAL ARTICLE

Confucian culture and executive compensation: Evidence from

China

Zhi Jin

1

| Yubin Li

2

| Shangkun Liang

3

1

School of Accounting, Southwestern

University of Finance and Economics,

Chengdu, China

2

School of Economics and Management,

Harbin Institute of Technology, Shenzhen,

China

3

School of Accountancy, Central University of

Finance and Economics, Beijing, China

Correspondence

Yubin Li, School of Economics and

Management, Harbin Institute of Technology,

Shenzhen 518055, China.

Email: liyubin@hit.edu.cn

Funding information

Central University Basic Research and

Operating Expenses of Special Funding, Grant/

Award Numbers: JBK2005003, 2020010029;

Sichuan Academy of Social Sciences, Grant/

Award Number: SC21B139; Shenzhen

Peacock Talent Plan Start-up Research Fund;

Shenzhen Key Research Base of Humanities

and Social Sciences, Grant/Award Number:

KP191002; National Natural Science

Foundation of China, Grant/Award Numbers:

71402169, 71872196, 72002059

Abstract

Research Question/Issue: This study investigates how traditional Confucian culture

affects executive compensation from three dimensions: CEO compensation level,

CEO pay gap (the pay gap between CEO and other management members), and the

gender pay gap.

Research Findings/Insights: We find that firms' exposure to stronger Confucianism is

associated with less CEO compensation, a smaller CEO pay gap, and a larger gender

pay gap in China. These findings are consistent with the core values of moderatism,

collectivism, and patriarchalism rooted in the Confucian culture. Our findings are

robust to different firms' exposure to Confucian culture measures. Endogeneity con-

cerns are further addressed with a subsample of firms that experienced headquarters

relocation. Cross-sectional analyses show that the influence of traditional Confucian

culture is more pronounced for firms facing less industry competition, owned by the

state, or with a higher concentration of power. Additional analyses show that the

Confucian culture also reduces the CEO's pay-for-performance sensitivity, weakens

pay incentives, and leads to lower firm risk-taking; however, it also mitigates firm

agency problems by reducing firm earnings management and managerial perk con-

sumption. The combination of these positive and negative effects reduces the firm's

overall value.

Theoretical/Academic Implications: This study expands our understanding of the

role of informal institutions in corporate behavior. Corporate governance is embed-

ded in the market's formal institutions, which, in turn, are embedded in local informal

institutions. Academically, our study suggests further corporate governance research

on informal institutions, especially in emerging markets where institutional develop-

ment is not yet complete and informal institutions play a particularly important role.

Practitioner/Policy Implications: This study could help practitioners better under-

stand the business culture and compensation contract design in Confucian nations. It

also suggests that policymakers consider the effect of informal institutions when

designing formal institutions.

KEYWORDS

corporate governance, Confucian culture, executive compensation

Received: 28 January 2021 Revised: 17 February 2022 Accepted: 19 February 2022

DOI: 10.1111/corg.12434

Corp Govern Int Rev. 2023;31:33–54. wileyonlinelibrary.com/journal/corg © 2022 John Wiley & Sons Ltd 33

1|INTRODUCTION

As an important corporate governance mechanism, executive com-

pensation contracts are designed to mitigate agency conflicts

between shareholders and management and incentivize the manage-

ment team to improve firms' performance and value. Existing studies

have examined many determinants that could affect executive

compensation, including managerial attributes (Graham et al., 2012),

corporate governance structure (Chhaochhariaa & Grinstein, 2009;

Hartzell & Starks, 2003), industrial characteristics (Chen et al., 2006;

Mayers & Smith, 1992), law enforcement (Brenner &

Schwalbach, 2009; Bryan et al., 2011), and informal institutions

(Greckhamer, 2016). However, few studies have investigated the role

of informal institutions, such as culture or religious beliefs, in deter-

mining executive compensation or the pay gap among management

members.

Culture is a relatively complex concept. Hofstede (1980) defined

culture as a common set of values that distinguishes one group of peo-

ple from another. These values contribute to the “collective program-

ming of the mind”ingrained in society. Neoinstitutional economic

theory argues that informal institutions (e.g., culture and religion) and

formal institutions (e.g., laws and administrative codes of conduct)

establish the “rules of the game”by which the society operates.

