Description
This study is to investigate the influences that external product market competition and internal
corporate governance mechanisms have on managerial incentives. In this study, the values of employee
stock options are used to measure managerial incentives. The findings show that excessively large
boards, CEO duality, cross-holding, and a pyramidal structure achieve a positive correlation with
managerial incentives. In addition, the presence of independent directors also increases the stock options
values of managers. The independent directors possible overlook governance functions to increase
managerial incentives, and they focus more on equity incentives. Furthermore, the relationship between
product market competition and managerial incentives is nonlinear, which implies that in less
competitive markets, an increase in competition stimulates firms to increase their managerial incentives.
By contrast, in highly competitive markets, an increase in competition stimulates firms to decrease their
managerial incentives.
External competition and internal governance on stock options plans: Evidence
from Taiwan
Anlin Chen
a
, Lanfeng Kao
b, *
a
Department of Business Management, National Sun Yat-sen University, Taiwan
b
Department of Finance, National University of Kaohsiung, Taiwan
a r t i c l e i n f o
Article history:
Received 19 July 2014
Accepted 28 May 2015
Available online xxx
Keywords:
Corporate governance
Equity-based managerial incentive
Product market competition
Stock options plan
a b s t r a c t
This study is to investigate the in?uences that external product market competition and internal
corporate governance mechanisms have on managerial incentives. In this study, the values of employee
stock options are used to measure managerial incentives. The ?ndings show that excessively large
boards, CEO duality, cross-holding, and a pyramidal structure achieve a positive correlation with
managerial incentives. In addition, the presence of independent directors also increases the stock options
values of managers. The independent directors possible overlook governance functions to increase
managerial incentives, and they focus more on equity incentives. Furthermore, the relationship between
product market competition and managerial incentives is nonlinear, which implies that in less
competitive markets, an increase in competition stimulates ?rms to increase their managerial incentives.
By contrast, in highly competitive markets, an increase in competition stimulates ?rms to decrease their
managerial incentives.
© 2015 College of Management, National Cheng Kung University. Production and hosting by Elsevier
Taiwan LLC. All rights reserved.
1. Introduction
Ownership and control are separated in contemporary corpo-
rate organizations. Subsequently, the incompleteness of employee
contracts, information asymmetry, and moral hazards that manifest
because of this separation cause managereowner (shareholders)
con?icts of interest (Jensen & Meckling, 1976). To resolve such
con?icts of interest, relevant governance mechanisms can be
established to reduce the agency problems between managers and
owners and protect shareholders' interests.
The governance mechanisms include internal corporate gover-
nance mechanisms (hereafter referred to as internal mechanisms),
which entails board structures monitoring managers, and external
governance mechanisms such as market competition (hereafter
referred to as external mechanisms). Moreover, the “Agency Prob-
lemII” proposed by Villalonga and Amit (2006) wherein controlling
shareholders seek private bene?ts at the expense of minority
shareholders can be mitigated through the implementation of
effective governance mechanisms.
The agency costs are typically re?ected in the design of contracts
between managers and owners. Managerial incentives can be used
for reducing agency problems; however, these incentives may also
be the source of such problems. We discuss the in?uences that the
board-related characteristics of internal mechanisms and the
product market competition of external mechanisms have on
managerial incentives. Economic theory stipulates that product
market competition alleviates ‘quiet life’ of management. Specif-
ically, in a competitive market environment, managers typically
devote their efforts to ensure corporate survival, preventing severe
agency problems from occurring even without the presence of
appropriate monitoring mechanisms.
The yardstick competition hypothesis indicates that product
market competition can reduce information asymmetry between
inside managers and outside shareholders because the outside
shareholders can easily benchmark a ?rm's performance to the
performance of competitors (Hart, 1983; Shleifer, 1985). Schmidt
(1997) shows that intensive competition increases the default risk
and liquidation risk of a ?rm and thereby reduces the agency
con?icts between managers and shareholders. Shleifer and Vishny
* Corresponding author. Tel.: þ886 7 5919502.
E-mail address: [email protected] (L. Kao).
Peer review under responsibility of College of Management, National Cheng
Kung University.
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Asia Paci?c Management Review xxx (2015) 1e8
Please cite this article in press as: Chen, A., & Kao, L., External competition and internal governance on stock options plans: Evidence from
Taiwan, Asia Paci?c Management Review (2015),http://dx.doi.org/10.1016/j.apmrv.2015.05.004
(1997) further show that competition reduces the agency costs of
free cash ?ows because competition discourages managers to
invest in negative NPV projects. Allen and Gale (2000) argue that
product market competition can either serve as a monitoring
mechanism or a corporate governance mechanism to reduce
agency con?icts. Bertrand and Mullainathan (2003) show that
competition eliminates the “quiet life” to reduce the input costs,
overheads, and wages.
However, the relationship between product market competition
and managerial incentives remains unclear, and previous studies
have yet to concede as to whether this relationship is positive or
negative. Some have contend that because managers have to devote
their efforts in highly competitive markets, enhancing the attrac-
tiveness of managerial incentives is necessary, which suggests that
competition positively in?uences managerial incentives. Others
argue that because managers must devote their efforts to ensure
corporate and personal survival in highly competitive markets,
attractive managerial incentives are unnecessary, which suggests
that competition negatively in?uences managerial incentive.
Nevertheless, because the empirical results of previous studies
have veri?ed both arguments, the relationship between product
market competition and managerial incentives remain ambiguous.
Schmidt (1997) argues that product market competition reduces
the pro?t margin leading to lower ?rm pro?tability. Therefore,
?rms faced with intense competition are less likely to offer an
attractive compensation scheme to motivate managers. Karuna
(2007) shows that product market competition can either substi-
tute for or complement managerial incentives. Competition can
serve as a disciplinary mechanism to reduce the need for mana-
gerial incentives. Nevertheless, ?rms have to pay greater incentives
to managers to motivate them in a more competitive market.
Consequently, in a more intensely competitive market, ?rms might
need to provide managers with higher allowances. The total effect
of product market competition on managerial incentives is, thus,
ambiguous.
Beiner, Schmid, and Wanzenried (2011) argue that the rela-
tionship between product market competition and managerial in-
centives is nonlinear depending on the absolute level of
competition. Beiner et al. (2011) propose a business stealing effect
and a scale effect to explain the relationship between competition
and managerial incentives. The business stealing effect indicates
that a positive relationship between managerial incentives and
competition. The scale effect indicates that a negative relationship
between managerial incentives and competition instead. During
low competition, the scale effect dominates; whereas during high
competition, the business stealing effect dominates.
Takeover threat is considered as an effective external mecha-
nism. However, in certain markets that provide insuf?cient investor
protection, takeover threat is unpopular or relatively weak. In
addition to external mechanisms, internal boards of directors are
crucial monitoring mechanisms. The function of a board of di-
rectors is to ensure that managers endeavor to maximize bene?ts
for owners or shareholders and reduce agency problems. This study
primarily investigates the in?uences of internal and external
mechanisms on managerial incentives.
The most common types of managerial incentives include salary
increases, bonuses, and employee stock options. Fixed salaries, one
of the sources of agency problems, fail to effectively stimulate
managers in devoting their efforts to enhance ?rm value and
maximize shareholders' wealth. By contrast, stock options effec-
tively link manager remuneration with a company's stock prices;
thus, employee stock options are considered a favorable method for
reducing the agency problems between managers and share-
holders, especially in emerging economies without solid investor
protection. There is little empirical evidence to demonstrate the
effectiveness of employee stock options to motivating managers in
economies with weak investor protection. Therefore, in the context
of managerial incentives, we focus on the stock options value that
managers can obtain to examine the in?uences of product market
competition on equity-based managerial incentives.
This paper focuses on the Taiwan case because Taiwan is an
emerging civil lawcountry where takeover threat is weak. La Porta,
Lopez-de-Silanes, Shleifer, and Vishny (2000) document that civil
law countries do not provide investors with strong enough pro-
tection. Claessens, Djankov, and Lang (2000) show Taiwanese ?rms
are also likely af?liated with pyramidal or cross-holding structures
with the existence of controlling families or groups. Choy, Gul, and
Yao (2011) characterize Taiwan as a country with high investor
expropriation risk. Moreover, market competition is generally
intensive in the emerging markets such as Taiwan. Faced with
intensively competitive markets, managers have to devote more
efforts and need motivations linked with performance.
This paper is other than Schmidt (1997), Karuna (2007), or
Beiner et al. (2011). Schmidt (1997) is a theoretical paper and does
not provide empirical evidence about the relationship between
managerial incentive and product market competition. Karuna
(2007) examines the relationship between managerial incentive
and product market competition but does not document a non-
linear association between managerial incentive and product
market competition. Beiner et al. (2011) indicate that there is still
little empirical evidence on the relationship between managerial
incentive and product market competition and investigate the non-
linear relationship between managerial compensation and product
market competition based on a unique Swiss data set, a signi?-
cantly more well-diversi?ed equity structure than Taiwan.
Previous research focuses on Western economies, no empirical
evidence ever examines the relationship between managerial
incentive and product market competition in East Asian countries,
economies with weak investor protection due to family control or
group control through pyramidal or cross-holding structure. This
paper contributes to the literature by ?lling this gap.
We ?nd that a non-linear relationship between product market
competition and managerial incentives, indicating that ?rms must
use attractive incentives to stimulate managers in confronting
external competitive environments at low competition level and
that managerial incentives decrease with competition at high
competition level. The managerial incentives in ?rms where the
internal boards of directors demonstrate weak monitoring capacity
(i.e., excessively large boards or CEO duality) are typically highly
attractive, suggesting that managers are extremely likely to seek
private bene?ts during the absence of supervision. The presence of
independent directors positively in?uences managerial incentives,
suggesting that independent directors favor stock options with
bene?ts that are directly proportional to stock performance rather
than salaries.
The remaining of this paper is organized as follows. Section 2
presents the data source and variable de?nitions. Section 3 dis-
cusses the descriptive statistics of our variables. Section 4 examines
the industry characteristics related to competition. Section 5 pre-
sents examinations of the relation between managerial incentives
and internal governance and the relation between managerial
incentive and product market competition. Robustness checks are
provided in Section 6. Finally, Section 7 concludes the paper.
2. Data source and variable de?nition
2.1. Data source
Our data cover all the listed ?rms in Taiwan over the period
1996.03 to 2012.12. Our sample period begins in 1996 because the
A. Chen, L. Kao / Asia Paci?c Management Review xxx (2015) 1e8 2
Please cite this article in press as: Chen, A., & Kao, L., External competition and internal governance on stock options plans: Evidence from
Taiwan, Asia Paci?c Management Review (2015),http://dx.doi.org/10.1016/j.apmrv.2015.05.004
Taiwan Economic Journal (TEJ) established its corporate gover-
nance dataset for listed ?rms in Taiwan in 1996. All the variables,
including sales, total assets, market equity, operating income,
operating expenses, R&D expenditure, stock returns, market index
returns, board structure variables, and equity structure variables
are obtained from the TEJ database. Managerial stock options are
collected from the website of market observation post system of
Taiwan stock exchange. Observations with missing values on
required variables are discarded from the sample. This leaves
41,256 ?rm-quarter observations in our sample.
2.2. Variable measurement
The measures of our variables are detailed below.
Managerial incentive variables (PPS and SOMV)
This study uses two variables to measure managerial incentives.
We follow Karuna (2007) and Riyanto and Wang (2012) to use pay-
to-performance sensitivity to measure managerial incentive. PPS
it
is
the pay-to-performance sensitivity of ?rm i in quarter t. We also
use the ratio of managerial stock option value to market capitali-
zation as another managerial incentive measure. Stock options
value is measured by the Black-Scholes model.
lnðStock options valueÞ ¼ a þb*ðstock returnÞ þ?: (1)
PPS
it
¼
b
b of (1) using data of ?rm i in quarter t.
SOMV
it
¼
Dollar amount of managerial stock options
Market value of equity at t
: (2)
Competition measure (HHI)
Previous studies generally employ the Her?ndahleHirschman
index (HHI) to measure industry intensity (Kao and Chen (2013);
Chen, Kao, and Lu (2014)). High HHI implies high concentration
and low product market competition. HHI is basically the sum of
the squares of individual ?rm market shares in a certain industry.
We follow the de?nition of the Taiwan Stock Exchange to de?ne
industry in this study.
HHI
jt
¼
X
n
j
i¼1
sales
ijt
P
n
j
i¼1
sales
ijt
!
2
: (3)
Here, sales
ijt
is total sales of ?rm i in industry j in quarter t, and n
j
is
the number of ?rms in industry j. Our results are robust to speci-
?cation of assets, market value of equity, or sales as calculations of
market share.
Other competition variables (lnSUB, lnENTRY)
Besides HHI, we also follow Raith (2003) and Karuna (2007) to
use product substitutability and industry protection to characterize
competition dimensions. Product substitutability (lnSUB) is calcu-
lated as the logarithm of the ratio of industry sales to industry
operating costs. Industry protection (lnENTRY) is measured by entry
costs calculated as logarithm of plant, property, and equipment.
ln SUB
jt
¼ ln
P
n
j
i¼1
sales
ijt
P
n
j
i¼1
operting costs
ijt
!
: (4)
ln ENTRY
jt
¼ ln
X
n
j
i¼1
PPE*
sales
ijt
P
n
j
i¼1
sales
ijt
!
: (5)
Internal governance variables (INDEPENDENT, BOARD, DUALITY,
OWN)
The percentage of independent directors on board (INDEPEN-
DENT) is the measure of board independence. BOARD
it
represents
the number of directors on the board of ?rmi at the end of quarter t.
Large boards prevent ef?cient communication, raise dif?culties in
decision-making and reduce the effectiveness of monitoring
(Jensen, 1993; Yermack, 1996). CEO duality means the CEO of a ?rm
also serves as the chair of the board (COB). Brickley, Coles, and
Jarrell (1997) argue that CEO duality implies a weak governance
structure since management is not under proper monitoring of the
board. DUALITY
it
¼ 1 if the CEO is also the COB of ?rm i during
quarter t; otherwise, DUALITY
it
¼ 0. OWN
it
is the ownership of
controlling shareholders of ?rm i at the end of quarter t. The higher
the controlling ownership, the more convergence of the interests
between controlling shareholders and minority shareholders. The
convergence of interests hypothesis implies that as controlling
ownership increases, the controlling shareholders are more likely
to take value-maximization projects.
Agency problem variables (CROSS, PYRAMIDAL)
Fan and Wong (2002) demonstrate that a higher ownership
concentration through cross-holding and/or pyramidal structures
raises agency con?icts between controlling shareholders and mi-
nority shareholders. A dummy variable (PYRAMIDAL) is used to
capture the pyramidal structure of ownership. PYRAMIDAL
it
¼ 1 if
?rm i is part of a pyramid in quarter t; otherwise, PYRAMIDAL
it
¼ 0.
CROSS is a dummy variable for cross-ownership. CROSS
it
¼1 if ?rmi
is subject to cross-holding in quarter t; otherwise, CROSS
it
¼ 0.
Control variables (ROA, SALESGROWTH, lnASSET, RandD, BETA)
We also use several control variables related to managerial
compensation and market competition to avoid possible spurious
effects. Our control variables are operating performance measured
by return on assets (ROA); growth potential measured by logarithm
of gross sales growth (SALESCGROWTH); ?rm size measured by
logarithm of total assets (lnASSET); R&D expenditure measured by
the ratio of R&D expenses to lagged total assets (RandD); ?rm
systematic risk measured by the beta risk from the market model
using daily returns during the quarter (BETA).
Variable de?nition is summarized in Table 1.
3. Descriptive statistics
The descriptive statistics of the sample data are presented in
Table 2, which shows that the average HHI is 0.136, with a median
of 0.095 and a maximumvalue of 1. The lowHHI suggests that ?rms
in Taiwan typically experience a high degree of competition. Sub-
sequently, the average product substitutability (lnSUB) is 0.073,
with a standard deviation of 0.091 and a median of 0.063. The
average value for entry cost (lnENTRY) is 16.312, with a standard
deviation of 1.853 and a median of 15.713. These results indicate
that neither product substitutability nor the entry cost presents
severe skewness. Regarding corporate governance variables, the
average percentage for an independent director on board (INDE-
PENDENT) is 12.1%; however, 50% of the samples do not include
independent directors. The average size of the boards included in
this study is 6.911 members, with a minimum of 1 member and a
maximum of 32. Of the samples, 30.2% present CEO duality. The
controlling shareholders hold 30.4% of the ownership on average.
Regarding other control variables, the average return on assets
(ROA) is 1.8%, SALESGROWTH is 1%, and lnASSET is 15.27, indicating
an average asset value of NT$3358 billion. In addition, the average
percentage for research and development (R&D) to assets is 0.8%.
The average beta is 0.913.
A. Chen, L. Kao / Asia Paci?c Management Review xxx (2015) 1e8 3
Please cite this article in press as: Chen, A., & Kao, L., External competition and internal governance on stock options plans: Evidence from
Taiwan, Asia Paci?c Management Review (2015),http://dx.doi.org/10.1016/j.apmrv.2015.05.004
4. Industry characteristics related to competition
Certain industry characteristics may drive both the industry
competition intensity and managerial compensation scheme,
creating a correlation between product market competition and
managerial incentive, even without the causal link from competi-
tion to managerial compensation. To eliminate this possibility, our
analyses control for several industry characteristics related to
competition.
Hou and Robinson (2006) and Kao and Chen (2013) show that a
signi?cant asset requirement deters the entry of competitors and
thus reduces competition; R&D expenditure decreases substan-
tially with increasing concentration, as does the ratio of R&D ex-
penses to assets; pro?tability increases with industry concentration
and is negatively related to market competition. Hou and Robinson
(2006) and Kao and Chen (2013) argue that concentrated industries
are more likely to experience large assets, high unit pro?tability,
and lowlevel of R&D expenditure. We, therefore, use the logarithm
of assets (lnASSET) as a proxy for the barrier to entry, ROA as a proxy
for unit pro?tability, and the ratio of R&D expenses to assets
(RandD) as a proxy for risk-innovation investment to control for
industry effects related to competition.
Table 3 shows that lnASSET and ROA are positively related to
competition intensity, and that RandD is negatively related to
competition intensity. These ?ndings are consistent with Hou and
Robinson (2006) and Kao and Chen (2013), who indicate that
concentrated industries have poor innovation but have high pro?t
and high barriers to entry. We thus control for lnASSET, ROA, and
RandD when examining the relationship between managerial
compensation and competition to avoid the possibility that in-
dustry characteristics drive both the managerial compensation
scheme and market competition.
5. Internal governance mechanisms and external
competition
5.1. Managerial incentives and internal governance mechanisms
In this study, the relationship between managerial incentives
and governance mechanisms is examined. According to Tables 4
and 5, the relationship between managerial incentives and inter-
nal mechanisms is consistent regardless of the methods used to
measure managerial incentives, which included methods such as
PPS or SOMV. In columns 1 of Tables 4 and 5, the correlation co-
ef?cients between INDEPENDENT and PPS and SOMV are 0.000 and
0.000, respectively (t values ¼ 6.10 and 4.85, respectively), sug-
gesting that managerial incentives increase as the percentage of
independent directors on a board increases.
The possible explanations for this result are as follows: InTaiwan,
managers and controlling shareholders possess the right to appoint
independent directors. The independent directors appointed by
such controlling parties may not value the bene?ts of minority
shareholders, and may thus place considerably reduced supervisory
attention on or even collaborate with controlling shareholders and
managers, thereby resulting in a positive relationship between
managerial incentives and the percentile for independent directors
on board. Moreover, independent directors may deem equity
incentive as a greater stimulating incentive than salary is, conse-
quently offering increased stock options to managers.
The size of the board achieves signi?cant and positive correla-
tions with PPS and SOMV (coef?cient ¼ 0.001 and t value ¼ 3.80 for
PPS; coef?cient ¼ 0.002 and t value ¼ 6.24 for SOMV). The corre-
lation coef?cients between DUALITY and PPS and SOMV are 0.001
and 0.000, respectively (t value ¼ 9.30 and 2.64, respectively),
suggesting that managerial incentives increase as internal gover-
nance conditions weaken.
Table 1
Variable de?nition.
Variable De?nition
PPS Logarithm of pay-to-performance sensitivity measured by the change of stock option value to change of stock price.
SOMV (Stock option value) divided by market capitalization
HHI Her?ndahleHirschman Index de?ned as the sum of the squared market shares for a certain industry.
LOWHHI LOWHHI ¼ HHI if HHI medium of HHI; otherwise LOWHHI ¼ 0.
HIGHHHI HIGHHHI ¼ HHI if HHI > medium of HHI; otherwise HIGHHHI ¼ 0.
lnSUB Logarithm of (industry sales/industry operating costs).
lnENTRY Logarithm of industry property, plant and equipment.
INDEPENDENT Percentage of independent directors on board.
BOARD Number of directors on board.