The informal system directly impacts the formal system

(Williamson, 2000). Both institutions can affect economic outcomes,

such as management practices or the capital market phenomenon

(Hofstede, 1980; Williamson, 2000). Numerous prior studies have

investigated the impact of culture on various aspects of corporate

behaviors.

1

CEO compensation has been examined in prior studies

from the multiple perspectives of formal institutions, but the role of

informal institutions, such as culture, has not been fully studied.

Unlike mature markets, the Chinese capital market is an emerging

market where institutions are not well developed. Law enforcement is

far from completely efficient, and traditional Confucian culture could

still play an important role in some corporate issues (Allen

et al., 2005). Second, China has maintained high economic growth

over the last 40 years and has become the largest emerging market in

the world today. Considerable attention has been paid by countries to

the success of their economic growth. Meanwhile, we focus on the

Confucian culture as it is almost the most important spiritual building

block in China and still influences people's beliefs, values, and behav-

iors. It provides “a series of rules of conduct in daily life”(Ackerman

et al., 2009; Hofstede & Bond, 1988). More importantly, today's com-

munist ideology does not replace the thousand-year Confucianism

belief system. Contrarily, the Chinese government still emphasizes the

importance of Confucian culture in the new era of reform and

opening-up and facilitates the establishment of overseas Confucian

institutions.

Prior studies have examined Confucian culture from several per-

spectives, such as intellectual property rights, transformational leader-

ship behavior, minority shareholders' interests, gender diversity, and

investment efficiency (Chen et al., 2019; Du, 2015,2016;

Lehman, 2006; Lin et al., 2013). However, whether a firm's exposure

to Confucianism affects executive compensation contracts remains

unexplored, and we aim to fill this void.

As Confucianism prefers collectivism and stresses the importance

of organizational goals over individual goals, we conjecture that

compensation to executives within the management team would be

more evenly distributed for firms with greater exposure to Confucian

culture. Another important value inherited in Confucianism is

moderatism, which could make CEOs lower their compensation to

avoid disharmony and depress extremely high CEO pay. Our third

hypothesis is based on the patriarchalism promoted by Confucianism.

Specifically, we conjecture that the gender pay gap could be larger for

firms with greater Confucian influence.

To test these predictions, we manually collect data on the Confu-

cian temples around every public company to proxy for the firm's

exposure to Confucianism. We find a significant negative relationship

between Confucianism and CEO pay gap. Additionally, CEO pay is

lower for firms with greater Confucian influence. Furthermore, we

find that the gender pay gap is larger for firms with greater exposure

to Confucianism.

As a robustness check, we employ the distance from the firm's

registered address to the official Confucian sages' hometown as an

alternative proxy of Confucian culture's influence, and our findings

remain qualitatively similar. To further address the endogeneity con-

cern, we manually collect data on firms that relocate headquarters

during our sample period and find that firms' relocation to more Con-

fucian places narrows down the CEO pay gap, reduces CEO pay, and

increases the gender pay gap. These results support our main findings.

Next, we conduct a battery of cross-sectional analyses. We find

that the above effect of Confucian culture on executive compensation

is only significant or stronger for firms facing less industry competi-

tion, owned by the state, or with a higher concentration of power. In

the additional analyses, we find that traditional Confucian culture dis-

courages firms' risk-taking behaviors by reducing the pay-for-

performance sensitivity of CEOs' compensation contracts. Further,

according to the law of high risk and high return, we find that a reduc-

tion in firm risk-taking is accompanied by a reduction in firm valuation.

However, we do not find that managers increase their perk consump-

tion to compensate for their relatively lower pay in firms under the

stronger influence of Confucianism. Contrarily, Confucian culture can

depress managerial perk consumption, which is consistent with the

notion that Confucian culture influences people with high moral

standards.

Our study contributes to existing literature in several ways. First,

our findings contribute to the growing literature on the economic

implications of informal institutions, such as culture and religion

(Aguilera et al., 2016; Mintz, 2005; Solomon et al., 2002). To our

knowledge, this is the first study to focus on the relationship between

Confucian culture and executive compensation. Previous studies

examine the economic consequences of informal institutions from dif-

ferent angles, such as economic growth, risk attitude, stock crash risk,

financial restatement possibility, earnings management, auditing opin-

ion, and management voluntary disclosure (Barro & McCleary, 2003;

Callen & Fang, 2015; Chourou et al., 2020; Du et al., 2015; Dyreng

34 JIN ET AL.