DUALITY DUALITY ¼ 1 if CEO duality; DUALITY ¼ 0 otherwise.
OWN Ownership of controlling shareholders.
CROSS CROSS ¼ 1 if cross-holding structure; CROSS ¼ 0 otherwise.
PYRAMIDAL PYRAMIDAL ¼ 1 if pyramidal structure; PYRAMIDAL ¼ 0 otherwise.
ROA Return on assets.
SALESGROWTH Logarithm of sales to lagged sales.
lnASSET Logarithm of total assets.
RandD R&D expenditure to total assets.
BETA Beta risk measured by the market model with daily returns during the year.
Table 2
Descriptive statistics, Descriptive statistics for a sample of 41256 ?rm-quarter ob-
servations in Taiwan from 1996 to 2012. All observations with missing variable
values are excluded.
Mean Std Minimum Median Maximum
PPS 0.006 0.010 À0.040 0.005 0.237
SOMV 0.005 0.007 0 0.003 0.177
HHI 0.136 0.151 0.020 0.095 1.000
LOWHHI 0.028 0.031 0.000 0.022 0.097
HIGHHHI 0.110 0.167 0.000 0.000 1.000
lnSUB 0.073 0.091 À0.331 0.063 1.370
lnENTRY 16.312 1.853 11.221 15.715 20.123
INDEPENDENT 0.121 0.160 0.000 0.000 0.750
BOARD 6.911 2.611 1.000 7.000 32.000
DUALITY 0.302 0.459 0.000 0.000 1.000
OWN 0.304 0.176 0 0.278 1.000
CROSS 0.241 0.419 0.000 0.000 1.000
PYRAMIDAL 0.224 0.411 0.000 0.000 1.000
ROA 0.018 0.028 À0.810 0.015 0.513
SALESGROWTH 0.010 0.424 À9.720 0.016 9.520
lnASSET 15.027 1.307 9.190 14.885 21.541
RandD 0.008 0.014 À0.096 0.003 0.547
BETA 0.913 0.347 À5.821 0.922 14.285
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Please cite this article in press as: Chen, A., & Kao, L., External competition and internal governance on stock options plans: Evidence from
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Table 3
Relationship between industry characteristics and competition, Tobit regression analyses of industry characteristics on product market competition with a sample of 41256
?rm-quarter observations in Taiwan from 1996 to 2012. All observations with missing variable values are excluded. The t-values in parentheses are adjusted by clustered
standard errors (Petersen, 2009).
HHI
Intercept 0.051*** (6.50) 0.135*** (166.76) 0.137*** (179.50) 0.054*** (94.33)
lnASSET 0.006*** (10.92) 0.050*** (6.23)
ROA 0.024*** (3.10) 0.005** (2.44)
RandD À0.051*** (À2.81) À0.156** (À1.96)
Industry dummies yes yes yes yes
Year dummies yes yes yes yes
Pseudo R
2
0.2027 0.2033 0.2026 0.2046
***,**, and* represent the signi?cance levels at 1%, 5%, and 10%, respectively. Pseudo R
2
¼ 1 À (log L
U
)/(log L
u
), where L
U
¼ the likelihood value of estimation with all the
exogenous variables, and L
u
¼ the likelihood value of estimation with the intercept only.
Table 4
Internal governance and external competition on managerial incentives (PPS), Regression analyses of internal governance and external competition mechanisms on managerial
incentives with a sample of 41256 ?rm-quarter observations in Taiwan from 1996 to 2012. All observations with missing variable values are excluded. The t-values in pa-
rentheses are adjusted by clustered standard deviations (Petersen, 2009).
Dependent variable: PPS
#1 #2 #3 #4 #5 #6 #7
Intercept 0.006*** (7.26) 0.006*** (6.86) 0.005*** (4.91) 0.005*** (4.9) 0.005*** (4.96) 0.002** (2.41) 0.001 (1.13)
HHI À0.003*** (À7.13) À0.002*** (À5.35) 0.002*** (5.56) À0.002*** (À5.54)
LOWHHI 0.003***(7.25) 0.002*** (5.96)
HIGHHHI À0.003*** (À6.26) À0.003*** (À5.91)
lnSUB À0.001 (À1.33) À0.001 (À1.24) À0.001 (À1.29) À0.001 (À1.26)
lnENTRY 0.000** (2.06) 0.000** (2.02) 0.000** (2.13) 0.000*** (2.67)
INDEPENDENT 0.000*** (6.10) 0.000*** (5.98)
BOARD 0.001*** (3.80) 0.002***(4.22) 0.002*** (4.21) 0.002*** (4.01) 0.002*** (4.81) 0.002*** (4.14) 0.002*** (3.83)
DUALITY 0.001*** (9.30) 0.001*** (8.62) 0.001***(9.27) 0.001*** (8.73) 0.001*** (8.51) 0.001*** (8.57) 0.001*** (8.69)
OWN 0.000 (0.99) 0.000 (0.32) 0.000 (1.14) 0.000 (0.61) 0.000 (0.97) 0.000 (0.36) 0.000 (0.75)
CROSS 0.001*** (5.27)
PYRAMIDAL 0.000*** (2.76)
ROA 0.010*** (3.97) 0.009*** (3.81) À0.009*** (À3.77) 0.009*** (3.52) 0.010*** (4.06) 0.010*** (3.93)
SALESGROWTH 0.000 (0.66) 0.000 (0.76) 0.000 (0.76) 0.000 (0.68) 0.000 (0.81)
lnASSET À0.000* (À1.81) À0.000 (À0.11) À0.000** (À2.14) 0.000 (À0.48) À0.000 (À1.08) 0.000 (0.09) À0.000 (À0.25)
RandD À0.013*** (À5.55) À0.014*** (À5.71) À0.014*** (À5.8) À0.014***(À5.79) À0.013*** (À5.43) À0.014*** (À5.82) À0.015*** (À6.06)
BETA 0.000** (2.23) 0.000 (2.33) 0.000** (1.99) À0.001*** (À2.64) 0.000** (2.43) 0.000** (2.36) 0.001*** (2.79)
Industry dummies yes yes yes yes yes yes yes
Year dummies yes yes yes yes yes yes yes
R
2
0.0057 0.0067 0.0082 0.007 0.008 0.0068 0.0072
***,**, and* represent the signi?cance levels at 1%, 5%, and 10%, respectively.
Table 5
Internal governance and external competition on managerial incentives (SOMV), Regression analyses of internal governance and external competition mechanisms on
managerial incentives with a sample of 41256 ?rm-quarter observations in Taiwan from1996 to 2012. All observations with missing variable values are excluded. The t-values
in parentheses are adjusted by clustered standard deviations (Petersen, 2009).
Dependent variable: SOMV
#1 #2 #3 #4 #5 #6 #7
Intercept 0.032*** (61.12) 0.031*** (59.28) 0.033*** (53.10) 0.033*** (53.09) 0.034*** (52.43) 0.032*** (50.71) 0.034*** (47.44)
HHI À0.002*** (À7.30) À0.001*** (À3.19) À0.001*** (À3.34) À0.001*** (À3.28)
LOWHHI 0.001*** (6.04) 0.001*** (3.32)
HIGHHHI À0.001*** (À3.60) À0.001*** (À2.77)
lnSUB 0.001* (1.77) 0.001* (1.7) 0.001 (1.53) 0.001* (1.70)
lnENTRY 0.000*** (7.68) 0.000*** (À7.64) 0.000*** (7.79) 0.000*** (7.37)
INDEPENDENT 0.000*** (4.85) 0.000*** (4.51)
BOARD 0.002*** (6.24) 0.000 (1.28) 0.000 (À0.93) À0.000 (À0.78) À0.000 (À0.14) À0.000 (À1.40) À0.000 (À0.76)
DUALITY 0.000*** (2.64) 0.000** (2.00 0.000 (1.18) 0.000 (1.62) 0.000** (2.05) 0.000* (1.93) 0.000 (1.63)
OWN À0.003*** (À10.43) À0.002*** (À8.39) À0.002*** (À9.67) À0.002*** (À9.29) À0.002*** (À9.72) À0.002*** (À8.33) À0.002*** (À9.29)
CROSS 0.000** (1.96)
PYRAMIDAL 0.000*** (2.70)
ROA 0.050*** (33.06) 0.051*** (32.72) À0.051*** (À32.74) 0.050*** (32.47) 0.051*** (33.15) 0.051*** (32.64)
SALESGROWTH 0.000 (0.77) 0.000 (0.54) 0.000 (0.54) 0.000 (0.8) 0.000 (0.53)
lnASSET À0.002*** (À45.15) À0.002*** (À45.07) À0.001*** (À40.59) À0.002*** (À43.59) À0.002*** (À42.79) À0.002*** (À44.42) À0.002*** (À43.44)
RandD À0.023*** (À14.83) À0.022*** (À14.43) 0.023*** (15.16) 0.023*** (15.15) À0.023*** (À14.79) À0.021*** (À14.19) À0.023*** (À15.06)
BETA 0.001*** (10.41) 0.001*** (9.03) 0.001*** (8.3) À0.001*** (À7.86) 0.001*** (7.9) 0.001*** (9.07) 0.001*** (7.83)
Industry dummies yes yes yes yes yes yes yes
Year dummies yes yes yes yes yes yes yes
R
2
0.1324 0.1662 0.169 0.1684 0.1689 0.1664 0.1684
***,**, and* represent the signi?cance levels at 1%, 5%, and 10%, respectively.
A. Chen, L. Kao / Asia Paci?c Management Review xxx (2015) 1e8 5
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Regarding the control variables, R&D expenditure shows a
negative correlation with managerial incentives, and beta achieves
a positive correlation with managerial incentives.
5.2. Product market competition and managerial incentive
In addition to internal mechanisms, external mechanisms such
as product market competition are also key factors that in?uence
managerial incentives. Previous studies have failed to produce
conclusive results pertaining to market competition and manage-
rial incentives. In this study, the HHI is adopted as the measure for
degree of competition. According to columns 2 of Tables 4 and 5,
the correlation coef?cients between HHI and PPS and SOMV
are À0.003 and À0.002, respectively, and the corresponding t
values are À7.13 and À7.30. HHI shows a negative correlation with
managerial incentives, suggesting that managerial incentives
decrease when HHI is highly concentrated and degree of competi-
tion is low. Firms typically do not abstain from providing managers
with incentives because of high market competition. By contrast,
?rms increase incentives when markets are highly competitive to
attract managers.
Karuna (2007) argues that product substitutability and the entry
cost can also characterize the dimensions of product market
competition. lnSUB and lnENTRY are included as another di-
mensions of competition. Columns 3, 4, and 5 of Tables 4 and 5
indicate that HHI is negatively correlated with managerial in-
centives. According to columns 3 of Tables 4 and 5, the correlation
coef?cients between HHI and the dependent variables of PPS and
SOMV are À0.002 and À0.001, respectively, and the corresponding t
values are À5.35 and À3.19. Tables 4 and 5 show that lnSUB and
lnENTRY achieve a positive correlation with managerial incentives,
suggesting that managers require increased managerial incentives
during high product substitutability conditions. The ?ndings also
show that equity-based incentives increase with increased entry
barriers, possibly because entry barriers elevate stock prices,
thereby increasing the value of stock options.
In columns 4 of Tables 4 and 5, sales growth is included as a
control variable and independent director is excluded. The results
presented in columns 4 are similar to those in columns 3, but the
R-square values are relatively lower in columns 4 than in columns
3. Comparing columns 3 and 4 of Tables 4 and 5 indicates that the
presence of independent directors imposes a greater in?uence on
managerial incentives than sales growth does. Nevertheless, sales
growth increases managerial incentives as a form of encourage-
ment to managers although the degree of in?uence is substandard
to that of the presence of independent directors. Thus, the pres-
ence of independent directors effectively elevates managerial
incentives.
5.3. Cross-holding and pyramidal structure
Cross-holding and a pyramidal structure increase the
complexity of the ?rm's ownership structure and increase the
possibility of expropriation of minority shareholders from con-
trolling shareholders. In addition to the original corporate gover-
nance control variables, we further include cross-holding and
pyramidal structure as control variables. Columns 5 of Tables 4 and
5 show that CROSS achieves positive correlations with PPS and
SOMV (coef?cient ¼ 0.001 and 0.000, respectively; t values ¼ 5.27
and 1.96), and that PYRAMIDAL achieves positive correlations with
PPS and SOMV (coef?cient ¼ 0.000 and 0.000; and t values ¼ 2.76
and 2.70). These results suggest that managerial incentives increase
with agency costs, which is evidence that controlling shareholders
expropriate minority shareholders.
5.4. Piecewise effect of product market competition
Columns 1 to 5 of Tables 4 and 5 show that the HHI shows a
negative correlationwith managerial incentives; that is, managerial
incentives increase with competition. Moreover, competition is also
a factor that in?uences managerial incentives. Beiner et al. (2011)
argue that competition presents a nonlinear relationship with
managerial incentives, explaining that when competition elevates
to a high level, ?erce competition reduces managerial incentives.
However, when competition is reduced to a low level, the lack of
competition consequently elevates managerial incentives. There-
fore, a piecewise regression method is employed in this study to
examine the nonlinear relationship between competition and
managerial incentives.
Columns 6 and 7 of Tables 4 and 5 showthat LOWHHI achieves a
signi?cant and positive correlation with PPS and SOMV, whereas
HIGHHHI presents a signi?cant and negative correlation with PPS
and SOMV. These results verify that a nonlinear relationship exists
between competition and managerial incentives, where competi-
tion below the median (HIGHHHI) implies weak competition. A
negative HIGHHHI coef?cient represents that an elevated compe-
tition increases managerial incentives whereas a positive LOWHHI
coef?cient represents that an elevated competition decreases
managerial incentives when the degree of competition is above the
median.
6. Robustness tests
It is reasonable to argue that the internal governance mecha-
nisms can be in?uential to one another. Moreover, the managerial
compensation scheme also affects the internal governance mech-
anisms. For example, the high managerial compensation incentives
might raise the possibility of CEOduality. Board chairs would like to
also serve as CEOs to bene?t more from the managerial compen-
sation scheme. In this section, we adopt 2SLS regression analyses to
examine the relationship between managerial compensation and
product market competition with managerial compensation and
internal governance mechanisms as endogenous variables.
Tables 6 and 7 report the 2SLS analyses of internal governance
and market competition on PPS and SOMV, respectively. Basically,
the 2SLS results are similar to the results reported in Section 5.
Table 6 shows that LOWHHI is positively related to PPS with t
value ¼ 8.08 and HIGHHHI is negatively related to PPS with t
value ¼ À5.96. Table 7 further shows that LOWHHI is positively
related to SOMV with t value ¼ 5.78 and HIGHHHI is negatively
related to SOMV with t value ¼ À3.42. Tables 6 and 7 also indicate
that DUALITY is negatively related to INDEPENDENT with t
values ¼ À6.16 and À10.17, respectively implying that board chairs
are less likely to serve as CEOs when more independent directors
are on board.
7. Conclusion
This study is to investigate the effects of external product mar-
ket competition and internal corporate governance mechanisms on
managerial incentives in an economy with weak investor protec-
tion (Taiwan). In U.S. markets, takeover threat is considered as an
effective external governance mechanism. Apart fromconventional
studies conducted in the United States, we consider product market
competition as the primary external governance mechanism
because merger and acquisition activities inTaiwan are uncommon.
Thus, takeover threat cannot be considered as an effective external
governance mechanism in Taiwan.
Regarding managerial incentives, we focus on the value of
employee stock options rather than the salary and remuneration of
A. Chen, L. Kao / Asia Paci?c Management Review xxx (2015) 1e8 6
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Taiwan, Asia Paci?c Management Review (2015),http://dx.doi.org/10.1016/j.apmrv.2015.05.004
managers and controlling shareholders primarily because stock
options values are closely linked to stock prices; thus, stock options
effectively reduce agency problems.
We show that lenient internal mechanisms (e.g., excessively
large boards or CEO duality) and severe agency problems (e.g.,
cross-holding and pyramidal structure) positively correlate to
managerial incentives, suggesting that managers or controlling
shareholders obtain great managerial incentives when monitoring
conditions are weak. In addition, the presence of independent
directors also increases the stock options values of managers. Two
possible explanations contribute to this phenomenon. Indepen-
dent directors overlook governance functions, and they focus on
equity incentive rather than salary. In the context of product
market competition, elevated competition increases managerial
incentives because ?rms anticipate attracting quali?ed managers
by increasing managerial incentives rather than considering
product market competition as a type of monitoring mechanism.
Furthermore, the relationship between product market competi-
tion and managerial incentives is nonlinear, which implies that in
comparatively less competitive markets, an increase in degree of
competition stimulates ?rms to increase their managerial
incentives. By contrast, in highly competitive markets, an increase
in competition stimulates ?rms to decrease their managerial
incentives.
We verify that in Taiwanese markets where takeover threat is
lacking, ?rms fail to consider product market competition as a
supervision to decrease managerial incentives; rather, they in-
crease managerial incentives to encourage managers and control-
ling shareholders. Firms should take market competition into
account when formulating employee contracts to effectively
encourage managers, enhance ?rm value, and protect minority
shareholders' bene?ts.
Acknowledgments
We appreciate the helpful comments from an anonymous
referee and the participants at the 2015 International Symposium
on Social Sciences and Management, Tokyo, Japan, National Sun
Yat-Sen University and National University of Kaohsiung. We also
thank the National Science Council of the Republic of China, Taiwan
for ?nancially supporting this research under Contract No. NSC100-
2410-H-110-020-MY2. All the remaining errors are ours.
Table 6
2SLS analyses of internal governance and external competition on managerial incentives (PPS), 2SLS regression analyses of internal governance and external competition
mechanisms on PPS with a sample of 41256 ?rm-quarter observations in Taiwan from1996 to 2012. All observations with missing variable values are excluded. The t-values in
parentheses are adjusted by clustered standard deviations (Petersen, 2009).
PPS BOARD DUALITY OWN
Intercept 0.009*** (5.91) 0.539 (0.22) À0.936 (À0.13) À2.779 (À0.08)
PPS 104.377** (2.62) 172.753* (1.65) 531.289 (0.14)
LOWHHI 0.003*** (8.08)
HIGHHHI À0.002*** (À5.96)
INDEPENDENT À0.002 (À1.11) À0.021*** (À6.16) À0.008 (À0.75)
BOARD 0.008** (2.48) 1.632 (0.30) 5.072 (0.13)
DUALITY 0.604 (0.3) À3.073 (À0.23)
OWN 0.191 (0.13) À0.350 (À0.25)
ROA À0.003 (À0.89)
SALESGROWTH 0.000 (0.5)
lnASSET À0.000*** (À4.23) 0.000 (0) 0.017 (0.09) 0.015 (0.02)
RandD 0.000 (À0.08)
BETA À0.030 (À0.95) 0.022 (0.16) 0.131 (0.13)
Industry dummies yes yes yes yes
Year dummies yes yes yes yes
R2 0.00307 0.00181 0.00198 0.00007
***,**, and* represent the signi?cance levels at 1%, 5%, and 10%, respectively.
Table 7
2SLS analyses of internal governance and external competition on managerial incentives (SOMV), 2SLS regression analyses of internal governance and external competition
mechanisms on SOMV with a sample of 41256 ?rm-quarter observations in Taiwan from1996 to 2012. All observations with missing variable values are excluded. The t-values
in parentheses are adjusted by clustered standard deviations (Petersen, 2009).
SOMV BOARD DUALITY OWN
Intercept 0.041*** (27.68) 2.558*** (7.04) 3.836 (1.10) 1.352*** (7.84)
SOMV 19.542** (1.98) 30.091* (1.68) 10.574** (2.03)
LOWHHI 0.002*** (5.78)
HIGHHHI À0.001*** (À3.42)
INDEPENDENT À0.003** (À2.10) À0.020*** (À10.17) À0.006*** (À9.24)
BOARD 0.019*** (7.07) À1.509 (À0.97) À0.532*** (À12.28)
DUALITY À0.683 (À0.95) À0.353 (À0.95)
OWN À1.875*** (À12.14) À2.841 (À0.99)
ROA 0.034*** (11.34)
SALESGROWTH À0.000 (À1.23)
lnASSET À0.002*** (À28.85) À0.095*** (À6.75) À0.134 (À1.03) À0.048*** (À6.69)
RandD À0.041*** (À12.74)
BETA À0.124** (À2.56) À0.201 (À0.79) À0.070*** (À2.85)
Industry dummies yes yes yes yes
Year dummies yes yes yes yes
R2 0.1415 0.01362 0.00977 0.03754
***,**, and* represent the signi?cance levels at 1%, 5%, and 10%, respectively.
A. Chen, L. Kao / Asia Paci?c Management Review xxx (2015) 1e8 7
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Taiwan, Asia Paci?c Management Review (2015),http://dx.doi.org/10.1016/j.apmrv.2015.05.004
doc_860005792.pdf
This study is to investigate the influences that external product market competition and internal
corporate governance mechanisms have on managerial incentives. In this study, the values of employee
stock options are used to measure managerial incentives. The findings show that excessively large
boards, CEO duality, cross-holding, and a pyramidal structure achieve a positive correlation with
managerial incentives. In addition, the presence of independent directors also increases the stock options
values of managers. The independent directors possible overlook governance functions to increase
managerial incentives, and they focus more on equity incentives. Furthermore, the relationship between
product market competition and managerial incentives is nonlinear, which implies that in less
competitive markets, an increase in competition stimulates firms to increase their managerial incentives.
By contrast, in highly competitive markets, an increase in competition stimulates firms to decrease their
managerial incentives.
External competition and internal governance on stock options plans: Evidence
from Taiwan
Anlin Chen
a
, Lanfeng Kao
b, *
a
Department of Business Management, National Sun Yat-sen University, Taiwan
b
Department of Finance, National University of Kaohsiung, Taiwan
a r t i c l e i n f o
Article history:
Received 19 July 2014
Accepted 28 May 2015
Available online xxx
Keywords:
Corporate governance
Equity-based managerial incentive
Product market competition
Stock options plan
a b s t r a c t
This study is to investigate the in?uences that external product market competition and internal
corporate governance mechanisms have on managerial incentives. In this study, the values of employee
stock options are used to measure managerial incentives. The ?ndings show that excessively large
boards, CEO duality, cross-holding, and a pyramidal structure achieve a positive correlation with
managerial incentives. In addition, the presence of independent directors also increases the stock options
values of managers. The independent directors possible overlook governance functions to increase
managerial incentives, and they focus more on equity incentives. Furthermore, the relationship between
product market competition and managerial incentives is nonlinear, which implies that in less
competitive markets, an increase in competition stimulates ?rms to increase their managerial incentives.
By contrast, in highly competitive markets, an increase in competition stimulates ?rms to decrease their
managerial incentives.
© 2015 College of Management, National Cheng Kung University. Production and hosting by Elsevier
Taiwan LLC. All rights reserved.
1. Introduction
Ownership and control are separated in contemporary corpo-
rate organizations. Subsequently, the incompleteness of employee
contracts, information asymmetry, and moral hazards that manifest
because of this separation cause managereowner (shareholders)
con?icts of interest (Jensen & Meckling, 1976). To resolve such
con?icts of interest, relevant governance mechanisms can be
established to reduce the agency problems between managers and
owners and protect shareholders' interests.
The governance mechanisms include internal corporate gover-
nance mechanisms (hereafter referred to as internal mechanisms),
which entails board structures monitoring managers, and external
governance mechanisms such as market competition (hereafter
referred to as external mechanisms). Moreover, the “Agency Prob-
lemII” proposed by Villalonga and Amit (2006) wherein controlling
shareholders seek private bene?ts at the expense of minority
shareholders can be mitigated through the implementation of
effective governance mechanisms.
The agency costs are typically re?ected in the design of contracts
between managers and owners. Managerial incentives can be used
for reducing agency problems; however, these incentives may also
be the source of such problems. We discuss the in?uences that the
board-related characteristics of internal mechanisms and the
product market competition of external mechanisms have on
managerial incentives. Economic theory stipulates that product
market competition alleviates ‘quiet life’ of management. Specif-
ically, in a competitive market environment, managers typically
devote their efforts to ensure corporate survival, preventing severe
agency problems from occurring even without the presence of
appropriate monitoring mechanisms.
The yardstick competition hypothesis indicates that product
market competition can reduce information asymmetry between
inside managers and outside shareholders because the outside
shareholders can easily benchmark a ?rm's performance to the
performance of competitors (Hart, 1983; Shleifer, 1985). Schmidt
(1997) shows that intensive competition increases the default risk
and liquidation risk of a ?rm and thereby reduces the agency
con?icts between managers and shareholders. Shleifer and Vishny
* Corresponding author. Tel.: þ886 7 5919502.
E-mail address: [email protected] (L. Kao).
Peer review under responsibility of College of Management, National Cheng
Kung University.
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Asia Paci?c Management Review xxx (2015) 1e8
Please cite this article in press as: Chen, A., & Kao, L., External competition and internal governance on stock options plans: Evidence from
Taiwan, Asia Paci?c Management Review (2015),http://dx.doi.org/10.1016/j.apmrv.2015.05.004
(1997) further show that competition reduces the agency costs of
free cash ?ows because competition discourages managers to
invest in negative NPV projects. Allen and Gale (2000) argue that
product market competition can either serve as a monitoring
mechanism or a corporate governance mechanism to reduce
agency con?icts. Bertrand and Mullainathan (2003) show that
competition eliminates the “quiet life” to reduce the input costs,
overheads, and wages.
However, the relationship between product market competition
and managerial incentives remains unclear, and previous studies
have yet to concede as to whether this relationship is positive or
negative. Some have contend that because managers have to devote
their efforts in highly competitive markets, enhancing the attrac-
tiveness of managerial incentives is necessary, which suggests that
competition positively in?uences managerial incentives. Others
argue that because managers must devote their efforts to ensure
corporate and personal survival in highly competitive markets,
attractive managerial incentives are unnecessary, which suggests
that competition negatively in?uences managerial incentive.
Nevertheless, because the empirical results of previous studies
have veri?ed both arguments, the relationship between product
market competition and managerial incentives remain ambiguous.
Schmidt (1997) argues that product market competition reduces
the pro?t margin leading to lower ?rm pro?tability. Therefore,
?rms faced with intense competition are less likely to offer an
attractive compensation scheme to motivate managers. Karuna
(2007) shows that product market competition can either substi-
tute for or complement managerial incentives. Competition can
serve as a disciplinary mechanism to reduce the need for mana-
gerial incentives. Nevertheless, ?rms have to pay greater incentives
to managers to motivate them in a more competitive market.
Consequently, in a more intensely competitive market, ?rms might
need to provide managers with higher allowances. The total effect
of product market competition on managerial incentives is, thus,
ambiguous.
Beiner, Schmid, and Wanzenried (2011) argue that the rela-
tionship between product market competition and managerial in-
centives is nonlinear depending on the absolute level of
competition. Beiner et al. (2011) propose a business stealing effect
and a scale effect to explain the relationship between competition
and managerial incentives. The business stealing effect indicates
that a positive relationship between managerial incentives and
competition. The scale effect indicates that a negative relationship
between managerial incentives and competition instead. During
low competition, the scale effect dominates; whereas during high
competition, the business stealing effect dominates.
Takeover threat is considered as an effective external mecha-
nism. However, in certain markets that provide insuf?cient investor
protection, takeover threat is unpopular or relatively weak. In
addition to external mechanisms, internal boards of directors are
crucial monitoring mechanisms. The function of a board of di-
rectors is to ensure that managers endeavor to maximize bene?ts
for owners or shareholders and reduce agency problems. This study
primarily investigates the in?uences of internal and external
mechanisms on managerial incentives.
The most common types of managerial incentives include salary
increases, bonuses, and employee stock options. Fixed salaries, one
of the sources of agency problems, fail to effectively stimulate
managers in devoting their efforts to enhance ?rm value and
maximize shareholders' wealth. By contrast, stock options effec-
tively link manager remuneration with a company's stock prices;
thus, employee stock options are considered a favorable method for
reducing the agency problems between managers and share-
holders, especially in emerging economies without solid investor
protection. There is little empirical evidence to demonstrate the
effectiveness of employee stock options to motivating managers in
economies with weak investor protection. Therefore, in the context
of managerial incentives, we focus on the stock options value that
managers can obtain to examine the in?uences of product market
competition on equity-based managerial incentives.
This paper focuses on the Taiwan case because Taiwan is an
emerging civil lawcountry where takeover threat is weak. La Porta,
Lopez-de-Silanes, Shleifer, and Vishny (2000) document that civil
law countries do not provide investors with strong enough pro-
tection. Claessens, Djankov, and Lang (2000) show Taiwanese ?rms
are also likely af?liated with pyramidal or cross-holding structures
with the existence of controlling families or groups. Choy, Gul, and
Yao (2011) characterize Taiwan as a country with high investor
expropriation risk. Moreover, market competition is generally
intensive in the emerging markets such as Taiwan. Faced with
intensively competitive markets, managers have to devote more
efforts and need motivations linked with performance.
This paper is other than Schmidt (1997), Karuna (2007), or
Beiner et al. (2011). Schmidt (1997) is a theoretical paper and does
not provide empirical evidence about the relationship between
managerial incentive and product market competition. Karuna
(2007) examines the relationship between managerial incentive
and product market competition but does not document a non-
linear association between managerial incentive and product
market competition. Beiner et al. (2011) indicate that there is still
little empirical evidence on the relationship between managerial
incentive and product market competition and investigate the non-
linear relationship between managerial compensation and product
market competition based on a unique Swiss data set, a signi?-
cantly more well-diversi?ed equity structure than Taiwan.
Previous research focuses on Western economies, no empirical
evidence ever examines the relationship between managerial
incentive and product market competition in East Asian countries,
economies with weak investor protection due to family control or
group control through pyramidal or cross-holding structure. This
paper contributes to the literature by ?lling this gap.
We ?nd that a non-linear relationship between product market
competition and managerial incentives, indicating that ?rms must
use attractive incentives to stimulate managers in confronting
external competitive environments at low competition level and
that managerial incentives decrease with competition at high
competition level. The managerial incentives in ?rms where the
internal boards of directors demonstrate weak monitoring capacity
(i.e., excessively large boards or CEO duality) are typically highly
attractive, suggesting that managers are extremely likely to seek
private bene?ts during the absence of supervision. The presence of
independent directors positively in?uences managerial incentives,
suggesting that independent directors favor stock options with
bene?ts that are directly proportional to stock performance rather
than salaries.
The remaining of this paper is organized as follows. Section 2
presents the data source and variable de?nitions. Section 3 dis-
cusses the descriptive statistics of our variables. Section 4 examines
the industry characteristics related to competition. Section 5 pre-
sents examinations of the relation between managerial incentives
and internal governance and the relation between managerial
incentive and product market competition. Robustness checks are
provided in Section 6. Finally, Section 7 concludes the paper.
2. Data source and variable de?nition
2.1. Data source
Our data cover all the listed ?rms in Taiwan over the period
1996.03 to 2012.12. Our sample period begins in 1996 because the
A. Chen, L. Kao / Asia Paci?c Management Review xxx (2015) 1e8 2
Please cite this article in press as: Chen, A., & Kao, L., External competition and internal governance on stock options plans: Evidence from
Taiwan, Asia Paci?c Management Review (2015),http://dx.doi.org/10.1016/j.apmrv.2015.05.004
Taiwan Economic Journal (TEJ) established its corporate gover-
nance dataset for listed ?rms in Taiwan in 1996. All the variables,
including sales, total assets, market equity, operating income,
operating expenses, R&D expenditure, stock returns, market index
returns, board structure variables, and equity structure variables
are obtained from the TEJ database. Managerial stock options are
collected from the website of market observation post system of
Taiwan stock exchange. Observations with missing values on
required variables are discarded from the sample. This leaves
41,256 ?rm-quarter observations in our sample.
2.2. Variable measurement
The measures of our variables are detailed below.
Managerial incentive variables (PPS and SOMV)
This study uses two variables to measure managerial incentives.
We follow Karuna (2007) and Riyanto and Wang (2012) to use pay-
to-performance sensitivity to measure managerial incentive. PPS
it
is
the pay-to-performance sensitivity of ?rm i in quarter t. We also
use the ratio of managerial stock option value to market capitali-
zation as another managerial incentive measure. Stock options
value is measured by the Black-Scholes model.
lnðStock options valueÞ ¼ a þb*ðstock returnÞ þ?: (1)
PPS
it
¼
b
b of (1) using data of ?rm i in quarter t.
SOMV
it
¼
Dollar amount of managerial stock options
Market value of equity at t
: (2)
Competition measure (HHI)
Previous studies generally employ the Her?ndahleHirschman
index (HHI) to measure industry intensity (Kao and Chen (2013);
Chen, Kao, and Lu (2014)). High HHI implies high concentration
and low product market competition. HHI is basically the sum of
the squares of individual ?rm market shares in a certain industry.
We follow the de?nition of the Taiwan Stock Exchange to de?ne
industry in this study.
HHI
jt
¼
X
n
j
i¼1
sales
ijt
P
n
j
i¼1
sales
ijt
!
2
: (3)
Here, sales
ijt
is total sales of ?rm i in industry j in quarter t, and n
j
is
the number of ?rms in industry j. Our results are robust to speci-
?cation of assets, market value of equity, or sales as calculations of
market share.
Other competition variables (lnSUB, lnENTRY)
Besides HHI, we also follow Raith (2003) and Karuna (2007) to
use product substitutability and industry protection to characterize
competition dimensions. Product substitutability (lnSUB) is calcu-
lated as the logarithm of the ratio of industry sales to industry
operating costs. Industry protection (lnENTRY) is measured by entry
costs calculated as logarithm of plant, property, and equipment.
ln SUB
jt
¼ ln
P
n
j
i¼1
sales
ijt
P
n
j
i¼1
operting costs
ijt
!
: (4)
ln ENTRY
jt
¼ ln
X
n
j
i¼1
PPE*
sales
ijt
P
n
j
i¼1
sales
ijt
!
: (5)
Internal governance variables (INDEPENDENT, BOARD, DUALITY,
OWN)
The percentage of independent directors on board (INDEPEN-
DENT) is the measure of board independence. BOARD
it
represents
the number of directors on the board of ?rmi at the end of quarter t.
Large boards prevent ef?cient communication, raise dif?culties in
decision-making and reduce the effectiveness of monitoring
(Jensen, 1993; Yermack, 1996). CEO duality means the CEO of a ?rm
also serves as the chair of the board (COB). Brickley, Coles, and
Jarrell (1997) argue that CEO duality implies a weak governance
structure since management is not under proper monitoring of the
board. DUALITY
it
¼ 1 if the CEO is also the COB of ?rm i during
quarter t; otherwise, DUALITY
it
¼ 0. OWN
it
is the ownership of
controlling shareholders of ?rm i at the end of quarter t. The higher
the controlling ownership, the more convergence of the interests
between controlling shareholders and minority shareholders. The
convergence of interests hypothesis implies that as controlling
ownership increases, the controlling shareholders are more likely
to take value-maximization projects.
Agency problem variables (CROSS, PYRAMIDAL)
Fan and Wong (2002) demonstrate that a higher ownership
concentration through cross-holding and/or pyramidal structures
raises agency con?icts between controlling shareholders and mi-
nority shareholders. A dummy variable (PYRAMIDAL) is used to
capture the pyramidal structure of ownership. PYRAMIDAL
it
¼ 1 if
?rm i is part of a pyramid in quarter t; otherwise, PYRAMIDAL
it
¼ 0.
CROSS is a dummy variable for cross-ownership. CROSS
it
¼1 if ?rmi
is subject to cross-holding in quarter t; otherwise, CROSS
it
¼ 0.
Control variables (ROA, SALESGROWTH, lnASSET, RandD, BETA)
We also use several control variables related to managerial
compensation and market competition to avoid possible spurious
effects. Our control variables are operating performance measured
by return on assets (ROA); growth potential measured by logarithm
of gross sales growth (SALESCGROWTH); ?rm size measured by
logarithm of total assets (lnASSET); R&D expenditure measured by
the ratio of R&D expenses to lagged total assets (RandD); ?rm
systematic risk measured by the beta risk from the market model
using daily returns during the quarter (BETA).
Variable de?nition is summarized in Table 1.
3. Descriptive statistics
The descriptive statistics of the sample data are presented in
Table 2, which shows that the average HHI is 0.136, with a median
of 0.095 and a maximumvalue of 1. The lowHHI suggests that ?rms
in Taiwan typically experience a high degree of competition. Sub-
sequently, the average product substitutability (lnSUB) is 0.073,
with a standard deviation of 0.091 and a median of 0.063. The
average value for entry cost (lnENTRY) is 16.312, with a standard
deviation of 1.853 and a median of 15.713. These results indicate
that neither product substitutability nor the entry cost presents
severe skewness. Regarding corporate governance variables, the
average percentage for an independent director on board (INDE-
PENDENT) is 12.1%; however, 50% of the samples do not include
independent directors. The average size of the boards included in
this study is 6.911 members, with a minimum of 1 member and a
maximum of 32. Of the samples, 30.2% present CEO duality. The
controlling shareholders hold 30.4% of the ownership on average.
Regarding other control variables, the average return on assets
(ROA) is 1.8%, SALESGROWTH is 1%, and lnASSET is 15.27, indicating
an average asset value of NT$3358 billion. In addition, the average
percentage for research and development (R&D) to assets is 0.8%.
The average beta is 0.913.
A. Chen, L. Kao / Asia Paci?c Management Review xxx (2015) 1e8 3
Please cite this article in press as: Chen, A., & Kao, L., External competition and internal governance on stock options plans: Evidence from
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4. Industry characteristics related to competition
Certain industry characteristics may drive both the industry
competition intensity and managerial compensation scheme,
creating a correlation between product market competition and
managerial incentive, even without the causal link from competi-
tion to managerial compensation. To eliminate this possibility, our
analyses control for several industry characteristics related to
competition.
Hou and Robinson (2006) and Kao and Chen (2013) show that a
signi?cant asset requirement deters the entry of competitors and
thus reduces competition; R&D expenditure decreases substan-
tially with increasing concentration, as does the ratio of R&D ex-
penses to assets; pro?tability increases with industry concentration
and is negatively related to market competition. Hou and Robinson
(2006) and Kao and Chen (2013) argue that concentrated industries
are more likely to experience large assets, high unit pro?tability,
and lowlevel of R&D expenditure. We, therefore, use the logarithm
of assets (lnASSET) as a proxy for the barrier to entry, ROA as a proxy
for unit pro?tability, and the ratio of R&D expenses to assets
(RandD) as a proxy for risk-innovation investment to control for
industry effects related to competition.
Table 3 shows that lnASSET and ROA are positively related to
competition intensity, and that RandD is negatively related to
competition intensity. These ?ndings are consistent with Hou and
Robinson (2006) and Kao and Chen (2013), who indicate that
concentrated industries have poor innovation but have high pro?t
and high barriers to entry. We thus control for lnASSET, ROA, and
RandD when examining the relationship between managerial
compensation and competition to avoid the possibility that in-
dustry characteristics drive both the managerial compensation
scheme and market competition.
5. Internal governance mechanisms and external
competition
5.1. Managerial incentives and internal governance mechanisms
In this study, the relationship between managerial incentives
and governance mechanisms is examined. According to Tables 4
and 5, the relationship between managerial incentives and inter-
nal mechanisms is consistent regardless of the methods used to
measure managerial incentives, which included methods such as
PPS or SOMV. In columns 1 of Tables 4 and 5, the correlation co-
ef?cients between INDEPENDENT and PPS and SOMV are 0.000 and
0.000, respectively (t values ¼ 6.10 and 4.85, respectively), sug-
gesting that managerial incentives increase as the percentage of
independent directors on a board increases.
The possible explanations for this result are as follows: InTaiwan,
managers and controlling shareholders possess the right to appoint
independent directors. The independent directors appointed by
such controlling parties may not value the bene?ts of minority
shareholders, and may thus place considerably reduced supervisory
attention on or even collaborate with controlling shareholders and
managers, thereby resulting in a positive relationship between
managerial incentives and the percentile for independent directors
on board. Moreover, independent directors may deem equity
incentive as a greater stimulating incentive than salary is, conse-
quently offering increased stock options to managers.
The size of the board achieves signi?cant and positive correla-
tions with PPS and SOMV (coef?cient ¼ 0.001 and t value ¼ 3.80 for
PPS; coef?cient ¼ 0.002 and t value ¼ 6.24 for SOMV). The corre-
lation coef?cients between DUALITY and PPS and SOMV are 0.001
and 0.000, respectively (t value ¼ 9.30 and 2.64, respectively),
suggesting that managerial incentives increase as internal gover-
nance conditions weaken.
Table 1
Variable de?nition.
Variable De?nition
PPS Logarithm of pay-to-performance sensitivity measured by the change of stock option value to change of stock price.
SOMV (Stock option value) divided by market capitalization
HHI Her?ndahleHirschman Index de?ned as the sum of the squared market shares for a certain industry.
LOWHHI LOWHHI ¼ HHI if HHI medium of HHI; otherwise LOWHHI ¼ 0.
HIGHHHI HIGHHHI ¼ HHI if HHI > medium of HHI; otherwise HIGHHHI ¼ 0.
lnSUB Logarithm of (industry sales/industry operating costs).
lnENTRY Logarithm of industry property, plant and equipment.
INDEPENDENT Percentage of independent directors on board.
BOARD Number of directors on board.
DUALITY DUALITY ¼ 1 if CEO duality; DUALITY ¼ 0 otherwise.
OWN Ownership of controlling shareholders.
CROSS CROSS ¼ 1 if cross-holding structure; CROSS ¼ 0 otherwise.
PYRAMIDAL PYRAMIDAL ¼ 1 if pyramidal structure; PYRAMIDAL ¼ 0 otherwise.
ROA Return on assets.
SALESGROWTH Logarithm of sales to lagged sales.
lnASSET Logarithm of total assets.
RandD R&D expenditure to total assets.
BETA Beta risk measured by the market model with daily returns during the year.
Table 2
Descriptive statistics, Descriptive statistics for a sample of 41256 ?rm-quarter ob-
servations in Taiwan from 1996 to 2012. All observations with missing variable
values are excluded.
Mean Std Minimum Median Maximum
PPS 0.006 0.010 À0.040 0.005 0.237
SOMV 0.005 0.007 0 0.003 0.177
HHI 0.136 0.151 0.020 0.095 1.000
LOWHHI 0.028 0.031 0.000 0.022 0.097
HIGHHHI 0.110 0.167 0.000 0.000 1.000
lnSUB 0.073 0.091 À0.331 0.063 1.370
lnENTRY 16.312 1.853 11.221 15.715 20.123
INDEPENDENT 0.121 0.160 0.000 0.000 0.750
BOARD 6.911 2.611 1.000 7.000 32.000
DUALITY 0.302 0.459 0.000 0.000 1.000
OWN 0.304 0.176 0 0.278 1.000
CROSS 0.241 0.419 0.000 0.000 1.000
PYRAMIDAL 0.224 0.411 0.000 0.000 1.000
ROA 0.018 0.028 À0.810 0.015 0.513
SALESGROWTH 0.010 0.424 À9.720 0.016 9.520
lnASSET 15.027 1.307 9.190 14.885 21.541
RandD 0.008 0.014 À0.096 0.003 0.547
BETA 0.913 0.347 À5.821 0.922 14.285
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Table 3
Relationship between industry characteristics and competition, Tobit regression analyses of industry characteristics on product market competition with a sample of 41256
?rm-quarter observations in Taiwan from 1996 to 2012. All observations with missing variable values are excluded. The t-values in parentheses are adjusted by clustered
standard errors (Petersen, 2009).
HHI
Intercept 0.051*** (6.50) 0.135*** (166.76) 0.137*** (179.50) 0.054*** (94.33)
lnASSET 0.006*** (10.92) 0.050*** (6.23)
ROA 0.024*** (3.10) 0.005** (2.44)
RandD À0.051*** (À2.81) À0.156** (À1.96)
Industry dummies yes yes yes yes
Year dummies yes yes yes yes
Pseudo R
2
0.2027 0.2033 0.2026 0.2046
***,**, and* represent the signi?cance levels at 1%, 5%, and 10%, respectively. Pseudo R
2
¼ 1 À (log L
U
)/(log L
u
), where L
U
¼ the likelihood value of estimation with all the
exogenous variables, and L
u
¼ the likelihood value of estimation with the intercept only.
Table 4
Internal governance and external competition on managerial incentives (PPS), Regression analyses of internal governance and external competition mechanisms on managerial
incentives with a sample of 41256 ?rm-quarter observations in Taiwan from 1996 to 2012. All observations with missing variable values are excluded. The t-values in pa-
rentheses are adjusted by clustered standard deviations (Petersen, 2009).
Dependent variable: PPS
#1 #2 #3 #4 #5 #6 #7
Intercept 0.006*** (7.26) 0.006*** (6.86) 0.005*** (4.91) 0.005*** (4.9) 0.005*** (4.96) 0.002** (2.41) 0.001 (1.13)
HHI À0.003*** (À7.13) À0.002*** (À5.35) 0.002*** (5.56) À0.002*** (À5.54)
LOWHHI 0.003***(7.25) 0.002*** (5.96)
HIGHHHI À0.003*** (À6.26) À0.003*** (À5.91)
lnSUB À0.001 (À1.33) À0.001 (À1.24) À0.001 (À1.29) À0.001 (À1.26)
lnENTRY 0.000** (2.06) 0.000** (2.02) 0.000** (2.13) 0.000*** (2.67)
INDEPENDENT 0.000*** (6.10) 0.000*** (5.98)
BOARD 0.001*** (3.80) 0.002***(4.22) 0.002*** (4.21) 0.002*** (4.01) 0.002*** (4.81) 0.002*** (4.14) 0.002*** (3.83)
DUALITY 0.001*** (9.30) 0.001*** (8.62) 0.001***(9.27) 0.001*** (8.73) 0.001*** (8.51) 0.001*** (8.57) 0.001*** (8.69)
OWN 0.000 (0.99) 0.000 (0.32) 0.000 (1.14) 0.000 (0.61) 0.000 (0.97) 0.000 (0.36) 0.000 (0.75)
CROSS 0.001*** (5.27)
PYRAMIDAL 0.000*** (2.76)
ROA 0.010*** (3.97) 0.009*** (3.81) À0.009*** (À3.77) 0.009*** (3.52) 0.010*** (4.06) 0.010*** (3.93)
SALESGROWTH 0.000 (0.66) 0.000 (0.76) 0.000 (0.76) 0.000 (0.68) 0.000 (0.81)
lnASSET À0.000* (À1.81) À0.000 (À0.11) À0.000** (À2.14) 0.000 (À0.48) À0.000 (À1.08) 0.000 (0.09) À0.000 (À0.25)
RandD À0.013*** (À5.55) À0.014*** (À5.71) À0.014*** (À5.8) À0.014***(À5.79) À0.013*** (À5.43) À0.014*** (À5.82) À0.015*** (À6.06)
BETA 0.000** (2.23) 0.000 (2.33) 0.000** (1.99) À0.001*** (À2.64) 0.000** (2.43) 0.000** (2.36) 0.001*** (2.79)
Industry dummies yes yes yes yes yes yes yes
Year dummies yes yes yes yes yes yes yes
R
2
0.0057 0.0067 0.0082 0.007 0.008 0.0068 0.0072
***,**, and* represent the signi?cance levels at 1%, 5%, and 10%, respectively.
Table 5
Internal governance and external competition on managerial incentives (SOMV), Regression analyses of internal governance and external competition mechanisms on
managerial incentives with a sample of 41256 ?rm-quarter observations in Taiwan from1996 to 2012. All observations with missing variable values are excluded. The t-values
in parentheses are adjusted by clustered standard deviations (Petersen, 2009).
Dependent variable: SOMV
#1 #2 #3 #4 #5 #6 #7
Intercept 0.032*** (61.12) 0.031*** (59.28) 0.033*** (53.10) 0.033*** (53.09) 0.034*** (52.43) 0.032*** (50.71) 0.034*** (47.44)
HHI À0.002*** (À7.30) À0.001*** (À3.19) À0.001*** (À3.34) À0.001*** (À3.28)
LOWHHI 0.001*** (6.04) 0.001*** (3.32)
HIGHHHI À0.001*** (À3.60) À0.001*** (À2.77)
lnSUB 0.001* (1.77) 0.001* (1.7) 0.001 (1.53) 0.001* (1.70)
lnENTRY 0.000*** (7.68) 0.000*** (À7.64) 0.000*** (7.79) 0.000*** (7.37)
INDEPENDENT 0.000*** (4.85) 0.000*** (4.51)
BOARD 0.002*** (6.24) 0.000 (1.28) 0.000 (À0.93) À0.000 (À0.78) À0.000 (À0.14) À0.000 (À1.40) À0.000 (À0.76)
DUALITY 0.000*** (2.64) 0.000** (2.00 0.000 (1.18) 0.000 (1.62) 0.000** (2.05) 0.000* (1.93) 0.000 (1.63)
OWN À0.003*** (À10.43) À0.002*** (À8.39) À0.002*** (À9.67) À0.002*** (À9.29) À0.002*** (À9.72) À0.002*** (À8.33) À0.002*** (À9.29)
CROSS 0.000** (1.96)
PYRAMIDAL 0.000*** (2.70)
ROA 0.050*** (33.06) 0.051*** (32.72) À0.051*** (À32.74) 0.050*** (32.47) 0.051*** (33.15) 0.051*** (32.64)
SALESGROWTH 0.000 (0.77) 0.000 (0.54) 0.000 (0.54) 0.000 (0.8) 0.000 (0.53)
lnASSET À0.002*** (À45.15) À0.002*** (À45.07) À0.001*** (À40.59) À0.002*** (À43.59) À0.002*** (À42.79) À0.002*** (À44.42) À0.002*** (À43.44)
RandD À0.023*** (À14.83) À0.022*** (À14.43) 0.023*** (15.16) 0.023*** (15.15) À0.023*** (À14.79) À0.021*** (À14.19) À0.023*** (À15.06)
BETA 0.001*** (10.41) 0.001*** (9.03) 0.001*** (8.3) À0.001*** (À7.86) 0.001*** (7.9) 0.001*** (9.07) 0.001*** (7.83)
Industry dummies yes yes yes yes yes yes yes
Year dummies yes yes yes yes yes yes yes
R
2
0.1324 0.1662 0.169 0.1684 0.1689 0.1664 0.1684
***,**, and* represent the signi?cance levels at 1%, 5%, and 10%, respectively.
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Please cite this article in press as: Chen, A., & Kao, L., External competition and internal governance on stock options plans: Evidence from
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Regarding the control variables, R&D expenditure shows a
negative correlation with managerial incentives, and beta achieves
a positive correlation with managerial incentives.
5.2. Product market competition and managerial incentive
In addition to internal mechanisms, external mechanisms such
as product market competition are also key factors that in?uence
managerial incentives. Previous studies have failed to produce
conclusive results pertaining to market competition and manage-
rial incentives. In this study, the HHI is adopted as the measure for
degree of competition. According to columns 2 of Tables 4 and 5,
the correlation coef?cients between HHI and PPS and SOMV
are À0.003 and À0.002, respectively, and the corresponding t
values are À7.13 and À7.30. HHI shows a negative correlation with
managerial incentives, suggesting that managerial incentives
decrease when HHI is highly concentrated and degree of competi-
tion is low. Firms typically do not abstain from providing managers
with incentives because of high market competition. By contrast,
?rms increase incentives when markets are highly competitive to
attract managers.
Karuna (2007) argues that product substitutability and the entry
cost can also characterize the dimensions of product market
competition. lnSUB and lnENTRY are included as another di-
mensions of competition. Columns 3, 4, and 5 of Tables 4 and 5
indicate that HHI is negatively correlated with managerial in-
centives. According to columns 3 of Tables 4 and 5, the correlation
coef?cients between HHI and the dependent variables of PPS and
SOMV are À0.002 and À0.001, respectively, and the corresponding t
values are À5.35 and À3.19. Tables 4 and 5 show that lnSUB and
lnENTRY achieve a positive correlation with managerial incentives,
suggesting that managers require increased managerial incentives
during high product substitutability conditions. The ?ndings also
show that equity-based incentives increase with increased entry
barriers, possibly because entry barriers elevate stock prices,
thereby increasing the value of stock options.
In columns 4 of Tables 4 and 5, sales growth is included as a
control variable and independent director is excluded. The results
presented in columns 4 are similar to those in columns 3, but the
R-square values are relatively lower in columns 4 than in columns
3. Comparing columns 3 and 4 of Tables 4 and 5 indicates that the
presence of independent directors imposes a greater in?uence on
managerial incentives than sales growth does. Nevertheless, sales
growth increases managerial incentives as a form of encourage-
ment to managers although the degree of in?uence is substandard
to that of the presence of independent directors. Thus, the pres-
ence of independent directors effectively elevates managerial
incentives.
5.3. Cross-holding and pyramidal structure
Cross-holding and a pyramidal structure increase the
complexity of the ?rm's ownership structure and increase the
possibility of expropriation of minority shareholders from con-
trolling shareholders. In addition to the original corporate gover-
nance control variables, we further include cross-holding and
pyramidal structure as control variables. Columns 5 of Tables 4 and
5 show that CROSS achieves positive correlations with PPS and
SOMV (coef?cient ¼ 0.001 and 0.000, respectively; t values ¼ 5.27
and 1.96), and that PYRAMIDAL achieves positive correlations with
PPS and SOMV (coef?cient ¼ 0.000 and 0.000; and t values ¼ 2.76
and 2.70). These results suggest that managerial incentives increase
with agency costs, which is evidence that controlling shareholders
expropriate minority shareholders.
5.4. Piecewise effect of product market competition
Columns 1 to 5 of Tables 4 and 5 show that the HHI shows a
negative correlationwith managerial incentives; that is, managerial
incentives increase with competition. Moreover, competition is also
a factor that in?uences managerial incentives. Beiner et al. (2011)
argue that competition presents a nonlinear relationship with
managerial incentives, explaining that when competition elevates
to a high level, ?erce competition reduces managerial incentives.
However, when competition is reduced to a low level, the lack of
competition consequently elevates managerial incentives. There-
fore, a piecewise regression method is employed in this study to
examine the nonlinear relationship between competition and
managerial incentives.
Columns 6 and 7 of Tables 4 and 5 showthat LOWHHI achieves a
signi?cant and positive correlation with PPS and SOMV, whereas
HIGHHHI presents a signi?cant and negative correlation with PPS
and SOMV. These results verify that a nonlinear relationship exists
between competition and managerial incentives, where competi-
tion below the median (HIGHHHI) implies weak competition. A
negative HIGHHHI coef?cient represents that an elevated compe-
tition increases managerial incentives whereas a positive LOWHHI
coef?cient represents that an elevated competition decreases
managerial incentives when the degree of competition is above the
median.
6. Robustness tests
It is reasonable to argue that the internal governance mecha-
nisms can be in?uential to one another. Moreover, the managerial
compensation scheme also affects the internal governance mech-
anisms. For example, the high managerial compensation incentives
might raise the possibility of CEOduality. Board chairs would like to
also serve as CEOs to bene?t more from the managerial compen-
sation scheme. In this section, we adopt 2SLS regression analyses to
examine the relationship between managerial compensation and
product market competition with managerial compensation and
internal governance mechanisms as endogenous variables.
Tables 6 and 7 report the 2SLS analyses of internal governance
and market competition on PPS and SOMV, respectively. Basically,
the 2SLS results are similar to the results reported in Section 5.
Table 6 shows that LOWHHI is positively related to PPS with t
value ¼ 8.08 and HIGHHHI is negatively related to PPS with t
value ¼ À5.96. Table 7 further shows that LOWHHI is positively
related to SOMV with t value ¼ 5.78 and HIGHHHI is negatively
related to SOMV with t value ¼ À3.42. Tables 6 and 7 also indicate
that DUALITY is negatively related to INDEPENDENT with t
values ¼ À6.16 and À10.17, respectively implying that board chairs
are less likely to serve as CEOs when more independent directors
are on board.
7. Conclusion
This study is to investigate the effects of external product mar-
ket competition and internal corporate governance mechanisms on
managerial incentives in an economy with weak investor protec-
tion (Taiwan). In U.S. markets, takeover threat is considered as an
effective external governance mechanism. Apart fromconventional
studies conducted in the United States, we consider product market
competition as the primary external governance mechanism
because merger and acquisition activities inTaiwan are uncommon.
Thus, takeover threat cannot be considered as an effective external
governance mechanism in Taiwan.
Regarding managerial incentives, we focus on the value of
employee stock options rather than the salary and remuneration of
A. Chen, L. Kao / Asia Paci?c Management Review xxx (2015) 1e8 6
Please cite this article in press as: Chen, A., & Kao, L., External competition and internal governance on stock options plans: Evidence from
Taiwan, Asia Paci?c Management Review (2015),http://dx.doi.org/10.1016/j.apmrv.2015.05.004
managers and controlling shareholders primarily because stock
options values are closely linked to stock prices; thus, stock options
effectively reduce agency problems.
We show that lenient internal mechanisms (e.g., excessively
large boards or CEO duality) and severe agency problems (e.g.,
cross-holding and pyramidal structure) positively correlate to
managerial incentives, suggesting that managers or controlling
shareholders obtain great managerial incentives when monitoring
conditions are weak. In addition, the presence of independent
directors also increases the stock options values of managers. Two
possible explanations contribute to this phenomenon. Indepen-
dent directors overlook governance functions, and they focus on
equity incentive rather than salary. In the context of product
market competition, elevated competition increases managerial
incentives because ?rms anticipate attracting quali?ed managers
by increasing managerial incentives rather than considering
product market competition as a type of monitoring mechanism.
Furthermore, the relationship between product market competi-
tion and managerial incentives is nonlinear, which implies that in
comparatively less competitive markets, an increase in degree of
competition stimulates ?rms to increase their managerial
incentives. By contrast, in highly competitive markets, an increase
in competition stimulates ?rms to decrease their managerial
incentives.
We verify that in Taiwanese markets where takeover threat is
lacking, ?rms fail to consider product market competition as a
supervision to decrease managerial incentives; rather, they in-
crease managerial incentives to encourage managers and control-
ling shareholders. Firms should take market competition into
account when formulating employee contracts to effectively
encourage managers, enhance ?rm value, and protect minority
shareholders' bene?ts.
Acknowledgments
We appreciate the helpful comments from an anonymous
referee and the participants at the 2015 International Symposium
on Social Sciences and Management, Tokyo, Japan, National Sun
Yat-Sen University and National University of Kaohsiung. We also
thank the National Science Council of the Republic of China, Taiwan
for ?nancially supporting this research under Contract No. NSC100-
2410-H-110-020-MY2. All the remaining errors are ours.
Table 6
2SLS analyses of internal governance and external competition on managerial incentives (PPS), 2SLS regression analyses of internal governance and external competition
mechanisms on PPS with a sample of 41256 ?rm-quarter observations in Taiwan from1996 to 2012. All observations with missing variable values are excluded. The t-values in
parentheses are adjusted by clustered standard deviations (Petersen, 2009).
PPS BOARD DUALITY OWN
Intercept 0.009*** (5.91) 0.539 (0.22) À0.936 (À0.13) À2.779 (À0.08)
PPS 104.377** (2.62) 172.753* (1.65) 531.289 (0.14)
LOWHHI 0.003*** (8.08)
HIGHHHI À0.002*** (À5.96)
INDEPENDENT À0.002 (À1.11) À0.021*** (À6.16) À0.008 (À0.75)
BOARD 0.008** (2.48) 1.632 (0.30) 5.072 (0.13)
DUALITY 0.604 (0.3) À3.073 (À0.23)
OWN 0.191 (0.13) À0.350 (À0.25)
ROA À0.003 (À0.89)
SALESGROWTH 0.000 (0.5)
lnASSET À0.000*** (À4.23) 0.000 (0) 0.017 (0.09) 0.015 (0.02)
RandD 0.000 (À0.08)
BETA À0.030 (À0.95) 0.022 (0.16) 0.131 (0.13)
Industry dummies yes yes yes yes
Year dummies yes yes yes yes
R2 0.00307 0.00181 0.00198 0.00007
***,**, and* represent the signi?cance levels at 1%, 5%, and 10%, respectively.
Table 7
2SLS analyses of internal governance and external competition on managerial incentives (SOMV), 2SLS regression analyses of internal governance and external competition
mechanisms on SOMV with a sample of 41256 ?rm-quarter observations in Taiwan from1996 to 2012. All observations with missing variable values are excluded. The t-values
in parentheses are adjusted by clustered standard deviations (Petersen, 2009).
SOMV BOARD DUALITY OWN
Intercept 0.041*** (27.68) 2.558*** (7.04) 3.836 (1.10) 1.352*** (7.84)
SOMV 19.542** (1.98) 30.091* (1.68) 10.574** (2.03)
LOWHHI 0.002*** (5.78)
HIGHHHI À0.001*** (À3.42)
INDEPENDENT À0.003** (À2.10) À0.020*** (À10.17) À0.006*** (À9.24)
BOARD 0.019*** (7.07) À1.509 (À0.97) À0.532*** (À12.28)
DUALITY À0.683 (À0.95) À0.353 (À0.95)
OWN À1.875*** (À12.14) À2.841 (À0.99)
ROA 0.034*** (11.34)
SALESGROWTH À0.000 (À1.23)
lnASSET À0.002*** (À28.85) À0.095*** (À6.75) À0.134 (À1.03) À0.048*** (À6.69)
RandD À0.041*** (À12.74)
BETA À0.124** (À2.56) À0.201 (À0.79) À0.070*** (À2.85)
Industry dummies yes yes yes yes
Year dummies yes yes yes yes
R2 0.1415 0.01362 0.00977 0.03754
***,**, and* represent the signi?cance levels at 1%, 5%, and 10%, respectively.
A. Chen, L. Kao / Asia Paci?c Management Review xxx (2015) 1e8 7
Please cite this article in press as: Chen, A., & Kao, L., External competition and internal governance on stock options plans: Evidence from
Taiwan, Asia Paci?c Management Review (2015),http://dx.doi.org/10.1016/j.apmrv.2015.05.004
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